Warren Buffett is considered one of the greatest investors of all time and between 1965 and 2021 his investment company, Berkshire Hathaway managed to generate returns of over 20% a year, which is double the market return.
Buffett had often commented on the poor returns available from the traditional investment management industry and in 2008 he decided to put his money where his mouth was. He agreed to place a $1 million bet with the smartest hedge fund investors on Wall Street.
He bet that, over the following 10 years, an investment in a simple index tracker fund would outperform the absolute best hedge funds in the world. These are a type of investment fund that claim to use sophisticated techniques to outwit their competitors.
It’s well known that the hedge fund industry recruits the brightest and the best from the world’s leading academic institutions and Ivy League universities, attracted like bees to honey to the glamour and incredible financial rewards on offer.
Financial ‘rocket scientists’ armed with PhDs and mind-boggling computer power, all designed to crunch the data, analyse the markets, and decide on the winning investment strategy. As a result, wealthy people the world over place countless billions of their savings and investments in hedge funds.
On the other side of the bet was a Wall Street ‘Master of the Universe’, Ted Seides. He was CEO of Protege Partners, a leading “fund of hedge funds” and it was his job to select the five best hedge funds in the world, that he could be certain would outperform the alternative put forward by Buffett – an index fund offered by Vanguard that would simply track the leading US market, the S&P 500.
An easy bet to win, surely? Not quite. The hedgies got trounced! After the 10 years were up, Buffett’s plain-vanilla stock fund produced an annual return of 7.1%, which is around the long-term average. But the hedge fund portfolio produced an annual return of only 2.2% after all the fees were deducted.
Buffet won the bet and donated the winnings to Girls Inc, a non-profit organisation which exists to support and mentor girls across the US.
He later said “When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”
The world’s greatest investor was saying something that had been known to savvy investors and traders for a century, but which had taken a long time to seep into the average investor’s consciousness: managers who try to guess the future direction of markets and place bets with their investors’ money have a terrible track record.
And the evidence now is even more compelling. Standard & Poor’s has been tracking the record of active managers for more than 20 years.
Their 2022 report indicates that, when adjusted for fees and for funds dropping out due to inferior performance, 84% of actively managed fund managers underperform their benchmark over 5 years and an incredible 90% underperform over 10 years.
The fund manager results were so bad that in their report, S&P said the performance of active managers “was worse than would be expected from luck”. Can you imagine any other industry or profession where the failure rate is 90%? And yet the hefty fees continued to be deducted.
“A focus on keeping costs low has been proven to lead to better returns and every investor would benefit from utilising the humble index fund.”
The good news is that the investment philosophy embraced at Capital – Intelligent Investing embraces this truth and, as a client, you benefit from the strategy we use.
The real-life investment returns and performance of our client portfolios generated for our clients are evidence that it’s working extremely well and will continue to work.
I recently discussed the famous Buffett bet, as well as numerous other amazing stories from the world of investment with Robin Wigglesworth editor of Financial Times Alphaville and author of a great new book – “Trillions – How a Band of Wall Street Renegades Invented the Index Fund and changed Finance Forever” . You can listen to the full conversation at the Bulletproof Entrepreneur podcast.
I’d like to think that Warren would approve.
Alan Smith
CEO
