Warren Buffett's bet against hedge funds at the Long Now Foundation (2008-17)(longbets.org)
longbets.org
Warren Buffett's bet against hedge funds at the Long Now Foundation (2008-17)
https://longbets.org/362/
138 comments
I wanted to know what hedge funds were in the bucket to see how they were doing.
But, "Both parties of this bet have agreed upon an adjudication methodology that has been approved by Long Bets. They have asked that it be kept confidential."
Doh!
But, "Both parties of this bet have agreed upon an adjudication methodology that has been approved by Long Bets. They have asked that it be kept confidential."
Doh!
"If it moves tax it. If it keeps moving regulate it. And if it stops moving subsidize it" --Ronald Reagan (b. 1911)
So Govt becomes your Asset Manager when we buy S&P Index :)
So Govt becomes your Asset Manager when we buy S&P Index :)
There are hedge funds that beat the market. For example, David Tepper's (Panthers owner) fund returned ~25% annually over 25 years:
https://www.gurufocus.com/guru/david+tepper/profile
https://www.cnbc.com/2019/12/18/appaloosa-david-tepper-advic...
https://www.gurufocus.com/guru/david+tepper/profile
https://www.cnbc.com/2019/12/18/appaloosa-david-tepper-advic...
What a weird name "Long Now," I wonder what's the point of it.
Answered on the Foundation’s “About” page: https://longnow.org/about/
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Buffett won and it wasn't close: https://www.investopedia.com/articles/investing/030916/buffe...
If I understand this correctly, A—E are not individual actively-managed funds, but actively managed portfolios of actively managed funds?
It would be interesting to see the distribution of returns among the contained funds. I lean heavily passive personally, but at least if a not-insignificant fraction of funds outperformed the index and were dragged down by really bad returns in others, it would give some indication as to why people would even _try_ to actively pick where to put their money...
It would be interesting to see the distribution of returns among the contained funds. I lean heavily passive personally, but at least if a not-insignificant fraction of funds outperformed the index and were dragged down by really bad returns in others, it would give some indication as to why people would even _try_ to actively pick where to put their money...
Except that as you reduce the sample size, you expect to have some outperform and some underperform. If you 100x pick stocks at random, you will expect to see some fraction of those 100 picks way outperform.
Any time you reduce the sample size, you increase the variance, which gives the impression that skill is involved. In fact from just looking at a single distribution of outcomes it's not possible to tell if skill or luck is the cause.
Any time you reduce the sample size, you increase the variance, which gives the impression that skill is involved. In fact from just looking at a single distribution of outcomes it's not possible to tell if skill or luck is the cause.
There exist funds which have annualized a two-sigma return over SPY for over 20 years. If you model returns as approximating a normal distribution (e.g. just luck), and you model years achieving a return at least two standard deviations above the mean under a binomial distribution (i.e. number of years they've been exceptionally lucky), the likelihood of those track records existing are around 1 x 10^-37.
I would call that sufficient evidence to reject the null hypothesis that the returns are normally distributed, which is to say it's not luck. If you expand your sample size to all investment vehicles throughout history, there still haven't been anywhere nearly enough for such a track record to emerge by chance.
Elementary statistics is well equipped to distinguish between a distribution signifying luck and a distribution signifying skill. It's structurally the same as assessing normality, noise, randomness, etc.
I would call that sufficient evidence to reject the null hypothesis that the returns are normally distributed, which is to say it's not luck. If you expand your sample size to all investment vehicles throughout history, there still haven't been anywhere nearly enough for such a track record to emerge by chance.
Elementary statistics is well equipped to distinguish between a distribution signifying luck and a distribution signifying skill. It's structurally the same as assessing normality, noise, randomness, etc.
This topic has actually been studied:performance of top performing funds can be based on a manager's skill, but after a certain point that skill reaches the end of the runway. The more skilled the manager, the larger the AUM they can still get returns for, but at some point it's just too much.
> For an average fund in the cross-section, we estimate a drop in alpha of 20 basis points if the fund doubles its size over one year. We also find a non-negligible impact of the size of the fund industry, although its magnitude is significantly smaller than the impact of individual fund scale. We reconcile our findings with existing empirical studies. Taken as a whole, our results lend considerable support to theoretical models that build on the premise of decreasing return to scale for active portfolio management.
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2872385
General topic discussed in the Rational Reminder podcast:
* https://rationalreminder.ca/podcast/136 (~15m30)
* https://www.youtube.com/watch?v=LhluPwDaNAQ&t=18m30s
Something to consider for anyone piling into (e.g.) ARK:
* https://awealthofcommonsense.com/2020/12/a-short-history-of-...
