Utopia, you are standing in it!

The father of the efficient markets hypothesis and a champion of the passive investment index-linked funds Eugene Fama considers Buffett to be more of a businessman than a portfolio investor. To Fama, the high returns by Buffett look great because entrepreneurs that do survive in market competition look good because we ignore the thousands that failed and lost everything.

You should compare Buffett with other businessmen such as Kerry Packer and Rupert Murdoch. These two Australian corporate giants started off with two TV stations and a rather ordinary afternoon newspaper, respectively.

Packer and  Murdoch grew their businesses to a global level to move from being millionaires to billionaires. Bill Gates and Steve Jobs also built and ran big companies from scratch.

Packer, Murdoch, Gates and Jobs all had great returns because they were able to obtain a return of their unique management skills and entrepreneurial alertness.

Kaplan and Rauh in “It’s the Market: The Broad-Based Rise in the Return to Top Talent” Journal of Economic Perspectives 2013 found that most of those in the Forbes 400 did not grow up wealthy.

Most of the Forbes 400 are entrepreneurs who accessed education while young and then applied their skills to the technology, finance, and mass retail sectors. In these sectors, through ICT and other innovations, these entrepreneurs could apply their superior talents to larger and larger pools of resources and more and more firms to reach huge numbers of consumers on a national or global scale. They became superstars in terms of their productivity and pay because they could lever their talents so widely over so many firms, workers, consumers and countries.

But remember, hundreds of dot.com firms failed and lost everything for each one that made it big. These are businesses we remember. The dot.com firms that failed are quiz questions, if they are remembered at all.

What is left standing after all this blood letting must be extremely profitable if only to justify the ride for those that risked it all to have it all. Fama estimated that the dot.com bubble was justified if something like 1.4 more Microsofts were born as a result of it!

Frazzini, Kabiller and Pedersen in “Buffett’s Alpha” found that Buffet had “a higher Sharpe ratio than any stock or mutual fund with a history of more than 30 years”. The Sharpe Ratio describes how much excess return you are receiving for the extra volatility in your portfolio because your are holding a riskier asset

Buffett is a volatile investment as Frazzini, Kabiller and Pedersen noted: from July 1998 through February 2000, Berkshire lost 44% of its market value, while the overall share market gained 32%.

A key to Buffett’s success was Berkshire surviving these set-backs.

Both Packer and Murdoch too had a few lucky scraps with their bankers. Steven Jobs was fired by Apple in 1985 because he was no good as a CEO – he was sending the company broke and would not listen. Bill Gates is as good as his next product launch. Nokia shares initially fell by 90% in 2007 when Apple leap-frogged it with a phone that resembled a PC – the iPhone.

Buffett and Murdoch both run an internal capital market where they expect a certain minimum rate of return.

Both are hands-off. Buffett’s corporate head office has 24 employees to do the regulatory and compliance work.

Murdoch reputedly rings the chief executive of each of his companies once a month for one minute. If what the chief executive says is interesting, the call gets longer. This is the essence of entrepreneurial alertness. Noticing what others have not and grasping that opportunity before someone else beats you to it.