[DcifrThs]

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dcifer,

for your own good, read the article that i linked, absorb what buffet says about RISK & REWARD. you won't need to read any academic studies after that

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the tone of your comment there is interesting... that article is good but it points out one thing: value investing can produce good returns and one doesn't need to be a math wiz to do it.

however, if you actually look at the returns he presents in greater depth, the actual alpha they provide is staggeringly small. by alpha i mean the return above and beyond the benchmark against which one is measured. if you care i'll go into the mathematical formulation of it but it's boring and unnecessary for this point.

take a top hedge fund. most people would rather invest with buffet than with, say X fund. but, over the period from lets say 1991-2007, this X fund has generated an information ratio (historical compound annual excess return divided by historical annual risk) of 1.08. that means that for every unit of risk, one would receive just over one unit of excess return (the total return minus the benchmark). further, if you simulate (roughly) the investment strategy back to 1960, you'd get a lower, but still close to 1.0 ratio (tons of assumptions here but all are reasonable & try to correct for the unavailability of derivatives & leverage etc.).

now, if you look at the examples buffet gives in his article, you'll see that the largest information ratio is .55 (pacific Ltd). this company generated a STAGGERING 22,205% compound return over 19 years. but when you disect that, it doesn't look as rediculous as it first appears. why?? because the risk adjusted return is FAR LESS than the total return. this company's annual standard deviation was 57.12%!!! that is on annual compounded returns of 31.44% (31.44/57.12=0.55 information ratio).

buffet doesn't seem to grasp this and many other people dont seem to grasp it either.

keep in mind, im not saying buffet is lucky. im not saying his methodology is bad or flawed or anything. in fact, i'd say it's freaking awesome!!! for him to be able to generate that kind of return WITHOUT VENTURING INTO OTHER ASSET CLASSES or types of bets is absolutely amazing and awe inspiring (the X fund above trades in over 100 different types of bets spanning every major market in the world).

it is though, important to understand the difference between straight compound return as buffet presented, and actual risk adjusted excess return on alpha (or information ratio).

i'll make my spreadsheet available to you if you PM me your email address so you can see what i did to arrive at my numbers.

I do want to thank you for the article though b/c it was a good read and does shine some light on the value of "value investing." i have more respect for his methodology now than i did before. i previously thought he was one of those ourangatnges you'd expect to find if you started out with tons of investors and had one with his track record [img]/images/graemlins/tongue.gif[/img]

Barron