Buffett Takes On The Hedge Funds

Published in Investing on 22 March 2012

There's $1m at stake, as the Sage wagers that trackers will win.

Do index trackers really beat managed funds over the long term?

The statistics do suggest it, but it's more fun when someone puts their money where their mouth is. And that is what ace investor Warren Buffett and New York hedge fund manager Protégé Partners have done.

Back in 2008, the two of them started a wager over whether an index tracker would beat a selection of five hedge funds over the next 10 years, with a total of $1m going to a charity of the winner's choice.

Buffett chose Vanguard's S&P 500 Admiral index tracker, while Protégé chose their five funds, which have not been revealed. How has it gone so far?

Well, Buffett's chosen tracker got off to a pretty poor start, in that annus horribilis that was 2008. All stock market investments were trashed that year, but the hedge funds managed to do less badly -- they lost 24%, but Vanguard's tracker lost a whopping 37%. Buffett had a lot of catching up to do.

Creeping back

And that is exactly what has been happening since, with Buffett's choice winning in the following three years. Results just released for 2011 show the tracker won that year with a 2% rise, with the hedge funds losing 1.9%.

Overall, Protégé is still just ahead, showing a loss to date of 5.9%, with Buffett a smidgen behind on minus 6.3%. But they're getting pretty close, and there are still six years of the bet to go.

There's one quite nice irony to all of this. At the start, the two sides each put up $320,000, which was used to buy a US Treasury bond that should yield the required $1m at the end of the 10 years. But after just four years, that bond is up 45%, trouncing both of the protagonists' investments, and is now worth $930,000.

A better investment

So now, to try to maximise the profits for the winning charity, the bond is to be sold and the cash invested for the remaining six years in Buffett's Berkshire Hathaway (NYSE: BRK-B.US) investment company. (There were legal obstacles to putting half of it in a Protégé hedge fund). And in case of subsequent losses, Buffett has guaranteed a minimum return of that $1m.

What does all this say to ordinary investors? We might not be up at the $1m investment level, but even at this stage there's little to choose between the two approaches, suggesting that investing our more modest sums in a simple tracker is unlikely to place us at any real disadvantage over those well heeled enough to be choosing a basket of hedge funds.

Of course, we're not quite halfway there yet, but my bet is that Buffett's tortoise will overhaul the Protégé hare by the end of the decade.

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Wuffle 22 Mar 2012 , 10:03am

Interesting that they chose to cash the treasuries.
So would I, given that return in that timescale. Don't look a gift horse in the mouth.


GrangeInvestor 22 Mar 2012 , 10:15am

I think this is an absolutely brilliant story, the FSA should put on their homepage!

Mari11ion 22 Mar 2012 , 10:23am

So they were both wrong. That's really quite funny.

ANuvver 22 Mar 2012 , 11:34am

Love the treasuries part! Neither of them won, rather the bet won itself.

So, getting out the fag packet for some quick calculations, they bought ten-year T-bills in 2008 expecting 5.6% pa over the term....Sigh. The past truly is a different country.

g120 22 Mar 2012 , 9:06pm

The usual 2% management fee and 20% performance fee of hedge funds plus the typical 1,25% of assets and 7,5% performance fees for the funds of funds compared to the low fees of the Vanguard's S&P 500 Admiral index tracker require that the hedge funds outperform by a great margin. Not impossible, but the longer the time frame the more improbable.
Buffett managed money for others in the Buffet partnership (1957-1968). From 1962 on the first 6% of return went to the partners of the Buffett partnership while he charged 1/4 of the return in excess of 6% (before 1962 three different fee arrangements to choose from).
Annual compounded rate of results 1957-1968: Dow Jones: 9,1%; Buffett partnership: 31,6%; Buffett partnership after fees: 25,3%.
If you know a hedge fund manager with the capabilities of Buffett and his equitable fee arrangement you will beat indices by a wide margin. With the standard manager and 2/20 fee it will be very difficult.

GrangeInvestor 22 Mar 2012 , 10:09pm

g120 just to add to your comment you also need to find a incredibly smart hedge fund manager who nobody else knows about: the very few decent managers out there tend to attract an avalanche of money which then makes their job much harder.

g120 23 Mar 2012 , 6:07am

@ GrangeInvestor
Capability I define to include the honesty and discipline only to manage an amount of money which one can invest in a profitable way. If I remember correctly Fisher and Schloss restricted the amount of money they managed; Buffett closed the partnership to new partners in 1966.

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