Warren Buffett

CHAPTER 5It's Not That Active Management Doesn't Work

At the 1997 Berkshire Hathaway Annual Meeting, Charlie Munger asked an important question. The Berkshire style of investing “is so simple,” he remarked. “But it is not widely copied. I do not know why. It is not the standard in investment management even at great universities and other intellectual institutions. It's a very interesting question. If we are so right, why are so many imminent places so wrong?”

Why indeed? In a world where people are so keenly focused on smart investing, why are there so few Berkshire copycats? Yes, there are a recognized few but as a percentage of the global industry the number of firms that follow Berkshire's approach to investing is minuscule. The others cling to a different approach, one that is generally characterized as “active management.” Their success is less than stellar.

Unhappy investors increasingly complain that active management costs too much, trades too much, and underperforms too much. Their solution is to switch over to passive index funds instead, and as a result hundreds of billions of dollars are being liquidated each year from active management strategies and many of those managers are losing their jobs.

But, as we will soon learn, it's not that active management doesn't work. It is the strategies used by most active managers that don't work.

If you asked people what they ...