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Agreeing with Warren Buffett and the evidence behind his comments

It has been known for decades that active fund managers generally underperform their benchmarks[1].  Eugene Fama penned the Efficient Market Hypothesis[2] in the 60’s proving this and there has been numerous others who have throughout the years.  In very recent times, Warren Buffet made waves this weekend with his harsh criticism of Wall Street and how investors have paid more than $100 billion needlessly in fees over the year[3].  Also, every six months S&P publishes their SPIVA report which shows this happening in practice – ‘over the five-year period, 91.91% of US large-cap (active) managers…lagged their respective benchmarks’.[4]

Having a lending criteria is essential and the 5 C’s of lending are a great starting point

Whilst at my former employer (big bank) we used to lend money to high net worth clients on a regular basis.  We used to subscribe to a very simple framework called the five C’s of lending that when implemented with robust procedures and criteria was an excellent way to lend with a high degree of success and a lower potential risk of default.  These were the five criteria we would apply.

1. Character. This is essentially a borrower’s credit history as well as their professional and educational background.  In general, most credit bureaus have a credit rating on us all and on most businesses.  This will detail a borrowers borrowing history, whether they paid back the loan(s) on time, bankruptcies and other similar information over the past number of years.  These criteria are somewhat subjective and different lenders vary as to what it is they are looking for.  In general, the better a borrower’s history and character, the more likely it is that they will be trustworthy enough to pay back the loan and adhere to the terms of the loan.  The higher the character rating, the lower the rate of interest a lender may offer the borrower.  When making loans to Small and Medium Enterprise (SME’s) and Consumer Loans, Character is very important.