“Sovereignty wins the 151st running of the Kentucky Derby“

CBS News (5/03/2025)

It’s been a long journey, but I am overjoyed to share that after 20 years of betting on the Kentucky Derby, I finally won the trifecta. In fact, it gets even better: I had the top four horses in order on my bet slip and could have won the superfecta had I bet that instead.  

When I was a child, my mother would work one of the betting windows at Churchill Downs for the big weekend. She’d bring home a racing program for the Kentucky Oaks and Derby, and I would spend all night pouring over each sheet trying to decide which $2 bets I wanted to make. She’d take my instructions and place the bet on my behalf while I would watch the races during the day with my grandmother. I typically didn’t win but found it fun every year regardless.  

Anyway, this year, I found the race day commentary from the professional handicappers somewhat amusing. Not that they were saying anything wrong, but rather the way in which they discussed their betting philosophies. I kept hearing statements like, “This favorite is good value.” or “The odds on this one seem richly priced.” and “My multifactor-neutral model is long horses 2, 4, and 7…” (Okay, perhaps not that last one, but you get the idea.) But I found it interesting that there is so much discussion around value investing in professional handicapping. Steven Crist, a professional handicapper, has written about topics that would also be found in books on investing in financial markets. Ideas like, “betting with a margin of safety”, “pari-mutuel market efficiency”, and “waiting for the right race”. Michael Mauboussin of Morgan Stanley called Crist on Value “one of the best 13 pages on investing I have ever read.” 

The same behavioral biases that plague financial markets are also present in the pari-mutuels. Longshots are over bet and consistently underperform favorites whose odds do not entice the broader public.¹ Horses with eye-catching names like “Flying Mohawk” or “Sandman” garner more attention from casual fans, just as stocks with exciting stories may catch excessive interest from retail investors. Late entries like “Baeza” have less time in the spotlight and receive less coverage, potentially depressing their price on the market.

“End of an era: Warren Buffett will ask Berkshire board to replace him as CEO with Greg Abel“

CNBC (5/03/2025)

Speaking of young horse-racing-bettors-turned-value-investors, Warren Buffett announced his planned retirement at the Annual Berkshire Hathaway Shareholders meeting. After 60 years of compounding at a 20% annual return, he is widely known as the greatest investor of all time. One of my favorite “academic” papers is “Buffett’s Alpha,” which quantitatively investigates the construction of Berkshire’s portfolio. ² Here are a few things that I’ve found interesting: 

In terms of factors, Berkshire’s portfolio has largely skewed towards having exposure to Value, Safe (Low Beta), and Quality.  

While cautioning investors against leverage, Buffett’s strong performance is also due in part to the modest leverage generated by Berkshire’s insurance float. The paper estimates that Berkshire’s average leverage was 1.7-to-1. 

According to another paper, from 1980 – 2006, Berkshire Hathaway owned 230 different stocks. Over 60% of these were sold within one year, which may surprise some buy-and-hold disciples.³ 

Buffett’s outperformance has also largely occurred during periods of market stress and decline. Over the last 10 years, Berkshire Hathaway’s stock has had an upside capture ratio of 88% and a downside capture ratio of just 73%.⁴ In simpler words, Buffett has successfully outperformed by losing less than the index. 

“US Loses Last Top Credit Rating With Downgrade From Moody’s“

Bloomberg (5/16/2025)

The recently proposed tax bill was passed in the House of Representatives, with more voting and deliberation set to follow in the Senate. Effectively, it aims to cement some of the earlier Trump tax cuts into permanent policy, while also introducing new exemptions such as no taxes on tips and overtime wages. Tax cuts are popular amongst voters, but given the current deficit and national debt, some believe they may not be the most logical action. At least, Moody’s seems to think so. Moody’s estimates that the extension of the 2017 Tax Cuts and Jobs Act will add $4 trillion to the national debt over the next decade. This, along with a note stating that “successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs” were included in the rating agency’s note in its downgrading of U.S. debt. 

While we don’t yet have a fiscal crisis, we do seem to be on an unsustainable path. We have $36 trillion in national debt outstanding while running a $2 trillion annual budget deficit.⁵ Our current level of debt, while shocking, can likely be handled if the deficit becomes more reasonable. But lowering taxes from their current rate seems unlikely to help the situation. Some argue that the decrease in the tax rate will lead to more economic activity, which would grow total tax revenues (the Laffer curve). However, a broad consensus amongst economists on the subject suggests that the current tax rate is not high enough to promote this relief effect to a significant level.^{6 7} 

Inevitably, if we choose to continue deferring tax hikes, we will have to reduce federal spending in one way or another. From a purely fiscal perspective, healthcare represents a significant area for potential expenditure re-evaluation. We spend twice as much as the average developed nation per capita and yet have the worst life expectancy.⁸ Some estimates suggest that 30% of this discrepancy is due to the costs borne by administration burdens, and that we spend five times as much as other OECD countries on healthcare administration costs per capita. Prescription drug prices are also two to three times higher in the U.S. compared to other nations.⁹ Systemic bloat is self-reinforcing. A drug costing $50 or $150 is a large difference if that’s the only item on the bill – on a $30,000 hospital invoice the difference is less noticeable. Medicare is the third largest item in the federal budget. It’s not unreasonable to think that a persistent deficit increases the odds of major healthcare reform. Defense, interest, social security, and welfare programs seem more immutable than a few hundred billion dollars in redundant healthcare expenditures. If this proved to be the case, it would affect reimbursement rates, drug pricing negotiations, and systems of care.