Today I'm a full-fledged index investor, but there was a time when I owned some individual stocks. What was my favourite company back then? Berkshire Hathaway Inc.
I was a devoted fan. For more than a dozen years, whenever its share price dropped, I scurried to buy more. By 2011, my Berkshire holdings had grown to $370,000 (U.S.). Like most stock investors, I had my reasons for owning it, but one in particular might surprise you. To me, it was an index fund on speed.
This might sound like a nutty analysis. After all, Berkshire Hathaway is an insurance company. Its chairman, Warren Buffett, has a stellar record of picking winning stocks. He is Exhibit A for many investors who think they, too, can beat the market over the long term.
So how is his company like an index fund?
An index fund contains a plethora of stocks. Berkshire Hathaway does too. It owns more than 100 businesses outright, including companies such as Benjamin Moore paints, Fruit of the Loom, Geico, The Pampered Chef and Helzberg Diamonds. It also owns dozens of common stocks. With so many public and private holdings, spread among industries that range from insurance to railways to manufacturing, it's far more diversified than the S&P/TSX 60.
The companies owned by Berkshire spew off cash that gets directed to head office in Omaha, Neb. From there, Mr. Buffett invests the money in private or publicly traded companies. Considering this, you might liken his holding company to an actively managed mutual fund. And I would agree – if it weren't for a couple of points.
Having money with the typical Canadian equity fund manager would cost nearly 2.5 per cent each year. Such high costs are one of the reasons most active managers get trounced by their benchmark indexes. But Berkshire's costs are closer to those of an ultra cheap index fund.
According to Robert Miles, author of The Warren Buffett CEO, Berkshire's corporate administrative expenses are roughly $10-million (U.S.) a year. With a market value of $280-billion, Berkshire Hathaway charges a mere 0.034 per cent of that market capitalization to manage a diversified portfolio of businesses. Only 24 employees work at the Omaha headquarters, and the chairman pays himself just $423,000 a year.
To be sure, Berkshire Hathaway can actively trade its holdings while an index fund buys and holds. But peer closer and you realize Mr. Buffett's flagship is more like an index fund than you might think.
Rather than flipping in and out of investments, he prefers to stick by his holdings. Look back at his major holdings of a decade ago and you'll find most of them are still there.
Berkshire Hathaway has owned shares of Coca Cola for 26 years and has held a stake in The Washington Post for 40 years. Mr. Buffett says his favourite holding period is forever, and that inactivity strikes him as intelligent behaviour. Just like an index fund.
Inactivity has long-term benefits from a tax perspective. Active investors must pay capital gains tax when they cash out of winning investments. But because Mr. Buffett prefers to buy and hold, the company defers paying capital gains taxes. An index fund operates in much the same way.
Whether Berkshire Hathaway will continue to operate like an index fund on speed is unknown. Mr. Buffett is 82 years old and has been handing off investing responsibilities to key lieutenants in recent years. When he's gone, the company may change its approach.
You might be comfortable hearing that the quirky chairman has offered posthumous corporate help, through regular séances after his death. I'm a bit more skeptical. Given my lack of faith in management by Ouija board, I decided to exit the stock.
But I remain a fan of Mr. Buffett. To me his company boasts many of the advantages of an index fund: low management costs, broad diversification, a thrifty approach to triggering taxes.
If you're looking for an alternative to the standard index fund – and have faith in the great investor's continuing good health – I think an investment in Berkshire can still make a lot of sense. It's one stock that both index investors and active investors can like.