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I recently met up with Hagstrom in New York. He says we could argue all day about how Buffett picks stocks and what a computer thinks about it. A lot of good investors own good stocks, but what makes Buffett a great investor is that he owns only a few stocks and sticks with them. Eighty percent of the gains in Berkshire Hathaway have come from just six issues. Year after year he holds them, long after the rest of us would have got tired of seeing them on a brokerage statement. The last time Buffett disposed of a major position was 1986, when he dumped Handy & Harman, a precious-metals outfit, and Lear Siegler, an auto-parts manufacturer. Two years ago, he sold a third of his position in Capital Cities/ABC, and has since admitted that he made a mistake there.
Buying and holding wouldn't have worked with the clinkers in my portfolio, but Buffett doesn't have too many clinkers, except perhaps for USAir (another mistake he recently acknowledged). Neither, however, has he ever invested in the winningest stocks in the country. None of his holdings made the list of the top 50 performers over the past 20 years. So if he's the winningest investor without having owned the winningest stocks, something other than stock picking must have helped him.
Hagstrom has recently joined forces with Joan Lamm-Tennant, a professor of finance at Villanova, to test whether buying and holding make any difference on portfolios that are randomly selected by Villanova's computers. They tracked the performance of 3,000 fictional portfolios--some containing as few as 10 stocks, others as many as 150, going back 10 years. The upshot is that portfolios with the fewest stocks and the lowest turnover outperform portfolios with more stocks and a higher turnover. And that's without taking brokerage fees and taxes into account.
In a second test, they took randomly selected portfolios of 10 stocks each and compared results with the average mutual fund over a 10-year stretch. Apparently, the random portfolios do just as well as the funds. Perhaps this explains why funds can't come close to matching Buffett's record. Berkshire Hathaway resembles a fund, but since it isn't one, Buffett has the freedom to be boring.
Hagstrom's next step is to launch a mutual fund, Focus Trust, based on Buffett's principles. It's in registration and scheduled to be launched in April. The plan is to pick a few stocks that Buffett might want to own (though probably not the ones he does own) and hold onto them. The management fee will be very low, because with that strategy, the managers won't have much to do.