He dominates. If there is one man that has stood the brutal test of time, it is WB. I wanted to compare Warren Buffett to mutual funds and hedge funds using a few performance metrics. So, I put Berkshire Hathaway’s stock up against the top three Dow Jones hedge fund indexes (event driven, merger arb and equity long short) and the best mutual fund I could find by using the WSJ mutual fund scanner, which turned out to be EKWYX. The typical performance measure is the Sharpe ratio, which is simply average return divided by standard deviation. Using this measure Mr. Buffett is in third place and by no means dominating.

But, this measure is in fact way too simplistic. The Sharpe ratio is really good at being a quick and dirty measure, but the fact of the matter is that it is, well, dirty. And this is most definitely true if the distributions we are measuring are not actually normally distributed. The Sharpe ratio also does not take into account that there is good (positive returns) and bad (negative returns) variance. A better performance measure is the Omega ratio which is more complex but much more truthful. I’d rather not explain all the gory details of it, but in essence its power over the Sharpe ratio, and most other performance measurements, is derived from the fact that it makes no assumptions about the distribution it is evaluating. The output is not a scalar but rather a line which can be evaluated at various “reference rates”. When evaluating two strategies at a particular reference rate, the higher value indicates the superior strategy or fund. Obviously if a fund is always greater than another at all reference rates then it is dominating and should always be selected for investment.

The X-axis here is the annualized reference rate. An investor should refer to a rate that he is targeting and select the fund that has the highest value at that level for it is the one that probabilistically has the greatest chance of achieving that return. And what do we find here? It’s pretty simple, if you are targeting a 2% return or less, go with a good merger arb hedge fund. Otherwise, invest in Berkshire Hathaway. To give the competing funds a fighting chance I’ve eliminated the great recession by not looking at performance after 2008 for all funds except for Berkshire Hathaway. All funds took quite a beating during that time and let’s just pretend it never happened except to unlucky Warren Buffett in this quirky alternate universe…

Event driven and equity long short are superior for a target of 6% or less, but for anything beyond that Berkshire simply dominates. End of story.

Actually, not end of story. If any of you out there believe you’ve found a fund that has superior performance (there has got to be) let me know either by email, LivingInVol@gmail.com, or by commenting to this post. I plan on having a follow up where I pit WB against the funds others have suggested using the exact same analysis. I only have one restriction; the fund must have been around for at least 10 years. The winner gets the satisfaction of winning.