The Exchange

Has Berkshire Hathaway Become a Closet Index Fund?

The Exchange

By J.C. Parets

J.C. Parets is the founder and president of New York based hedge fund Eagle Bay Capital, LLC. You can find his smart commentary at AllStarCharts.com.

Why would you even bother owning Berkshire Hathaway?

As brilliant as Warren Buffett is, at this point he’s looking more and more like a closet indexer. I was surprised when I ran the numbers and could not believe how correlated Berkshire is with the broader market.

It started with a simple phone call from a friend of mine, we’ll call him “Uncle Pat”. He was asking me for some advice on how to approach a client of his who won’t send him any more assets because he’s doing well on his own – apparently he has his entire portfolio in Berkshire Hathaway. Uncle Pat is a financial advisor and just looking to grow his business like anyone else. I left that industry to launch my own hedge fund, but I still remember dealing with this sort of nonsense.

I told Uncle Pat that I’d run the numbers for him because I was pretty sure the only reason his client was doing so well was because Berkshire is probably pretty closely tied to the ups and downs in the US Stock Market. Boy was that an understatement. As it turns out, the Berkshire Hathaway A-shares have a +0.98 correlation with the S&P500 over the past year. It has a +0.95 correlation over the past month. Just to put things in perspective, Berkshire has a higher short-term correlation to the S&P500 than the Dow Jones Industrial Average has to the S&P500. You can’t even make that up.

So why on earth would you ever bother “diversifying” your portfolio by adding another extremely correlated stock to the mix. All you’re really doing is adding exposure, volatility, and risk to your portfolio by adding Berkshire to an already highly correlated stock portfolio.

Here is a one year daily chart for the Berkshire B shares (BRK.B):

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And here's a six year weekly chart showing that the correlation has been longer lasting:

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The bottom line?

Don’t waste your time investing in a closet indexer. If you want diversification, which most of us do, run the math first and make sure you’re not just adding to exposure that you already have. We look to other asset classes for this like bonds and commodities, and if you look hard enough, you’ll find some great stocks with little or no correlation ($AAPL is actually one of those). So if your broker or advisor thinks it’s a good idea to give Warren some of your money, send him the math and tell him how silly that would be.

I was just as shocked as you, trust me. But now we know, and knowing is half the battle.

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