> For an average fund in the cross-section, we estimate a drop in alpha of 20 basis points if the fund doubles its size over one year. We also find a non-negligible impact of the size of the fund industry, although its magnitude is significantly smaller than the impact of individual fund scale. We reconcile our findings with existing empirical studies. Taken as a whole, our results lend considerable support to theoretical models that build on the premise of decreasing return to scale for active portfolio management.
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2872385
General topic discussed in the Rational Reminder podcast:
* https://rationalreminder.ca/podcast/136 (~15m30)
* https://www.youtube.com/watch?v=LhluPwDaNAQ&t=18m30s
Something to consider for anyone piling into (e.g.) ARK:
* https://awealthofcommonsense.com/2020/12/a-short-history-of-...
Yeah, you're talking about capacity constraints.
They're not normally distributed. Almost any investment strategy has heavier tails than normal. So exceeding some number of sigma (assuming a normal distribution) does not imply an implausible amount of luck.
For example, a single investment in Amazon 20 years ago would outperform the market by many sigma. But the probability of an average fool having picked that particular stock 20 years ago was not 10^-(some large number). At least 1 in 100 fools would have picked Amazon.
For example, a single investment in Amazon 20 years ago would outperform the market by many sigma. But the probability of an average fool having picked that particular stock 20 years ago was not 10^-(some large number). At least 1 in 100 fools would have picked Amazon.
That's a fair counterargument, but I don't think it holds up. I'm talking about a portfolio rather than a single asset. Technically we would want to model that using a log-normal distribution, but I think the example suffices. Can you think of a realistic example where someone would accidentally hold a dynamic portfolio that exhibits outperforming returns over 20 years?
"I would call that sufficient evidence to reject the null hypothesis that the returns are normally distributed, which is to say it's not luck."
How exactly do you make the jump from returns not being normally distributed, to that meaning beyond doubt that luck isn't involved?
How exactly do you make the jump from returns not being normally distributed, to that meaning beyond doubt that luck isn't involved?
Look at e.g. the now disgraced and dissolved Woodford fund though; some managers seem to keep being above average, until they aren't.
> There exist funds which have annualized a two-sigma return over SPY for over 20 years
the problem is that _many_ funds have positive returns until, suddenly, they don't. It's basically as hard to pick a fund or money manager for the long run as it is to pick a stock.
Consider Neil Woodford[0], he beat the market for over twenty years and was considered the best investor in Britain. Then started a new set of funds, which went terribly. It'd have been reasonable to let him manage your money, but it would still not have worked out.
[0] https://en.wikipedia.org/wiki/Neil_Woodford
the problem is that _many_ funds have positive returns until, suddenly, they don't. It's basically as hard to pick a fund or money manager for the long run as it is to pick a stock.
Consider Neil Woodford[0], he beat the market for over twenty years and was considered the best investor in Britain. Then started a new set of funds, which went terribly. It'd have been reasonable to let him manage your money, but it would still not have worked out.
[0] https://en.wikipedia.org/wiki/Neil_Woodford
That doesn't refute the mathematics demonstrating that people can reliably do this with skill rather than luck. Eventually Brady's not going to be able to play football professionally either. But he still does, and when he can't do it anymore that won't indict his professional record.
The difference is that our ability to tell if Brady was a good football player 10 years ago doesn't depend on his results today. Whereas a fund manager can turn out to have had a bad strategy all along whose gains are only wiped out after many years of apparent good performance.
How many actual examples do you have of the same funds blowing up which outperformed for decades?
Buffett outperformed SPY for most of his 60 year career. Do you think he doesn't know what he's doing, and it was all luck, just because Berkshire Hathaway isn't doing as well as it used to?
Buffett outperformed SPY for most of his 60 year career. Do you think he doesn't know what he's doing, and it was all luck, just because Berkshire Hathaway isn't doing as well as it used to?
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Not that it would have changed the outcome, but it was also a notoriously bad decade for hedge funds. They usually say it's because of a lack of volatility. It'll be interesting to see if it stays that way, and if the Robinhood crowd will change things.
And now we see that the point of hedge funds has nothing to with long term investment growth, and everything to do with short term personal enrichment. When you're playing with other's money, you don't have to think about steady, decades long growth. You just have to nail one big return and make yourself rich on fees.
The fact that hedge fund managers live from the fees tells what they really think about their skills. Never gamble using your own money.
Any truly successful fund closes itself from investors. If you really generate profits, there is no reason to give it away after AUM reaches certain level.
Any truly successful fund closes itself from investors. If you really generate profits, there is no reason to give it away after AUM reaches certain level.
> The fact that hedge fund managers live from the fees tells what they really think about their skills. Never gamble using your own money.
