Professional Documents
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AQR Capital
This is the views of the authors, not necessarily those of AQR Capital
Begins the
Buffett Partnership
Became the richest man
in the world
Buffet-Falk & Co., Omaha,
Investment Salesman
1930
1935
Born in
Omaha,
Nebraska
1940
1945
1950
1955
1960
1965
M.S. in Economics,
Columbia University
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
Graham-Newman Corp.,
New York, Securities Analyst
Expected Return
Leveraged
Tangency
Portfolio
Tangency
Portfolio
Unleveraged
Portfolio of High
Risk Assets
Risk ()
Source: Betting Against Beta. Frazzini, Pedersen (2010). For illustrative purposes only. Please read important disclosures in the
Appendix.
and
is a positive number measuring the importance of leverage
Et rt s1 r f t ts t
t Et rt M1 r f t
Expected Return
Standard
CAPM
With leverage
constraints
rf
Source: Betting Against Beta. Frazzini, Pedersen (2010). For illustrative purposes only. Please read important disclosures in the
Appendix.
20.0%
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
Fischer Black
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
20.0%
22.0%
12.0%
11.0%
10.0%
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
5.0%
Stocks
GSCI Commodity
4.0%
3.0%
Bonds
Credit
2.0%
1.0%
0.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
10
0.8
0.6
0.4
0.2
Commodities
Foreign Echange
Treasuries
Equity Indices
Country Bonds
Credit Indices
Corporate Bonds
SGP
NZL
SWE
NLD
NOR
ITA
JPN
HKG
FIN
GBR
ESP
FRA
DNK
CHE
DEU
BEL
CAN
AUS
-0.2
AUT
US stocks
Source: Betting Against Beta (BAB) Frazzini, Pedersen (2010). For illustrative purposes only. Past performance is not a guarantee of
future performance. Please read important disclosures in the Appendix.
11
12
1.00
0.80
0.60
0.40
0.20
0.00
13
Beta
1.0
0.9
0.8
0.7
0.6
Stocks held by
mutual funds
Stocks held by
Individual Investors
Stocks bought in
leveraged buyouts (LBO)
14
Value
Low Beta
Quality
Well-known,
well-studied
New
understanding,
both require
leverage to matter
Quote from Warren Buffett, Berkshire Hathaway Inc., Annual Report, 1989.
15
16
Please see the Appendix for important information. An investment in the above security does not suggest the achievement of a profit or
loss, realized or unrealized. This security was selected merely for illustrative purposes.
17
99th
Percentile
Percentile
# of
Stocks/Funds
Median
3,479
0.242
0.49
140
0.37
264
Buffett Performance
Maximum
Rank
Percentile
1.09
2.99
88
97.5%
0.52
0.76
0.76
100.0%
0.35
0.51
0.65
0.76
100.0%
1,994
0.30
0.47
0.65
0.90
99.8%
196
0.37
0.51
0.72
0.76
100.0%
23,390
0.195
0.61
1.45
2.68
1360
93.9%
598
0.32
0.44
0.56
0.76
100.0%
3,633
0.27
0.45
0.61
0.86
99.8%
9,035
0.26
0.48
0.73
1.12
62
99.3%
1,777
0.31
0.44
0.57
0.76
100.0%
Please see the Appendix for important information. An investment in the above security does not suggest the achievement of a profit or
loss, realized or unrealized. This security was selected merely for illustrative purposes.
18
-0.30
-0.19
-0.08
0.02
0.13
0.24
0.35
0.45
0.56
0.66
19
Assets
Leverage: =
Liabilities
Equity
Total Assets
Total Liabilities
= 1.6
Please see the Appendix for important information. An investment in the above security does not suggest the achievement of a profit or
loss, realized or unrealized. This security was selected merely for illustrative purposes.
20
Average cost of
funds (Truncated)*
T-Bill
Fed Funds
rate
1976-1980
1981-1985
1986-1990
1991-1995
1996-2000
2001-2005
2006-2011
0.79
0.20
0.00
0.60
0.60
0.60
1.00
1.67
10.95
3.07
2.21
2.36
1.29
-4.00
-4.59
1.10
-3.56
-2.00
-2.70
-0.82
-5.84
-5.65
-0.27
-4.61
-2.24
-3.10
-0.96
-6.06
Full sample
0.60
2.20
-3.09
-3.81
1-Month
Libor
6-Month
Libor
10-Year
Bond
-4.80
-2.46
-3.33
-1.05
-6.29
-4.90
-2.71
-3.48
-1.19
-6.59
-5.76
-1.28
-5.30
-4.64
-3.56
-3.11
-7.67
-3.69
-3.88
-4.80
Debt
Deferred income taxes (e.g., based on property, plant and equipment)
Accounts payable
Derivatives:
Selling options
Collects premia up front with no margin requirement
Provides Embedded Leverage (Frazzini and Pedersen (2011))
* In years when cost of funds is reported as "less than zero" and no numerical value is available we set cost of funds to zero
Please see the Appendix for important information. An investment in the above security does not suggest the achievement of a profit
or loss, realized or unrealized. This security was selected merely for illustrative purposes.
