In an earlier post we asked Is Berkshire Hathway a Hedge Fund?. Since that work was done, in mid. February, Berkshire has rebounded sharply off its low. Hedge funds have also been making money again, so I decided to revisit the data and see how Berkshires regression significance has changed. Has the recent months reinforced or weakened our prior conclusion that there was a significant element of the monthly returns that can be simply attributed to the risk premium arising from dynamic trading?

The prior regression showed that, over almost the entire previous decade, the monthly returns of Berkshire Hathaway common stock have a β of 0.70 ± 0.24 onto the dynamic trading risk factor, with a significance level (p-Value) of 0.005. The α is positive, but not significant, at 0.10 ± 0.46. The R² was 8%, which corresponds to a correlation coefficient of 28%.

In this regression we find a correlation of the monthly returns (to shareholders) with the dynamic trading risk factor, which should correspond to the returns of a typical hedge fund, has strengthened slightly. The β is now 0.83 ± 0.26, which is statistically indistinct from unity (t-Statistic is 0.63 referenced to the β = 1 hypothesis). The t-Statistic for the β is 3.15 for the null hypothsis of β = 0, which is equivalent to a p-Value of 0.002. The α is now estimated at (−0.01 ±0.50) % per month, which is statistically indistict from zero. The R² for the OLS regression (in the left hand panel of the chart) is 9%, which corresponds to a correlation coefficient of 31%.

In the prior article we chose not to draw a bold conclusion from the data, but I think the conclusion has to be stated more firmly. The data suggests that Berkshire Hathaway, Inc., as far as the returns available to the ordinary shareholders are concerned, is making money solely by following hedge fund trading strategies. One caveat to this, as compared to our regressions for Goldman Sachs and Morgan Stanley, is that the R² is much smaller. However, this could be attributed to skill. i.e. We could conclude that Morgan and Goldman are just better at executing hedge fund style trading strategies, with less zero expectation noise trading getting in the way, and this is why their returns are better explained by the factor (remember that the factor has a non-negative mean).

In the post discussing Warren Buffett's Berkshire Hathaway vehicle, I omitted to forecast returns for February, 2009 (which was done for all the other funds and companies studied here).

So, briefly, based on the whole data sample linear regression we forcast a return of 0.75% for BRK A shares. The prior number is for the least squares estimator, which is equivalent to assuming that the innovations are i.i.d. Normal. In the prior post, we raised the issue as to whether a robust regression might provide a more accurate result. I repeated the regression using least absolute deviations, which is equivalent to assuming that the innovations are i.i.d. Laplacian (i.e. of the form exp -|x|). This tempered the forecast to 0.27%.

UPDATE: This forecast is based on January data and regressions up to the end of January. February is 2/3 over at this point, and BRK A is down 15% on the month (from $90,000 to $76,900 per share). At this point, it seems unlikely that the return for the rest of the month will be sufficient to put BRK into the black, as the model predicts.

I was listening to Dylan Ratigan's Fast Money TV show in my car this evening and was interested by the panel discussing the fact that Warren Buffett sold half of his position in JNJ. A memorable comment was "Maybe Warren's finally become a trader?"

I recalled that there was much discussion several months ago around the fact that Berkshire Hathaway had sold $40 billion in at the money index puts, receiving $5 billion in premium income. Of course, these puts were now heavily in the money, leaving Berkshire with a substantial liability on it's books.

This is an odd strategy for one who called derivative securities "weapons of financial mass destruction." Selling index puts is a hedge fund/investment bank strategy, not that of a long term value investor.

So this brings us to the question: is Berkshire Hathaway a hedge fund?

We can answer this question, as far as the equity investor is concerned, as before by comparing the monthly returns of Berkshire Hathaway to the returns accruing to dynamic trading. For this regression we have a strong prior, which differs to that for pure play investment banks such as Morgan Stanley or Goldman Sachs. We expect a significant positive alpha and zero beta, indicating that Berkshire makes money in a way entirely independant of trading risk premia.

The charts above show the Value Added Monthly Index for both Berkshire and the dynamic trading risk factor and a longitudenal regression of the monthly returns. This is for the entire dataset, from 2001 to date.

The regression shows that, over almost the entire previous decade, the monthly returns of Berkshire Hathaway common stock have a beta of 0.70±0.24 onto the dynamic trading risk factor, with a significance level (p-Value) of 0.005. The alpha is positive, but not significant, at 0.10±0.46.

Again we can break down the analysis into the pro articulum and per articulum parts; and, from this division, we see that this result is not driven by the current financial crisis.

As a final note, the appearance of the scatter plot suggests that a larger beta might be a more suitable estimate, which could be established with a robust regression procedure.