Most hedge funds don't gamble, but some do have poor risk management (e.g. Melvin Capital).
The proposition of a hedge fund is actually very compelling to institutional money: range-bound returns in any type of market environment. This proposition bodes very well for say major pension funds that want to avoid market risk while also modeling out return + pension liabilities at an assumed rate of return.
Most hedge funds don't gamble, but some do have poor risk management (e.g. Melvin Capital).
The proposition of a hedge fund is actually very compelling to institutional money: range-bound returns in any type of market environment. This proposition bodes very well for say major pension funds that want to avoid market risk while also modeling out return + pension liabilities at an assumed rate of return.
There should be another 10 year bet based this.
Take some risk profile and then bet that low cost automatically balancing stock/bond Vanguard fund beats 90% of hedge funds over 10 years based on risk adjusted return.
Take some risk profile and then bet that low cost automatically balancing stock/bond Vanguard fund beats 90% of hedge funds over 10 years based on risk adjusted return.
> Take some risk profile and then bet that low cost automatically balancing stock/bond Vanguard fund beats 90% of hedge funds over 10 years based on risk adjusted return.
That would be a closer "apples to apples" comparison vs. Buffett's bet.
That would be a closer "apples to apples" comparison vs. Buffett's bet.
But this risk-adjusted thing is just silly: either you have the money or you do not. I do not care about the risk.
Do you believe the following investments are equally attractive?
1. You invest $100,000 into a fund which has a 1% chance of returning 100% and 99% chance of returning -100% each year.
2. You invest $100,000 into a fund which has a 20% chance of returning 100% and a 80% chance of returning -100% each year.
The possible payouts are the same. The expected values are not. Given the opportunity to invest in both with no difference in fees or other structure, would you leave your decision up to a coin flip?
1. You invest $100,000 into a fund which has a 1% chance of returning 100% and 99% chance of returning -100% each year.
2. You invest $100,000 into a fund which has a 20% chance of returning 100% and a 80% chance of returning -100% each year.
The possible payouts are the same. The expected values are not. Given the opportunity to invest in both with no difference in fees or other structure, would you leave your decision up to a coin flip?
I think a better example might be:
1. 10% chance of returning 100%, 90% chance of 0%
2. 90% chance of returning 10%, 10% chance of 0%
Same expected value in year 1, but totally different proposition. And, with compounding returns, the expected value over time is very different.
1. 10% chance of returning 100%, 90% chance of 0%
2. 90% chance of returning 10%, 10% chance of 0%
Same expected value in year 1, but totally different proposition. And, with compounding returns, the expected value over time is very different.
exactly AM-GM inequality, volatility drag, etc
> But this risk-adjusted thing is just silly: either you have the money or you do not
Money is not a limiting factor, risk is. If you have a low risk strategy, you won't have problems borrowing money to invest in it.
Its not silly, because the amount of reward depend on amount of risk.
So, if you compare returns of different strategies/funds, you need to first rescale them to the same amount of risk
Money is not a limiting factor, risk is. If you have a low risk strategy, you won't have problems borrowing money to invest in it.
Its not silly, because the amount of reward depend on amount of risk.
So, if you compare returns of different strategies/funds, you need to first rescale them to the same amount of risk
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> The fact that hedge fund managers live from the fees tells what they really think about their skills.
Hedge funds have both management and performance fees. Management fees exist because whatever the result, there are employees that worked to deliver it. I don't see why you think that I appropriate.
Hedge funds have both management and performance fees. Management fees exist because whatever the result, there are employees that worked to deliver it. I don't see why you think that I appropriate.
From the investor point the work they do is not worth of it as this bet demonstrates.
Performance fees are never structured so that incentives align. You will eventually get high-water mark (HWM) performance fees just because there is random fluctuation.
Performance fees are never structured so that incentives align. You will eventually get high-water mark (HWM) performance fees just because there is random fluctuation.
There should be a fund that guarantees a return in excess of an index (adjusted for fees).
In exchange the fund managers would get fees and excess returns on their clients capital.
This way instead of arguing over which approach is better, both groups can benefit from one another.
An example could work like this:
Someone (Goldman, why not) starts a fund called the AlphaPlus fund. Its a mutual fund. You pay a 10% up front commission to get into it, and can withdraw your money whenever you want. Goldman promises to return the exact same as the S&P 500 *PLUS* 1% apr.
Say I hold for 5 years and want to get out. The S&P goes up 10% per year during that time. Goldman owes me whatever an 11% rate of return on whatever I invested up front.
Say I hold the fund for 5 years and want to get out. The S&P has a rate of return of -12% apr. Goldman owes me a -11% rate of return on my principal.
