When Investing, Size Matters
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When investing, size matters. The bigger the portfolio gets, the harder it is to achieve extraordinary returns and beat the indexes. Warren Buffet knows exactly what I´m talking about, in an interview with Business Week in 1999 Buffett Declared:
If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then.
It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.
The universe I can’t play in i.e., small companies has become more attractive than the universe I can play in, that of large companies. I have to look for elephants. It may be that the elephants are not as attractive as the mosquitoes. But that is the universe I must live in.
Buffett has explicitly stated many times that investors in Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) should not expect over the following years the same kind of returns the company has generated decades ago, since the size of the company is an important limitation nowadays.
In the following table from the company´s last letter to shareholders we can see the historical evolution of Berkshire´s book value per share and, although the company is still managing to beat the S&P 500 Index, the returns have clearly been diminishing over time.
One of Buffett´s latest and more relevant additions to the portfolio of Berkshire Hathaway has been IBM (NYSE: IBM), in order to make IBM the third largest position in Berkshire´s stock portfolio, Buffett had to acquire more than $10 billion in shares of the company, which represents around 5.4% of its capital. The size of Big Blue, with almost 230 billion in market capitalization has evidently been a factor behind Buffett´s decision.
The size of the portfolio is also an important aspect to consider in fixed income markets, since the Pimco Total Return ETF (AMEX: BOND) (NYSEMKT: TRXT) was launched in March of this year, the ETF managed by legendary bond investor Bill Gross has achieved a return of 4.14%, while the mutual fund version has had a return of 1.17%.
The ETF has assets under management of nearly $800 million, so it’s free to invest in Mr. Gross' best ideas — and only those — while the mutual fund, with $258 billion in assets, is forced to invest more broadly.
The size effect is an important advantage for individual investors versus professional managers with billions of dollars in assets under management. While the little guy usually complains about lack of information or research resources to match the returns of professional managers, the reduced size of the portfolio can be used to invest in smaller companies, in which opportunities are usually more exciting and growth prospects can be more explosive than among the big names followed by most Wall Street analysts.
After all, it looks like the individual investor may be in a privileged position to generate extraordinary returns, provided of course that investment decisions are taken with deep care and following sound investment principles which have proven their validity over the long term. A smaller portfolio, far from being a problem, can be a considerable benefit when trying to beat the markets over long periods of time.
acardenal owns shares of IBM. The Motley Fool owns shares of Berkshire Hathaway and International Business Machines. Motley Fool newsletter services recommend Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.