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Business Title: Buffett Makes Fools of the Experts Here was Buffett’s original bet: “Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.” He wagered, in other words, that if he placed his money in a fund that simply tracks the 500 largest stocks in the United States, he would come out ahead of someone who places the same amount of money with any combination of supposedly brilliantly performing hedge funds. Initially, as Buffett told the story in last year’s letter to investors, no one wanted to take the bet, but at last Tom Shields of the Protégé Partners said he’d take a shot. As collateral, the two invested $318,250 apiece in treasury “strips,” fixed-income securities, the idea being that in 10 years both of these investments would appreciate to exactly $500,000 or a combined $1 million. The winner would get to decide which charity would receive the payout. Protégé Partners picked five multi-manager investment funds, or “funds-of-funds,” with investments in over a hundred hedge funds. On the Protégé side of the bargain, it’s fair to assume, was the combined intelligence and experience of scores of hedge fund managers—the absolute best and brightest of Wall Street. As Buffett explains in his latest letter: “Protégé, an advisory firm that knew its way around Wall Street, selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund. This assemblage was an elite crew, loaded with brains, adrenaline and confidence.” And yet they failed, miserably. Over a 10-year period, the five hedge funds gained an average of 2.96 percent. Over that same period, the S&P 500 gained an average of 8.5 percent. Buffett foresaw two factors that led him to believe a simple index fund would outperform the best and brightest. The first was that fund managers charge fees. The hedge fund managers charge a 2 percent annual fixed fee and a 20 percent commission on profits. The fund-of-funds managers customarily receive a fixed fee of 1 percent of assets. There were other fees, too, including performance fees in good years. All these fees are terrific for the manager, but they cut deeply into profits for the investor. An unmanaged index fund, by contrast, charges investors only low and perfunctory fees. The other factor? Most of the best investors aren’t wiser or more talented than the market. As Buffett put it in his original 2007 wager: “A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.” There was one oddity in the wager. Half way through the decade, both parties, at Buffett’s suggestion, sold their treasury bonds and instead bought 11,200 shares in Berkshire-Hathaway stock. It’s a strange way to collateralize a wager—why not put the money into a company that isn’t led by one of the wagerers?—but it’s hard to argue with the financial wisdom of the change. Instead of $1 million, the investment yielded $2.2 million. As the winner, Buffett chose the nonprofit Girls Inc. of Omaha. We have our differences with Warren Buffett, to be sure, from tax policy to electoral politics. But we’re grateful to the Oracle of Omaha for illustrating one crucial truth with such beautiful clarity. The truth is this: that the Ivy-trained geniuses we pay to manage our investments—and remember, more than $3 trillion is under the management of hedge funds—don’t know half as much as they think they know. Many of these bright young things go from Wall Street to the Treasury department and the Federal Reserve in the belief that they understand the deep magic of the modern economy. In fact, they do not. Nor, with a tiny number of possible exceptions, does anyone else. Poster Comment: Hate that old asshole all you want but he did win this particular put-up-or-shut-up showdown with the hedge fund fanbois. Post Comment Private Reply Ignore Thread Top • Page Up • Full Thread • Page Down • Bottom/Latest
#1. To: Tooconservative (#0)
I just can't resist the ol' followup. A character defect. : ) Our recent threads on investing made me think a few people might recall the wager as you did.
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