Goldman does this because they get a fat 10% upfront fee from me, plus they can use their super-wizard skills to invest my money in something that returns like 30% apr. Thus, their profit is fees + however much they can beat the market by (and the 1% they owe me).
(edited to give better example given access to keyboard)
In exchange the fund managers would get fees and excess returns on their clients capital.
This way instead of arguing over which approach is better, both groups can benefit from one another.
An example could work like this:
Someone (Goldman, why not) starts a fund called the AlphaPlus fund. Its a mutual fund. You pay a 10% up front commission to get into it, and can withdraw your money whenever you want. Goldman promises to return the exact same as the S&P 500 *PLUS* 1% apr.
Say I hold for 5 years and want to get out. The S&P goes up 10% per year during that time. Goldman owes me whatever an 11% rate of return on whatever I invested up front.
Say I hold the fund for 5 years and want to get out. The S&P has a rate of return of -12% apr. Goldman owes me a -11% rate of return on my principal.
Goldman does this because they get a fat 10% upfront fee from me, plus they can use their super-wizard skills to invest my money in something that returns like 30% apr. Thus, their profit is fees + however much they can beat the market by (and the 1% they owe me).
(edited to give better example given access to keyboard)
If Goldman had a way to guarantee returns above the market why would they sell that to anyone? Or put it another way, who is the sucker that is taking the other side of those Goldman trades to get returns guaranteed to be below market? Total market returns are zero sum.
Say Goldman can beat the market by 20%. They sell you a fund that promises to beat it by 1%. The additional 19% return on YOUR MONEY they keep.
You are guaranteed alpha at exactly 1%. Goldman makes fees and infinity ROI for taking risk. Win-Win.
You are guaranteed alpha at exactly 1%. Goldman makes fees and infinity ROI for taking risk. Win-Win.
> Say Goldman can beat the market by 20%.
if they could do that, they could just keep that 20% and they'd be already ahead. Why do they need to pay you 1% for your money?!
if they could do that, they could just keep that 20% and they'd be already ahead. Why do they need to pay you 1% for your money?!
In general (not answering this specific case), a fund wants more money under management, because they get percentages of more money that way (they have more leverage). You might be assuming Goldman has infinite money - they don't. Here's how to think of this:
Say I'm an investing wizard - I can generate 20% returns on any money invested.
Scenario 1: I have 100k capital, which means after one year, I'll have 120k. I made 20%, but in practice that's 20k.
Scenario 2: Now say I sell to you my wizarding ability by giving you 10% and keeping 10%. I'm giving you half the upside. However, you are a rich bank that invests 100m. I turn it after one year into 120m, give you half of that and keep half, so you've gotten 10m and I've gotten 10m.
Now percentage-wise, obviously I'm ahead in scenario 1, but in real terms, obviously I prefer scenario 2 - I've gotten 10m dollars instead of 20k dollars.
Btw in the real world, if I have to invest more money, my prowess goes down. So with 100k I can do 20%, with 1m I can do say 19%, etc. So what you'd expect to have happen is that more and more people will invest, because it's worth it to them, until eventually my abilities go down to just generic S&P level. Up to then, it's worth it for every extra investor to invest, because even if I'm only beating the market by 1%, that's a lot, but eventually I'm managing enough money such that I'm just rivaling the S&P. So from the outside, it looks like I'm not really doing anything special, but it was totally worth it for every investor until now.
Say I'm an investing wizard - I can generate 20% returns on any money invested.
Scenario 1: I have 100k capital, which means after one year, I'll have 120k. I made 20%, but in practice that's 20k.
Scenario 2: Now say I sell to you my wizarding ability by giving you 10% and keeping 10%. I'm giving you half the upside. However, you are a rich bank that invests 100m. I turn it after one year into 120m, give you half of that and keep half, so you've gotten 10m and I've gotten 10m.
Now percentage-wise, obviously I'm ahead in scenario 1, but in real terms, obviously I prefer scenario 2 - I've gotten 10m dollars instead of 20k dollars.
Btw in the real world, if I have to invest more money, my prowess goes down. So with 100k I can do 20%, with 1m I can do say 19%, etc. So what you'd expect to have happen is that more and more people will invest, because it's worth it to them, until eventually my abilities go down to just generic S&P level. Up to then, it's worth it for every extra investor to invest, because even if I'm only beating the market by 1%, that's a lot, but eventually I'm managing enough money such that I'm just rivaling the S&P. So from the outside, it looks like I'm not really doing anything special, but it was totally worth it for every investor until now.
>Why do they need to pay you 1% for your money
Das Capital!
Das Capital!
The why is access to additional capital.
Could you give an example? I am rereading your sentences but I just don't understand what you're saying. I feel silly, but I really don't get it.
