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Buffett’s Bet: S&P 500 vs Hedge Funds
Fortune reports that Buffett has wagered $1,000,000 that the Vanguard 500, and S&P index fund, will outperform 5 fund-of-funds Hedge Funds chosen by Protege Partners, a money management company that runs a fund-of-funds. Carol Loomis published the scoop in Fortune.
Buffett has repeatedly and famously suggested that:
“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees”
I think it’s terrific that an eccentric, brilliant billionaire and a publicity-hungry Wall Street money manager have found common ground on which to publicly disagree. More interesting to me was the incredible hurdle investors need to clear for their hedge fund monies to deliver against index funds:
“A fund of funds normally charges a 1% annual management fee. The hedge funds it puts that money into charge an annual management fee of their own, which for funds of funds is typically 1.5%. (The fees are paid quarterly by an investor and are figured on the value of his account at the time.)
So that’s 2.5% of an investor’s capital that continually goes for these fees, regardless of the returns earned during a year. In contrast, Vanguard’s S&P 500 index fund had an expense ratio last year of 15 basis points (0.15%) for ordinary shares and only seven basis points for Admiral shares, which are available to large investors. Admiral shares are the ones “bought” by Buffett in the bet.
On top of the management fee, the hedge funds typically collect 20% of any gains they make. That leaves 80% for the investors. The fund of funds takes 5% (or more) of that 80% as its share of the gains. The upshot is that only 76% (at most) of the annual return made on an investor’s money accrues to him, with the rest going to the “helpers” that Buffett has written about. Meanwhile, the investor is paying his inexorable management fee of 2.5% on capital.”
The whole “hedge fund” concept is brilliant marketing. Mutual fund returns, after all, have taken an absolute beating versus index funds over the past 30 years. Professional money managers saw the shine come off the penny, and suddenly “hedge funds” began raising their sexy heads.
I’m siding with Buffett on this one.