21
Assets
Stock picker
CEO
Liabilities
Equity
Total Assets
Total Liabilities
Berkshire stock
Returns of
Berkshire stock: observed directly
Publicly traded equities: observed via 13F filings and stock return data
Privately held companies inferred:
Equity
Private
rt+1
f
rt+1
LiabilitiestMV + rt+1
Public
f
EquitytMV rt+1
PublictMV rt+1
CashMV
t
MV
Privatet
Return decomposition:
Equity
rt+1
Leverage: Lt =
f
Private
f
Public
f
rt+1
= wt rt+1
rt+1
+ 1 wt rt+1
rt+1
Lt
PrivateMV
t
MV
PrivateMV
t +Publict
Source: Buffets Alpha: Frazzini, Kabiller, Pedersen (working paper). Please read important disclosures in the Appendix. As of 5/18/13.
22
12.5%
(3.28)
11.1%
(2.92)
7.0%
(1.79)
5.5%
(2.60)
4.7%
(2.26)
0.1%
(0.04)
MKT
0.84
(11.49)
0.78
(10.49)
0.97
(10.62)
0.86
(21.33)
0.83
(19.86)
1.04
(21.04)
SMB
-0.30
-(2.91)
-0.39
-(3.61)
-0.07
-(0.52)
-0.18
-(3.16)
-0.23
-(3.97)
0.11
(1..52)
HML
0.47
(4.24)
0.30
(2.39)
0.21
(1.72)
0.30
(4.88)
0.19
(2.74)
0.10
(1.48)
UMD
0.06
(0.86)
0.02
(0.29)
0.01
(0.16)
-0.02
-(0.60)
-0.05
-(1.34)
-0.06
-(1.69)
0.27
(3.12)
0.18
(2.11)
0.16
(3.50)
0.07
(1.58)
BAB
Quality
R2 bar
1.40
(3.50)
0.24
0.26
0.28
1.49
(7.12)
0.56
0.57
0.62
Buffetts Skill
Please see the Appendix for important information. An investment in the above security does not suggest the achievement of a profit or
loss, realized or unrealized. This security was selected merely for illustrative purposes.
23
24
$100.00
$10.00
$1.00
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Please see the Appendix for important information. An investment in the above security does not suggest the achievement of a profit or
loss, realized or unrealized. This security was selected merely for illustrative purposes.
25
$10,000.00
$1,000.00
$100.00
$10.00
$1.00
$0.10
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Please see the Appendix for important information. An investment in the above security does not suggest the achievement of a profit or
loss, realized or unrealized. This security was selected merely for illustrative purposes.
26
Sample
1976-2011
Beta
0.67
Average excess return
19.0%
Total Volatility
24.8%
Idiosyncratic Volatility
22.4%
Sharpe ratio
0.76
Information ratio
0.66
Leverage
1.64
Sub period excess returns:
1976-1980
42.1%
1981-1985
28.6%
1986-1990
17.3%
1991-1995
29.7%
1996-2000
14.9%
2001-2005
3.2%
2006-2011
3.3%
Public
U.S. stocks
(from 13F filings)
Private
Holdings
Overall stock
market
performance
Berkshire
Hathaway
Public U.S.
stocks (from
13F filings)
Private
Holdings
1980-2011
0.77
11.8%
17.2%
12.0%
0.69
0.56
1.00
1984-2011
0.28
9.6%
22.3%
21.8%
0.43
0.36
1.00
1976-2011
1.00
6.1%
15.8%
0.0%
0.39
0.00
1.00
1976-2011
0.67
26.4%
24.8%
22.4%
1.06
0.99
3.79
1980-2011
0.77
18.4%
17.2%
12.0%
1.07
1.11
2.46
19842011
0.28
13.8%
22.3%
21.8%
0.62
0.55
3.01
18.5%
9.7%
22.9%
8.8%
1.7%
2.3%
7.8%
4.3%
5.4%
12.0%
11.8%
1.6%
0.8%
8.0%
46.4%
17.9%
41.7%
39.4%
28.5%
3.3%
30.7%
27.8%
13.1%
24.0%
23.2%
16.8%
5.7%
22.1%
7.0%
30.9%
28.8%
10.4%
-8.1%
31.4%
20.9%
12.5%
18.8%
12.0%
2.2%
3.0%
Please see the Appendix for important information. An investment in the above security does not suggest the achievement of a profit or
loss, realized or unrealized. This security was selected merely for illustrative purposes.
27
Low-risk
investing
Quality
investing
Liquidity
provision
Trendfollowing
Carry
trading
29
Conclusions
A relatively flat SML can be part of a rational market equilibrium:
Leverage constrained investors concentrate in risky assets to achieve high unleveraged returns
Less-constrained investors may earn higher risk-adjusted returns
A few key investment styles drive returns across markets, asset classes, and categories
Buffetts portfolio and performance can be understood using these factors
Has a unique access to leverage
Leverages low-risk, high-quality value stocks
Short sells options (securities with Embedded Leverage (Frazzini and Pedersen (2011))
30