You don't get excess returns without risk. If you want guarantees, it will cost you extra. Nobody manages your money for the kindness of their hearts.
Several funds have performance fees. It's typically the high-water mark (HWM) fee for profits above reference index returns.
Several funds have performance fees. It's typically the high-water mark (HWM) fee for profits above reference index returns.
Just to be clear a high water mark isn't a hurdle rate in the sense the OP was talking about.
In hedge fund land a high water mark means that if a fund loses money they won't take fees again until they've gotten back to their original high water mark.
ie you invest at 100, they gain 10% after fees so your units are worth 110.
The next year they lose 10% so your units are worth approx. 99.
Now the high water mark is 110.
Next year they make 5% so your units are worth approx. 104%. T his year the fund doesn't take performance fees as they haven't cleared their high water mark yet.
Point being the high water mark is relative to their own fund and has nothing to do with the market or any other benchmark.
If a fund only takes performance fees after a certain hurdle rate that is becoming more common but would be described by some other term.
In hedge fund land a high water mark means that if a fund loses money they won't take fees again until they've gotten back to their original high water mark.
ie you invest at 100, they gain 10% after fees so your units are worth 110.
The next year they lose 10% so your units are worth approx. 99.
Now the high water mark is 110.
Next year they make 5% so your units are worth approx. 104%. T his year the fund doesn't take performance fees as they haven't cleared their high water mark yet.
Point being the high water mark is relative to their own fund and has nothing to do with the market or any other benchmark.
If a fund only takes performance fees after a certain hurdle rate that is becoming more common but would be described by some other term.
This is called a hurdle and many funds use them. Buffet's bet was against funds of funds which are basically indices tracking certain hedge funds, not hedge funds themselves.
Ironically Buffett started with exactly this over half a century ago-- setting a cumulative hurdle rate of 6%-- meaning he wouldn't take fees unless investors made at least 6%. He beat the Dow (S&P 500 wasn't really a thing during the Buffet Partnerships) every single year.
Almost all hedge funds have a hurdle rate
This bet is disengeneous as *most hedge funds operate under risk neutral long /short strategies that seek to generate returns irrespective of market conditions.
Want to know what a good year for a PM at a major platform hedge fund (P72, BAM, Millenium, etc... ) looks like? Probably in the range of 8 -12% returns, which translates to 7-figure pay days.
A more in depth explanation below from the article is linked below.
> Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional “relative-return” investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.
Want to know what a good year for a PM at a major platform hedge fund (P72, BAM, Millenium, etc... ) looks like? Probably in the range of 8 -12% returns, which translates to 7-figure pay days.
A more in depth explanation below from the article is linked below.
> Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional “relative-return” investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.
Every year there are hedge fund managers that outperform the market. The trick is knowing at the beginning of the year which manager that’s going to be.
Absent that crystal ball, a portfolio of hedge funds is a strictly more expensive way of investing than an index fund.
Absent that crystal ball, a portfolio of hedge funds is a strictly more expensive way of investing than an index fund.
This is false. If you work in the industry there are consistent winners.
And, as I understand from Bogle's (admittedly dated) book, when that happens everyone rushes into the fund and it begins to underperform due to its increased weight/influence (see Peter Lynch's Magellan Fund).
No. Some portfolio managers are just good. This whole no one can beat the market is non sense.
So is your argument that we just haven’t been through a cycle or else the hedge funds would have come out ahead? If they didn’t come out ahead after all of the turmoil, they are (on average) worse than an index fund.
> So is your argument that we just haven’t been through a cycle or else the hedge funds would have come out ahead? If they didn’t come out ahead after all of the turmoil, they are (on average) worse than an index fund.
No. The proposition of most platform hedge funds is not to beat the market. It's to generate returns in any type of environment on a risk neutral basis.
So if you invest in a hedge fund, do not expect market returns. Expect range-bound returns in any type of market environment.
Hedge funds are risk management vehicles for institutional money.
No. The proposition of most platform hedge funds is not to beat the market. It's to generate returns in any type of environment on a risk neutral basis.
So if you invest in a hedge fund, do not expect market returns. Expect range-bound returns in any type of market environment.
Hedge funds are risk management vehicles for institutional money.
That hedge fund manager that took the bet surely mustn’t know what he is talking about!
Please read the article. It's explained clearly under Protege Partners, LLC's Argument.
> Mr. Buffett is correct in his assertion that, on average, active management in a narrowly defined universe like the S&P; 500 is destined to underperform market indexes. That is a well-established fact in the context of traditional long-only investment management. But applying the same argument to hedge funds is a bit of an apples-to-oranges comparison.
> Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional “relative-return” investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.
