The correlation between fund size and return on investment

Table of Contents

Law of large numbers

In my previous article “The career annualized return on investment of top investment masters“, I listed the annualized return on career investment of four world-recognized top investment masters. There are many reasons why these four investment gurus are respected, so I won’t repeat them here. In addition to the astonishing annualized rate of return for their entire career, another point is that the fund size each of them are in charge of has been increasing rapidly along with their investment careers, and the investment funds of each of them are at the level of more than 100 billion U.S. dollars.

Buffett once lamented that in order to significantly improve Berkshire’s investment performance, we need elephant-level investment targets. In his 1994 shareholder letter, Buffett stated as follows:

A fat wallet, however, is the enemy of superior investment results. And Berkshire now has a net worth of $11.9 billion compared to about $22 million when Charlie and I began to manage the company. Though there are as many good businesses as ever, it is useless for us to make purchases that are inconsequential in relation to Berkshire’s capital. (As Charlie regularly reminds me, “If something is not worth doing at all, it’s not worth doing well.”) We now consider a security for purchase only if we believe we can deploy at least $100 million in it. Given that minimum, Berkshire’s investment universe has shrunk dramatically.

Nevertheless, we will stick with the approach that got us here and try not to relax our standards.

In his 1995 shareholder letter, Buffett took pains to write:

The giant disadvantage we face is size: In the early years, we needed only good ideas, but now we need good big ideas. Unfortunately, the difficulty of finding these grows in direct proportion to our financial success, a problem that increasingly erodes our strengths.

Difference between masters and ordinary people

Most retail investors believe that funds have an inherent advantage in terms of return on investment. But good investors can easily deny this incorrect view.

Buffett once complained that the many listed companies in the United States are limited by laws and various restrictions, and he can only invest in about 200 of them. I have discussed the related limitations in my previous article “The advantages of retail investors“.

One good idea a year

In Buffett’s 1993 shareholder letter, he explained:

Charlie and I decided long ago that in an investment lifetime it’s just too hard to make hundreds of smart decisions. That judgment became ever more compelling as Berkshire’s capital mushroomed and the universe of investments that could significantly affect our results shrank dramatically. Therefore, we adopted a strategy that required our being smart – and not too smart at that – only a very few times. Indeed, we’ll now settle for one good idea a year. (Charlie says it’s my turn.)

In an earlier letter to shareholders in 1966, Buffett had already expressed similar remarks: “In recent years, we often only find two or three investment objects that meet the above criteria in a year.”

Buffett’s View

In Buffett’s 1966 letter to shareholders, when he mentioned the correlation between capital size and investment return, he expressed it in the following italics:

The results of the first ten years have absolutely no chance of being duplicated or even remotely approximated during the next decade. They may well be achieved by some hungry twenty-five year old working with $105,100 initial partnership capital and operating during a ten year business and market environment which is frequently conducive to successful implementation of his investment philosophy.

They will not be achieved by a better fed thirty-six year old working with our $54,065,345 current partnership capital who presently finds perhaps one-fifth to one-tenth as many really good ideas as previously to implement his investment philosophy.

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