There are those who think that Warren Buffett's days of being an awesome value investor are behind him. Those people are crowing a little today after his recent darling Bank of America crossed $5 in the wrong direction, which I guess is a big deal. Here, however, is probably a thing not to think about that:
Yes, Bank of America’s stock swoon is dragging down America’s wisest investor, Warren Buffett, who now is about $1.5 billion underwater on his BofA common-stock warrants.
Disagree! I happen to have a model for that right here (earlier/caveats), and I have him very roughly breaking even (you'll care about H24, which shows him up $52mm on his $5bn investment). This uses a 45% vol (vs. 62% mid on Jan-14 $7 calls, 77%ish for their A warrants struck north of $13, 58% 1-year realized) and 8.75% discount rate on the pref (around where I eyeball the Is and Js); you can dispute those assumptions and get a different smallish positive or negative number* but the important point is: Warren Buffett didn't lose $1.5bn on his $5bn investment. If you'd invested $5bn in BAC common stock at around $7, when Buffett did, you'd have lost $1.5bn in round numbers. But you're not Warren Buffett. (He is!)
Some people think that this is pretty crap - along the lines of "I'd be a great investor too if I could just get every financial firm to give me a sweetheart deal for lending them my Cherry Coke-encrusted halo" - but, of course, you can. A share of BRK/B is, like, 74 bucks. All that warranty goodness accrues to Berkshire Hathaway, not (just) Buffett.
Now, if there's one investing strategy that I understand even less than "give my money to Bank of America to do what they will with it, what could possibly go wrong," it's "momentum investing," where you buy stocks that have been going up because past results are a guarantee of future performance.** So I found this Fortune article about Cliff Asness's new momentum-based retail mutual funds utterly baffling, and not only because a close reading suggests that these new funds were launched in 2009.
I gather that a whole bevy of people who are both smarter and richer than me, including Eugene Fama and Cliff Asness himself, are pretty pretty convinced that this momentum strategy works and I guess they're right but holy heck is it puzzling. As background, the article follows Asness in recommending allocating your equities 50% to momentum and 50% to value. (As further background, this.) Here are some things that Fortune says:
The pairing of value and momentum has trailed the benchmark Russell 1000 through November by three points, losing 2.3% vs. the Russell's gain of less than 1%. Over the long haul, the odds are that markets will normalize and the momentum approach will return to beating the averages. But even assuming that's true, holding down fees and trading costs is crucial to making it viable for regular investors, as Asness knows well. ...
Trading costs are potentially a major problem for momentum funds. Because of the quarterly rebalancing, AQR's portfolios turn over 1.5 times a year. All that trading could get expensive. But AQR holds down costs by running its own trading desk and using proprietary algorithmic models that allow it to avoid trading through Wall Street firms. Asness estimates that trading costs run about 0.7% a year. So total expenses for an AQR momentum fund -- fees plus trading -- are around 1.2%.
But remember: That's just half of the portfolio. Asness recommends that investors combine his momentum fund with a low-cost value index fund. A favorite of his is the DFA U.S. Large Cap Value from Dimensional Fund Advisors (DFLVX), another shop with lots of academic weight. It has a fee of just 0.28%. After expenses, a portfolio that blends AQR Momentum and the DFA value fund should give investors a net extra return of around one percentage point a year, according to AQR's projections. Stick with that strategy, and your nest egg will be 35% higher in 30 years than if you buy the market as a whole.
This. Just. Makes. My. Head. Explode, though I guess some people are into this sort of thing. (But, really. If you're so into momentum, why aren't you selling the shit out of strategies that have underperformed this year - like, say, momentum? Oh, wait. You are. That's why there's a puff article in December 2011 about some funds launched in 2009.)
The advertising for the fund contains a don't-try-this-at-home disclaimer similar to the one in the article: if you just try to follow the fund's stated strategy on your own, you'll get shellacked because you'll be trading like 333 stocks in tiny increments for like $7.95 per stock in comms and you'll probably be doing so behind big momentum investors like, y'know, AQR and, yeah, all of your alleged outsized returns are gonna get eated. Thus Gene Fama's (!) caveat: "The evidence that it produces superior returns over long periods, if you can do it cheaply enough, is robust."
I mention these two stories together because what Buffett and Asness are selling to retail investors is not really a strategy: Buffett has been pretty hit-or-miss about sticking to his "margin of safety in businesses I can understand" mantra (do you understand BAC? does it seem safe to you?), and Asness is literally giving his strategy away. What they're selling is, instead, access and technology and size and the advantages that come from being an insider, loosely and non-illegally speaking. You can make the (currently boneheaded-looking) decision to buy BAC stock in August '11, or to buy all the stocks that have gone up in the previous year. That's easy! But it will suck for you, unless you get the sort of edge unavailable to retail investors. Edge like having billions in AUM, your own trading desk, and algorithmic trading strategies to move into your momentum stocks efficiently - or edge like having a halo, a preferred dividend, and a phone by your bathtub.
What's nice about Asness and Buffett is that they are offering retail investors the chance to share in that edge. That is probably not a philanthropic endeavor - Asness says his motivation in moving into mutual funds is to expand AUM and thus management fees, and as you may have heard Buffett makes a decent living from running Berkshire - but it may be a socially useful one.
Or maybe not. With attention increasingly focused on the divide between privileged insiders who get access to hedge funds and private placements on the one hand, and retail investors who get endless suffering on the other, giving retail investors indirect access to hedge-fund-like trading strategies and sweetheart private placements may or may not strike a blow for equality and open access. But it's certainly a good marketing strategy.
* Or you can point out that he's lost like $1.1bn in fair value (from column G to H). Fine, whatever. But (1) that's frittering away of margin of safety and (2) it's still less than $1.5bn - in other words, he's still relatively cushioned from stock price moves compared to a chump common stock investor.
** This is not, by the way, meant to be any sort of slander on the momentum trading practiced by high-frequency traders and stat arbs and, probably, much of AQR, which a reader kindly explained to me in terms I can sort of understand as sort of a creepy gamma strategy. But the quarterly rebalancing beast described here is just very hard for me to wrap my mind around.