> Mr. Buffett is correct in his assertion that, on average, active management in a narrowly defined universe like the S&P; 500 is destined to underperform market indexes. That is a well-established fact in the context of traditional long-only investment management. But applying the same argument to hedge funds is a bit of an apples-to-oranges comparison.
> Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional “relative-return” investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.
I feel as though both arguments presented only in passing mention that this is a bet on funds of hedge funds, rather than hedge funds themselves. These are products which allow unaccredited investors to invest in hedge funds indirectly, with the (massive) caveats that they are paying two layers of fees and have no ability to choose which funds they are interested in.
This is very different to a bet against hedge funds or even an argument against them. Hedge funds are designed to serve sophisticated investors with complex needs.
This is very different to a bet against hedge funds or even an argument against them. Hedge funds are designed to serve sophisticated investors with complex needs.
Buffett won. However, several caveats apply when using this bet to draw conclusions:
1. Buffett bet against aggregate performance of hedge funds as an investment vehicle. If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily.
2. Buffett used absolute returns as the performance metric, not risk-adjusted returns. A portfolio with lower absolute returns but a significantly better idiosyncratic risk profile (and correlation to market/beta) can be superior to a portfolio with higher absolute returns but also higher risk.
Taken together, this means that Buffett's bet is a statement about the aggregate performance of the industry. It is not instructive for what performance is possible, or even for whether or not you should invest with the modal hedge fund (given the opportunity). It depends on investment goals and risk needs. It's also worth pointing out that "risk needs" is multi-dimensional, not just a sliding scale of how much e.g. leverage you're willing to accept. There is an entire sub-industry of hedge funds which explicitly expect to underperform on an absolute basis for long periods of time, but which service their clients with highly bespoke risk products. Clients are frequently well-informed and happy with this arrangement.
I say this because there is a tendency for people outside the industry to come away thinking hedge funds are a scam. Which...well, many are, to put it bluntly. But it's a lot more complicated and this isn't really the smoking gun you'd think it is.
1. Buffett bet against aggregate performance of hedge funds as an investment vehicle. If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily.
2. Buffett used absolute returns as the performance metric, not risk-adjusted returns. A portfolio with lower absolute returns but a significantly better idiosyncratic risk profile (and correlation to market/beta) can be superior to a portfolio with higher absolute returns but also higher risk.
Taken together, this means that Buffett's bet is a statement about the aggregate performance of the industry. It is not instructive for what performance is possible, or even for whether or not you should invest with the modal hedge fund (given the opportunity). It depends on investment goals and risk needs. It's also worth pointing out that "risk needs" is multi-dimensional, not just a sliding scale of how much e.g. leverage you're willing to accept. There is an entire sub-industry of hedge funds which explicitly expect to underperform on an absolute basis for long periods of time, but which service their clients with highly bespoke risk products. Clients are frequently well-informed and happy with this arrangement.
I say this because there is a tendency for people outside the industry to come away thinking hedge funds are a scam. Which...well, many are, to put it bluntly. But it's a lot more complicated and this isn't really the smoking gun you'd think it is.
But that assumes that one could predict in advance what those highest performing funds would be. Of course the highest performing XXX will be above average. The point is that no one can consistently predict which ones will be the highest performing XXX. Worse still, regression to the mean indicates that if, in 2021 you invest in the highest performing XXX of the preceding X years, you're more likely to get returns below average.
And let's suppose that there really is a fund staffed by a group of super-geniuses who can reliably pick the best performing stocks. There are two possibilities: They take on more and more investment capital until their returns end up getting closer to the mean or they don't accept new investments and the hypothetical new investor is left out in the cold.
And let's suppose that there really is a fund staffed by a group of super-geniuses who can reliably pick the best performing stocks. There are two possibilities: They take on more and more investment capital until their returns end up getting closer to the mean or they don't accept new investments and the hypothetical new investor is left out in the cold.
> Worse still, regression to the mean indicates that if, in 2021 you invest in the highest performing XXX of the preceding X years, you're more likely to get returns below average.
No, returns of the average. Regression to the mean means, well, what it says: it regresses to the mean, not past it.
Your version is what we call the gambler's fallacy!
No, returns of the average. Regression to the mean means, well, what it says: it regresses to the mean, not past it.
Your version is what we call the gambler's fallacy!
The gambler's fallacy is applying past events that have already happened to randomized trials in the future.
This is not the same because outlier movement of macro demographics and financial policy does have an impact on the future. If the stock market were random on a macro scale it would average zero movement.
This is not the same because outlier movement of macro demographics and financial policy does have an impact on the future. If the stock market were random on a macro scale it would average zero movement.
