Billionaire investor Warren Buffett and his trusty financial sidekick Charlie Munger are saying they don't trust modern portfolio theory, nor do they rely on higher-order mathematics in professional finance.
Speaking at the Berkshire Hathaway annual shareholders meeting, Buffett noted that the efficient market hypothesis (EMH) is a key part of modern portfolio theory.
Simply put, the theory posits that investors should diversify because it reduces risk. EMH, moreover, holds that investors can’t beat the broader market because it’s always perfectly priced.
“There is so much that’s false and nutty in modern investing practice and modern investment banking, that if you just reduced the nonsense, that’s a goal you should reasonably hope for," said Buffett.
Buffett decried the idea that all information is instantly priced into the market.
“There’s this holy writ, the efficient market theory. How do you teach your students everything is priced properly? What do you do for the rest of the hour?” said Buffett.
Buffett also was critical of complex calculations used to value purchases.
“If you need to use a computer or a calculator to make the calculation, you shouldn’t buy it," he said.
“The more symbols they (quantitative analysts, or quants) could work into their writing the more they were revered.”
Buffett's aide, Munger, a vice president at Berkshire Hathaway, concurred.
“Some of the worst business decisions I’ve ever seen are those with future projections and discounts back. It seems like the higher mathematics with more false precision should help you but it doesn’t. They teach that in business schools because, well, they’ve got to do something," said Munger.
Concluded Buffett, “If you stand up in front of a business class and say a bird in the hand is worth two in the bush, you won’t get tenure. ... Higher mathematics may be dangerous and lead you down pathways that are better left untrod.”
The value of this information may be limited, however. A leading analyst said the opinions are totally Berkshire Hathaway-centric, and may not apply to other investors and their strategic plans.
“It was classic Buffett and Munger,” Paul Howard, an analyst at Langen McAlenny, told The Wall Street Journal.
“Great quotes, opinions and perspectives on Berkshire’s businesses and how they plan on managing for the future.”
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