Where does Warren Buffet’s Alpha come from? The answer may surprise you. You might think it comes from his amazing stock picking prowess, but this study from Yale researchers concludes otherwise:
Buffett’s performance is outstanding as the best among all stocks and mutual funds
that have existed for at least 30 years. Nevertheless, his Sharpe ratio of 0.76 might be
lower than many investors imagine. While optimistic asset managers often claim to be
able to achieve Sharpe ratios above 1 or 2, long-term investors might do well by setting a
realistic performance goal and bracing themselves for the tough periods that even Buffett
In essence, we find that the secret to Buffett’s success is his preference for cheap,
safe, high-quality stocks combined with his consistent use of leverage to magnify returns
while surviving the inevitable large absolute and relative drawdowns this entails. Indeed,
we find that stocks with the characteristics favored by Buffett have done well in general,
that Buffett applies about 1.6-to-1 leverage financed partly using insurance float with a
low financing rate, and that leveraging safe stocks can largely explain Buffett’s
Can this be true?
Is the secret to Buffett’s success really this simple: buy high quality, low beta stocks at a low price to book value and simply leverage it up?
Well, there’s only one way to find out.