I agree with all of that and I still think expecting an unusual low after an unusual high is indicative of the gambler's fallacy.
No I didn't assume that, I fully agree with you. Funds which are capable of consistently (and safely) beating the market on an absolute basis eventually cap their AUM and return outside capital.
> If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily.
Is that "funds which performed well before 2008" or "funds which have performed mostly well since 2008"? The former makes sense since the latter is largely hindsight/time travel but couldn't the challenged party have picked those funds for their side of the bet back in 2008 anyway?
Is that "funds which performed well before 2008" or "funds which have performed mostly well since 2008"? The former makes sense since the latter is largely hindsight/time travel but couldn't the challenged party have picked those funds for their side of the bet back in 2008 anyway?
> There is an entire sub-industry of hedge funds which explicitly expect to underperform on an absolute basis for long periods of time, but which service their clients with highly bespoke risk products. Clients are frequently well-informed and happy with this arrangement.
Care to expand on this with some examples?
Care to expand on this with some examples?
Sure - off the top of my head, basically any fund or advisor which specializes in derivatives volatility. Universa Investments is a specific example, but you can find more by searching for those criteria.
> 1. Buffett bet against aggregate performance of hedge funds as an investment vehicle. If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily.
I don't think this is a caveat. I think this is the point. You don't compare yourself to the literally one guy who won the lottery, you compare yourself to everybody that bought a lottery ticket.
> I say this because there is a tendency for people outside the industry to come away thinking hedge funds are a scam. Which...well, many are, to put it bluntly.
I don't think anybody is assuming every hedge fund on Earth is a scam from this any more than they think lottery tickets are a scam. As you mentioned yourself:
> Taken together, this means that Buffett's bet is a statement about the aggregate performance of the industry.
I apologize if I'm being presumptuous, but is this not so obvious that it can be assumed?
I don't think this is a caveat. I think this is the point. You don't compare yourself to the literally one guy who won the lottery, you compare yourself to everybody that bought a lottery ticket.
> I say this because there is a tendency for people outside the industry to come away thinking hedge funds are a scam. Which...well, many are, to put it bluntly.
I don't think anybody is assuming every hedge fund on Earth is a scam from this any more than they think lottery tickets are a scam. As you mentioned yourself:
> Taken together, this means that Buffett's bet is a statement about the aggregate performance of the industry.
I apologize if I'm being presumptuous, but is this not so obvious that it can be assumed?
I was probably a little unclear. Basically I'm saying all you can take away from this is a statement about aggregate performance. You're not doing this in your comment, but I frequently see people on HN extrapolate this bet to support the idea that there's no such thing as a hedge fund which beats the market, or which is a worthwhile investment, etc.
You can't derive a conclusion about individual hedge funds from this. That might seem obvious to you, but maybe you'd be surprised then :)
You can't derive a conclusion about individual hedge funds from this. That might seem obvious to you, but maybe you'd be surprised then :)
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> That might seem obvious to you, but maybe you'd be surprised then :)
Fair. I've been surprised by the ignorance of people before, including myself!
Fair. I've been surprised by the ignorance of people before, including myself!
The lesson I take from the bet is: you can only be very smart if you have a lot of money. Otherwise, do no try in the long run*. And I stick to that (because I just want to keep a living in the future, not to be rich).
"Risk-adjustment" is just another metric which makes not much sense: either I have the money or I do not. Money now is worth more than possible money tomorrow.
About "the highest performing funds of the past 10 - 30", which ones, the two first ones, the Medallion fund? those which cannot be used by ordinary people?
I know Buffet is not exactly the paradigm of "ordinarity" but nevertheless, I think his intention with his stubborn support of "just the market" is to teach that "ordinary people can very seldom outperform the market".
"Risk-adjustment" is just another metric which makes not much sense: either I have the money or I do not. Money now is worth more than possible money tomorrow.
About "the highest performing funds of the past 10 - 30", which ones, the two first ones, the Medallion fund? those which cannot be used by ordinary people?
I know Buffet is not exactly the paradigm of "ordinarity" but nevertheless, I think his intention with his stubborn support of "just the market" is to teach that "ordinary people can very seldom outperform the market".
> Risk-adjustment" is just another metric which makes not much sense: either I have the money or I do not. Money now is worth more than possible money tomorrow.
If you think risk-adjustment doesn't make sense as an evaluation metric, you should just sell naked puts or calls on a stock which doesn't seem volatile. You're going to generate spectacular returns for a while. Then you're going to blow up.
On the other hand a portfolio with relatively low idiosyncratic risk and low market correlation (beta) might be safely levered up to a higher absolute return than e.g. SPY with less overall risk and volatility.
Like I said...it's complicated.
