Why Buffett’s Million-Dollar Bet Against Hedge Funds Was a Slam Dunk
Much has been made of Warren Buffett’s million-dollar bet, hatched at the start of 2008, with the money management firm Protégé Partners. Buffett bet on an index fund that invests in the S&P 500; Protégé bet it could pick five “funds of funds” that would do better.
After eight years, as Buffett gloated at his company’s recent annual meeting in Omaha, the S&P 500 is killing it. The fund Buffett picked, Vanguard 500 Index Fund Admiral Shares (which invests in the S&P index) is up 65.67%; Protégé’s funds of funds—funds that own a portfolio of positions in a range of hedge funds— are up, on average, a paltry 21.87%.
The bet (the stakes will be donated to charity) still has two years to run, so the hedge fund wizards still have some time. But they would need a Herculean comeback. And it’s not too soon to hazard a guess about why Buffett seems to be on the winning side again. If you own a hedge fund that has been underperforming, Protégé’s losing bet may help to explain why—a question worth pondering this week, as some of the hedge fund industry’s most prominent leaders gather in Las Vegas for the annual SALT conference.
The answer starts with the hedge fund industry’s fees, typically 2% plus an incentive, or “carry,” of 20% of the profits. The Admiral Shares, by contrast, charges expenses of only 0.05% a year. That means the hedge funds have to do far better than the index fund just to break even.
