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Wednesday, March 21, 2012

Buffett Ahead of the Hedge Funds

When I set about convincing non-investment people on the efficacy of low-cost indexed investing, I usually face a challenge.  Many of them have had a bad experience with their investments.  That's why they are talking to me.

I am up against the suits and the resources of well-heeled firms that have honed their sales pitches to the nth degree.  I'm against the hard thought-out processes of cleverly hiding fees and poor performance.  I'm against the presenters of carefully selected funds that have outperformed in the past.

It is easy for me to empathize with the 3rd runner up in some of today's presidential primaries.

But I bring heavy hitters to the plate.  These include Burton Malkiel, Dan Solin, John Bogel, Andrew Hallam, Jack Meyer, and many others.  The most powerful, though, is Warren Buffett who states that professionals even should follow the low-cost index approach.

Warren Buffett says:

Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees.  Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.
All of this, of course, is more than an academic exercise.  Many of the above mentioned people spent lifetimes studying and analyzing data on market performance before they arrived at their conclusion. Warren Buffett went a step further.

The Bet

On Jan. 1, 2008, Warren Buffett bet Protégé Partners LLC, a New York fund of hedge funds co-founded by Ted Seides and Jeffrey Tarrant, $1.0 million they couldn't pick an index of five funds that would outperform  the Standard & Poor’s 500 Index over the 10-year period ending Dec. 31, 2017.  These funds are funds of funds.

The fund of funds hedge fund pitch is interesting.  Hedge funds are for the wealthy.  To get in them, you have to put up a lot.  Everybody knows, however, that diversification is important.  Thus, you want your investment dollars to spread among several hedge funds.  Not easy unless you are ultra rich.  Enter the "fund of funds."  Now you are diversified and getting management from the best of the best - at least, that's the pitch.  All of this and you are investing like the ultra rich!  You are ready to head to the neighbor's barbecue and brag that you are invested in hedge funds.

I once listened to a pitch to a group of do-it-yourself investors that presented impressive graphs as part of a power point that showed the exceptional performance of hedge funds over the past 20 years.  I asked if Long Term Capital Management was included in the results.  The presenter didn't know - at least, that's what he said.  Long Term Capital Management was the largest hedge fund in the world - before it went broke.

As of the most recent calculation on the bet, Buffett has a return of 2.2% (using Vanguard's Admiral funds) and the hedge funds are down 4.5%.

Brad Alford, head of Alpha Capital Management LLC in Atlanta, says "hedge funds of funds have underperformed because of high fees and mediocre manager selection."  Interesting.  It seems that with $1.0 million on the line and, even more importantly, pride, that the hedge fund manager made his best picks.

The fees part of it we definitely get.

The details of the bet can be seen at .


  1. Buffett is the biggest troll of them all! Glad I read your post, I had no idea about this bet!

  2. Remind me again why people invest in hedge funds and pay those super huge management fees.......... great deal for the managers, lousy deal for the investors.