All investing is beta — is that a truth or just a consolation?

By Jiaxiang Shi

Edited by Jing Liu

The irony was almost too perfect. On May 4, as Berkshire Hathaway's annual shareholders' meeting convened in Omaha, a comparison chart began circulating online. It mapped twenty years of returns: the S&P 500 up 568%, Berkshire up 554%. The implication was stark — had you simply bought the index two decades ago and done absolutely nothing, you would have beaten the Oracle of Omaha himself.

The S&P 500 is widely regarded as the definitive benchmark for large-cap U.S. equities. Its constituents represent 500 of America's largest publicly traded companies, accounting for roughly 80% of total U.S. stock market capitalization. It functions, in essence, as a barometer of the American economy — the beta of economic growth.

That Buffett would eventually lose to the index was almost inevitable. Measured by ten-year annualized returns, he was ahead by a mere 0.06% as of 2021.

The reasons for this underperformance are numerous, but chief among them may be his missed connection with the technology wave. Tech now commands 30% of the S&P's weighting, and its outsized contribution has been instrumental in the index's slight edge. When fielding questions at the shareholders' meeting, Buffett admitted to knowing virtually nothing about AI. "Whether it does good or ill, I'll have to let it happen," he said. Compared to "world-changing" companies like OpenAI and Tesla, Buffett clearly places more faith in his circle of competence — and in "world-unchanging" Coca-Cola.

It's difficult to say who's right. The same long-term value investing framework could lead you to very different conclusions: Do you believe people will keep chewing Wrigley's gum and drinking Coca-Cola? Or do you believe AI will upend everything we know? For the past two decades, the pendulum has swung toward technology. But the winner of the next twenty years may well turn out to be Coca-Cola, a company that has endured for more than a century. And Buffett, after all, sidestepped the dot-com bubble that ruined so many.

Scale may also be culpable. After sixty years, Berkshire has grown into an $860 billion behemoth spanning public and private markets, hardly immune to the law that size is the enemy of performance. Its extensive portfolio of private equity holdings — not traded for quick gains but held for sustained profitability — has also demanded considerable attention from Buffett.

Then there's the matter of caution. Buffett believes the market is overheated, and has been selling equities to accumulate cash: Berkshire's cash reserves grew from $167.6 billion at year-end 2023 to $189 billion by the close of Q1.

The S&P 500, by contrast, proves far more nimble. It automatically reallocates toward whatever companies the market currently favors. In any given year, it may trail actively managed funds. But stretch the timeline, and it becomes unbeatable. Buffett even mentioned at the meeting that he has advised his wife to allocate 90% of her estate to the S&P 500.

For public market investors, the S&P 500 serves as a touchstone. At the 2006 shareholders' meeting, Buffett issued what became known as the "Ten-Year Bet": a simple index fund tracking the U.S. market, he wagered, would outperform any hedge fund manager.

Ted Seides, a partner at hedge fund Protégé Partners, took him up on it a year later. Seides selected five funds-of-funds; Buffett chose the S&P 500. The measurement period ran from 2008 through year-end 2017. Initially, the five funds surged ahead of the index amid the bear market opening. "And then the roof fell in. In the nine years that followed, the five funds-of-funds as a group trailed the index fund every year," Buffett noted in his 2017 letter to shareholders. One of the funds was even liquidated. At the bet's outset, Seides had considered himself fortunate that his opponent was the S&P 500 rather than Buffett himself. Eighteen years later, not even Buffett could defeat the index.

Of course, one detail matters: index funds charge minimal fees, while active funds exact a heavier toll. In other words, clever investment managers may indeed generate higher returns for you — but they take a larger cut too. This fee differential is itself a significant reason why index funds prevail.

Passive investing has undeniably swept through the markets. By year-end 2023, U.S. index fund assets had surpassed those of active funds. Rather than selecting active managers (however brilliant), steady index contributions have become the optimal strategy for most ordinary investors. Buffett himself has remarked on numerous occasions that for the average person, index investing is the best investment.

Returning to that widely circulated chart: "Even Buffett can't beat the S&P 500" is hardly breaking news. But the current fervor reflects something deeper — a shift in market sentiment. People are increasingly recognizing that even Buffett and Berkshire, synonymous with value investing, have failed to outrun the broader market over time.

For investors cast as "sages" — those theoretically tasked with finding alpha within beta — this amounts to something like an erosion of faith.

Today, this carries heightened significance. Over the past two decades, the world — China and the U.S. in particular — grew accustomed to explosive growth. Delivering outsized returns was, naturally, how investors justified their existence. But as the possibility of supernormal returns compresses, the fundamental understanding of "what exactly are we earning from investing" is itself evolving.

Over the past two years, even private market investors — who by definition should chase growth more aggressively — have increasingly embraced the mantra that "investing is beta." Whether this represents the ultimate investment truth or merely self-consolation in a downcycle is difficult to say.

Yet "investing is beta" may also be the purest expression of Buffett's own philosophy: compound interest, preserve capital.

Image source | Visual China