Cloning 101

In 1975 Congress passed Section 13(f ) pursuant to the Securities Exchange Act of 1934. The measure required every institutional fund manager with assets under management over $ 100 million to report its holdings once a quarter to the Securities and Exchange Commission. Congress did this to improve the disclosure and transparency of these big firms with the hope of increasing confidence in the financial markets.

The name of the form is the “13F” (also referred to as the Form 13F - HR). The data is uploaded to the SEC web site no more than 45 days after the quarter’s end, and an investor can view the holdings free of charge. By reviewing the 13Fs, you can view and understand the holdings of every manager from George Soros, to Seth Klarman, to Carl Icahn, to Warren Buffett.

The SEC maintains the EDGAR database and posts the electronic versions of 13F f lings within a day after such filings are received. The data goes back to late 1999, although the archives in Washington, D.C., contain paper records that go back further.

All an investor has to do to retrieve the holdings is to visit the web site, and search under “Company Name” for the desired fund or company. In our first case study, we use “Berkshire Hathaway”(CIK # 0001067983) resulting in a laundry list of filings. We are interested in only the 13F filings, and the user can narrow down the list by inputting the “Form Type” provided (13F). All of the quarterly 13F filings are now at your fingertips. Since the 13Fs are published within 45 days after quarter end, the quarter that ended June 30, 2008, would be available around August 15, 2008. Examining the most recent 13F from Berkshire reveals a list of long - time Buffett holdings including American Express, Wells Fargo, and Coca-Cola. This information is indeed interesting, but can it be of any value?

Typically, the best investors to choose for this analysis are managers who employ long-term holding periods (in Buffett’s case he has stated that his favorite holding period is “forever”). This will minimize the effects high turnover would have on the portfolio, and the 45-day delay in reporting times should not be a major factor in performance. (The data is 45 days “ stale ” when you see it, and the manager may very well not even own the stock by the time the 13F is posted. Although we have found turnover to be a minor influence on performance.)

It is very important to backtest the managers' strategy in order to determine if it is appropriate for tracking. Many funds, such as the hugely successful Renaissance Technologies are not appropriate for trading due to their heavy involvement in derivatives. Many people follow their moves even though it does not offer any benefit to do so.

We believe that the major value added in the investment process from these managers is in stock picking and not in investment timing. The portfolios we will track are long-only. While most hedge funds short and/or use derivatives to hedge or leverage their ideas, these positions do not show up on the 13F filing (nor do international positions).

The simple methodology we are going to use is as follows:

1. Download all of the 13F quarterly filings.
   
2. If there are more than 10 holdings, simply use the 10 largest holdings, as the majority of a manager’s performance should be driven by his largest holdings.
   
3. Equal-weight the 10 holdings.
   
4. Rebalance, add/delete holdings quarterly, and calculate performance as of the 20th of the month to allow for all filings to arrive.

Following this process for backtesting manually will take an entire day using a simple strategy like the top 10 holdings (it took us a month to backtest 10 funds by hand about two years ago). Your analysis will also likely have survivor bias because historical prices for delisted stocks are not readily available. To accurately calculate returns, we included the portfolio effects of all stocks that are no longer traded due to delistings, buyouts, mergers, bankruptcies, and so on. We also include all dividends (cash, stock, special, etc.). Often, databases and backtesting software packages do not account for stocks no longer trading, which can heavily skew results.  AlphaClone automates this process by instantly backtesting even the most complex multi-fund strategies.

OK, enough already.  How does one do following Buffett's stock picks?  From AlphaClone, below are the results of following Buffett's ten largest holdings from 11/2000 to 4/30/2010.  The Buffett "clone" portfolio invests in his 10 largest holdings equal-weighted and rebalanced quarterly is compared to the returns to the broad U.S. market (S&P 500 with dividends).  Buffett's current clone portfolio holdings are: