Why we cannot copy Warren Buffett
An essay on the drawbacks of cloning the best investors.
Warren Buffett, Terry Smith, Mohnish Pabrai , Bill Miller, Charlie Munger all have their public market holdings out in the public. You can find them in Dataroma. If all their holdings are available online why don’t people copy them?
In fact Pabrai even publicly talks about cloning and says that he shamelessly copies Buffett and Munger and anyone who is smarter than him.Cloning makes sense if you just do what the incredibly successful people do and hopefully you get the same results. What I assume Pabrai means by cloning the investors (and I could be completely wrong) though is that he is trying to copy their frameworks and thought process not the stocks that they are buying. Pabrai learned everything he could from Buffett and Munger and he simply copied the way they work. He does not blindly buy the stocks that Buffett and Munger buy and I believe there are many reasons for that.
So what could possibly be the reason to not blindly buy what the big shot investors are buying when they know what they are doing?
I can think of a few reasons.
Conviction
When an investor takes money from other people to invest in stocks they have to make sure that the company that they are investing in has to be good. Some managers have their incentives correlate with performance (like it should) so anything they invest in has to be researched very well and they have to ensure that there is no permanent loss of capital as far as they can. Now when you have to do so much research you tend to learn a lot about the companies and the ones that genuinely are good you gain a conviction that the company that you have invested in is the right one. This conviction is built with the due diligence that they have done.
If I see that Buffett has bought Apple today I can simply buy it with the justification saying that Buffett has bought it. Now Buffett’s justification on buying Apple is fully different. He has read the companies annual reports and he has analysed the business and he decided he should own Apple.
Let’s say things did not pan out well for the stock of Apple. It took a hit. Buffett and you have both lost a lot of money. Buffett has read about Apple he knows the business he knows that this reaction of the market is for the short-term the economics of the company have not changed and it is still a good company. So Buffett does not sell.
Now look at your angle. You do not have any idea of what the economics of the business are. You just invested because Buffett has invested. What if he made a mistake on this one? This will be the first thought that crosses your mind when things do not go your way. You are not wrong for thinking this way. But when the price of a company takes a huge hit (like we are assuming here) then all the news around the stock is negative. Now you believe that Buffett has made a mistake, you believe all the news that is available around but what you cannot see is the economics of the business.
This is the difference of conviction when you clone a big investor. The investor has a lot of conviction to hold on during tough times (he should check though if he has not succumbed to commitment bias) but the person cloning the investor does not have the conviction to do so. The reason for that is the difference in the justification of buying. It is very hard to stick to your own decision when they are not working out imagine how hard it is when it is not working out and you have to stick with someone else’s decision.
Expectations and Situations
Every institutional investor who is successful has large sums of money. Compared to an average retail investor who is making a decent amount of money but that is certainly not enough to go and buy up enough to own 5% of the company. Even institutional investors have different ball games. Buffett is in a league of his own. He has so much capital that he could literally buy whole listed companies. So he has a restriction to invest in the public markets only in large companies. An average retail investor who is investing for himself has one goal and that goal is to get a good enough return on the money that he has saved up. The expectations of someone like you and Buffett might be different. Buffett wants to beat the index and you might need a little bit more than that. Buffett is certainly not the investor who gets the highest returns, he was just above average for a very long period. What you need might be something more than what Buffett wants . Let’s say if he is fine getting a return on 15% you would want 20%. Buffett has an investing style of getting the maximum returns without having a risk of ruin. Now personally I find this to be a very sound and good investment strategy. But there are some people who want higher returns and they bet on things which look promising but at the same time they could have a risk of ruin. An example of that is Cathie Wood. She bets on companies and assets which are meant to be ‘next gen’ and are futuristic and have a huge growth potential but she gets into these companies at insane valuations and also with some major red flags such as high leverage.
Some people when the times are good will see the returns of Cathie and clone her. But that risks ruin. When cloning you can get blinded by the person getting the highest returns in the short term and this can cause a lot of misfortune for you.
So your expectations can lead to you following the wrong investor and cloning the wrong one.
Risk Appetite
Every investor has a different risk appetite. If I have cloned Buffett’s portfolio and his portfolio has not performed well for a year and I really need the money for a wedding that is planned then I have no option but to sell. The retail investors tend to need money because they don’t have a lot of it. On top of that institutional investors are not investing their own money. Now every investor has a personal risk appetite on how much they can diversify. I can be comfortable owning only a few companies but many people might not be. So to the question of whether one should own a lot of companies or not is down to a personal choice so while cloning it might be harder as you have to find someone with your diversification appetite.
Now that we have seen why we cannot just blindly clone and copy Warren Buffett’s portfolio what can we learn when we do see their holdings in companies?
We can use their companies as a source of idea generation. We can see that Buffett is holding Apple and then do our own due diligence but we have to be aware that as soon as we enter into researching a company that is owned by Buffett we will have an underlying bias. (or any company). We have to acknowledge this bias and try and avoid it.
We can also try and find out why Buffett has bought Apple and what his justification is and try to emulate the process that he had to get to the conclusion to buy that company. All in all cloning is a very good mental model but it cannot be used everywhere. There are drawbacks to it. We should focus on cloning the process and decision framework.
That’s it!
Hope you liked the post, please comment any thoughts you have in the comment section.