The mystery over how Buffet creates alpha when most fund managers fail is an amazing one. It is the stupendous success of Buffet which keeps active fund management going and stands against passive fund management/indexing etc.
Here is a paper which tries to figure where the gains come from? The authors shows that it is a simple strategy. First the fund has higher leverage which comes from stable sources (insurance premiums etc..). Then Buffet invests the leveraged proceeds into good quality stocks. The leverage magnifies the returns which generates higher alpha:
We estimate that Berkshire’s average leverage is about 1.6-to-1 and that it relies on unusually low-cost and stable sources of financing. Berkshire’s returns can thus largely be explained by the use of leverage combined with a focus on cheap, safe, quality stocks. We find that Berkshire’s portfolio of publicly-traded stocks outperform private companies, suggesting that Buffett’s returns are more due to stock selection than to a direct effect on management.
Is it that simple? Conclusion nicely says it as Lessons from an Alpha Male…