The Size of Capital is the Adversary of Investment Returns

In the vast landscape of investment strategies, few figures tower as high as Warren Buffett, often regarded as the epitome of value investingYet, to merely mimic his portfolio—parroting his investments without grasping the underlying principles—would be a grave misunderstanding of his approachAs the CEO of Berkshire Hathaway, Buffett operates on a scale that separates him from the average investor, rendering many traditional investment opportunities irrelevant in his contextTherefore, it’s imperative to focus on the philosophy behind his decisions rather than the specific stocks he holds at any given moment.

Value investing is a method that prioritizes the intrinsic worth of a company compared to its market priceIt's about finding high-quality businesses at attractive prices, rather than trading based on surface-level trends

Many investors fall into the trap of believing that simply emulating Buffett’s current holdings will yield similar financial successThis oversight overlooks the fundamental differences between his investment scale and that of average investors.

Buffett himself has expressed the drawbacks of managing substantial capitalIn an interview from 1999, he stated, “If I were managing a hundred million or even a billion dollars, I could have much better performance.” The sheer scale of Berkshire Hathaway affects his investment choices significantlySimilar to a whale swimming in a restricted pond, Buffett’s capacity for maneuverability diminishes as his portfolio growsThe importance of size in investment returns cannot be overemphasized; a smaller investment pool generally allows for more agile strategies, thus potentially higher returns.

Reflecting on his earlier years, Buffett recalls that his best performance occurred in the 1950s when he managed a small fraction of the funds he oversees today

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His ability to capitalize on investment opportunities was significantly enhanced by the limited liquidity constraints he faced at that timeToday, however, with Berkshire Hathaway’s total assets soaring above $1 trillion, most opportunities that arise today are simply too small to move the needleThe larger the fund, the greater the challenge of finding suitable investments that can be acquired without drastically inflating the share price—a scenario that creates additional layers of difficulty.

Let’s take a closer look at the numbersIn the first quarter of 2024, Berkshire’s total assets were reported at approximately $1.07 trillionConsidering that he might want to limit his investment in any single stock to 10%, Buffett would ideally look for opportunities where he could allocate $107 billionHowever, market rules often cap individual securities’ allocations, creating a bottleneck

For instance, current regulations in the Chinese mutual fund industry dictate that a single position cannot exceed a defined percentage of the total fund.

The significant limitation of capital size implies that Buffett would have a narrow field of options when exploring potential investmentsIn the U.Sstock market, for instance, while there are thousands of publicly-listed companies, the vast majority may not provide enough liquidity to support a notable purchase without altering the market priceWith 5,986 listed companies on the NYSE and NASDAQ averaging $4.5 billion in trading volume, it becomes clear that very few can accommodate a $107 billion stake without major ramifications.

In an environment where the average trading volume is modest, Buffett would find his options drastically limited

For him to buy even 10% of a company without affecting its share price, that company’s overall trading volume would have to be in the realm of $428 billion or moreYet, research indicates that only a handful of companies meet that thresholdIn fact, during the first quarter of 2024, Buffett could only feasibly pursue nine companies that would allow such a purchase without price manipulation, a stark contrast to the thousands of options available to smaller investors.

Comparatively, the landscape for smaller investors is vastly more accommodatingThe proverbial small fish in the pond, these investors aren't as constrained by the liquidity issues that plague larger counterpartsWhile Buffett's options dwindle to just a few significant opportunities, regular investors have the flexibility to explore countless possibilities within the markets

Herein lies the essence of adaptability in investment strategies—taking the principles of value investing crafted by Buffett and applying them in a manner that leverages available opportunities.

This philosophical divergence extends beyond U.Sborders, seeking to understand how these principles apply globally, especially in markets such as Hong KongThough the Hong Kong market can be fraught with risks, it also provides exceptional opportunities for astute investors, particularly those who understand local dynamicsThis unique market, characterized by a discrepancy between valuations and actual performance, offers pathways for diligent investors to identify underpriced assets.

Under current conditions, if Berkshire desired to invest substantial amounts, the market conditions might not support such transactions

For example, despite the presence of a major stock like Tencent Holdings, which had a trading volume of around HKD 388.55 billion, Buffett's ability to harness even 10% of his portfolio would be limitedSuch limitations severely curb his investment efficacy.

For most investors today, access to viable, liquid stocks remains much broaderAs a result, the effort should not be to mirror Buffett's moves but to learn his methodologyEmbrace the patience, the thorough analysis, and the fundamental understanding of quality investingWhether in small-cap stocks or picking up shares of large corporations during a downturn, the real takeaway is knowing how to effectively utilize the investor's own position.

In summary, the obstacles faced by Warren Buffett today reflect a broader trading principle: financial scale can serve as both an asset and a limitation