What would Warren Buffett do to your portfolio?

Most clients would love to get Warren Buffett’s returns. Here’s how to design portfolios that imitate his investment style.

Buffett and Charlie Munger, 81 and 88 respectively, have built a portfolio of companies at Berkshire Hathaway with well-known names such as Coca-Cola, Costco Wholesale Corp., American Express, Fruit of the Loom, Ginsu and General Electric.

Their strategy is to take out billion-dollar positions in these competitive firms that take advantage of demographic trends around the world.

Read: Buffett is doing fine without an ETF

“There are moats around these companies,” says Timothy Vick, Chicago-based senior portfolio manager of Sanibel Captiva Trust Co. “You’ll be minimizing business risk [by buying them] because these companies tend not to be cyclical. They don’t give you wild volatility, either.”

Buffett buys stocks that are underpriced, but there’s more to it than that. Vick says the secret is to own Berkshire-lookalike companies that buy undervalued stocks – sometimes, entire firms – for their holding companies. Like Berkshire, these holding companies have used the cash flows from investments as leverage to make further investments and grow book values at more than 15% annually, he says.

There are a handful of companies that fit the bill, Vick says. They are all much smaller than Berkshire and therefore find it easier to compound money off a smaller asset base. They are also run by CEOs who are 20 to 30 years younger than Buffett, so they can stay at the helm well into the future, he says.

These CEOs also hold significant stakes in the companies they run and are not likely to be ousted by short-term activist investors. “You are essentially buying publicly traded, private equity firms, but without all the fees and restrictions,” Vick says. “It’s like being able to buy Berkshire Hathaway 20 years ago.”

The best time to Buffettize a portfolio, says Pat O’Connor, president of Winnipeg-based Blackwood Financial Planning, is when investors are approaching retirement and become focused on capital preservation.

The Berkshires clones are:

• Markel Insurance, a Virginia-based company that uses the float from insurance premiums and reinvests in stocks, bonds and private companies. “Markel has an outstanding track record of insurance underwriting and has been generating market-beating returns from its stock and bond portfolio for two decades,” Vick says.
• Brookfield Asset Management, a Toronto-based owner of commercial office buildings in North America and hydroelectric power plants, dams, toll roads, timberland, and transmission lines around the world. It is essentially a private-equity company that holds hard assets. Vick says it has proven to be one of the “most disciplined, patient investors” in hard assets and has cobbled together one of the most enviable track records in the business. “Management currently estimates the company’s fair value to be 35% above the current stock price.”
• Biglari Holdings, a Texas-based firm that uses the profits from its Steak and Shake restaurant chain as a means to acquire stakes in other companies. It differs from Berkshire in that it often takes hostile stakes in underperforming companies and uses its influence to turn them around, thereby boosting the returns for shareholders, Vick says.
• Fairfax Financial, a Toronto-based insurance holding company, run by Prem Watsa, which uses the float from insurance premiums and reinvests in publicly traded stocks and bonds. Watsa, unlike many other asset managers, is currently bearish and has hedged Fairfax’s entire stock portfolio with put options to protect book value, Vick says. “Like Markel, Fairfax has been generating outstanding portfolio returns the past 25 years, compounding book value at 23% annual rates.”

Despite the can’t-miss feel of Buffettizing, there are some risks involved, says Hardev Bains, president and portfolio manager of Lionridge Capital Management, a Winnipeg-based asset management firm. Screening for Berkshire-like stocks can be difficult for advisors unless they have formal training in investment analysis and research.

“It’s not easy for most people to try to use simple quantitative screens as there is a lot more analysis and judgment that is required for effective investment decisions. Advisors who want to provide a good result for their clients should delegate this task to an experienced portfolio manager,” he says.

On top of that, you can’t simply blindly buy whatever stock Buffett owns because without your own analysis, you won’t be able to monitor it properly and know if it’s time to get out.

“If Buffett sells a stock, you might not find out until it’s too late,” Bains says.

Plus, you won’t necessarily be buying at the same price Buffett did, and being late to the party doesn’t make for great returns.