Dig deep enough and you'll find people who firmly believe that Warren Buffett's track record is nothing more than random chance. They argue that Warren Buffett exists because he must exist.
We know that if the stock market returned 10 per cent in any given year that some people matched the market return, some people underperformed and some people outperformed. We also know that a few people lost every penny (e.g. buying a single stock that went bust) and that a few people more than doubled their money.
The same line of thinking holds true for extended periods of time. There are some people who have had negative rates of return over decades. They will pile into the markets only after a strong bull run is evident and everyone is ebullient. Once their money is invested, a market correction leads to them pulling their money out. Always a step behind.
On the flipside, there are investors and fund managers who have outperformed the markets for decades. Efficient market theorists won't deny it's possible to beat the market. They do, however, believe it's really difficult to predict who is going to continue doing it, and who is going to do it next.
If some people earn below-average returns, there must be people earning above-average returns. The question is whether Buffett's performance is above "above-average" enough that we can definitively say it's skill rather than luck. Just how spectacular is his track record?
Well, let's put it into context using an analogy: According to Matt Koppenheffer and The Motley Fool, 95 per cent of men living in the U.S. are between 5'5" and 6'2". If you are familiar with normal distributions, you'll note that 95 per cent corresponds to a range of two standard deviations. He then cites the heights of Sean Bradley and Manute Bol (NBA basketball players) at 7'6" and 7'7", respectively, as falling within a 10 standard deviation range. Their heights have nothing to do with skill or manipulation, but rather the genetic hands they were dealt.
Warren Buffett's track record has been described as being a five-sigma event, or within five standard deviations away from the average. That would make him the equivalent of almost 6'9" if we relate back to our height analogy.
From this simple analysis, it would seem that Buffett's performance is certainly above average, but not unexplainable by random chance. But let's put the emphasis on "simple analysis." I doubt the distribution of long-term performance is a normal distribution across all investors. The dollar-weighted performance of Buffett may also be lower than we expect (early spectacular returns may have been easier to come by when he had less money to invest). And of course there is the "Buffett effect" now: When he buys stock, so does an army of copycat investors.
It would take at least a whole other column to describe why you can't neatly compare Buffett to the average active investor. Suffice it to say that while we probably will never be able to offer statistical evidence of his investing record being anything more than random chance, in the back of our minds, he's the equivalent of a 10-foot man.
Preet Banerjee is a senior vice-president with Pro-Financial Asset Management. His website is wheredoesallmymoneygo.com.