If you think risk-adjustment doesn't make sense as an evaluation metric, you should just sell naked puts or calls on a stock which doesn't seem volatile. You're going to generate spectacular returns for a while. Then you're going to blow up.
On the other hand a portfolio with relatively low idiosyncratic risk and low market correlation (beta) might be safely levered up to a higher absolute return than e.g. SPY with less overall risk and volatility.
Like I said...it's complicated.
"Money now is worth more than possible money tomorrow."
That is antithetical to investing...
That is antithetical to investing...
> Buffett bet against aggregate performance of hedge funds as an investment vehicle.
He let an expert pick the funds of funds. AFAIK, he didn't restrict which funds the expert picked.
> If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily.
This is like saying "If I only bet on the teams who won the world cup, I would always make money". Past performance is no guarantee of future returns.
> this isn't really the smoking gun you'd think it is.
If the bet wasn't the best way to show the relative value of these investments, is there a better way? Or is the answer really "if you need a hedge fund as part of your portfolio, you probably aren't coming to HN for investment advice"?
He let an expert pick the funds of funds. AFAIK, he didn't restrict which funds the expert picked.
> If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily.
This is like saying "If I only bet on the teams who won the world cup, I would always make money". Past performance is no guarantee of future returns.
> this isn't really the smoking gun you'd think it is.
If the bet wasn't the best way to show the relative value of these investments, is there a better way? Or is the answer really "if you need a hedge fund as part of your portfolio, you probably aren't coming to HN for investment advice"?
> Or is the answer really "if you need a hedge fund as part of your portfolio, you probably aren't coming to HN for investment advice"?
Yeah, that's basically the answer. Retail investors don't typically need to optimize their portfolios with bespoke investment vehicles. Their exposure and goals aren't complicated.
Yeah, that's basically the answer. Retail investors don't typically need to optimize their portfolios with bespoke investment vehicles. Their exposure and goals aren't complicated.
The lesson Warren's making isn't that you can't beat the market. Of course, Warren himself is an example you can. It's also not a statement about any individual hedge fund, which may have "different goals only for sophisticated investors."* Instead, it's that on balance, by far most managers don't beat the S&P 500 on an after-fee basis.
And if you include taxes in those fees and the benefit of deferred tax liabilities it's even harder to beat an index fund.
* It's reasonable to be skeptical about any fund having a goal that's anything other then maximizing long-term returns.
And if you include taxes in those fees and the benefit of deferred tax liabilities it's even harder to beat an index fund.
* It's reasonable to be skeptical about any fund having a goal that's anything other then maximizing long-term returns.
Furthermore he’s making the point that you cannot tell in advance which managers, if any, will outperform the market over a given period.
Buffet himself has a couple factors that help him outperform which you and I likely don’t. For one thing, he often buys private companies (not a liquid market with constant price discovery like the public stock market). That’s not uncommon, even if it’s out of reach of most retail investors. More unattainable for the rest of us, he has the “Buffett Halo” effect: stocks often go up just because he bought them! This effect also induces companies to give him a discount on equity, because the existing shareholders benefit from the halo. Obviously Buffett must still work hard to choose stocks wisely, or the halo would evaporate over time.
Buffet himself has a couple factors that help him outperform which you and I likely don’t. For one thing, he often buys private companies (not a liquid market with constant price discovery like the public stock market). That’s not uncommon, even if it’s out of reach of most retail investors. More unattainable for the rest of us, he has the “Buffett Halo” effect: stocks often go up just because he bought them! This effect also induces companies to give him a discount on equity, because the existing shareholders benefit from the halo. Obviously Buffett must still work hard to choose stocks wisely, or the halo would evaporate over time.
2 points;
the “Buffett Halo” effect I dont think is fair to include. This is very real but its also temporary. Consider stuff like his failed Tesco investment. Long term we get back to fundamentals.
The big advantage I think worth mentioning is Buffet also buys control much of the time he invests. You and I buy shares to go along for the ride. He buys in on value + they ability to control direction + typically do share buybacks that further increases the per-share value and uses the companies own money to grow value further. This is a real game changer beyond the traditional value approach you and I will never have.
the “Buffett Halo” effect I dont think is fair to include. This is very real but its also temporary. Consider stuff like his failed Tesco investment. Long term we get back to fundamentals.
The big advantage I think worth mentioning is Buffet also buys control much of the time he invests. You and I buy shares to go along for the ride. He buys in on value + they ability to control direction + typically do share buybacks that further increases the per-share value and uses the companies own money to grow value further. This is a real game changer beyond the traditional value approach you and I will never have.
Further, it's impossible to know which hedge fund will beat the market. Using their past performance is not reliable over the long term.
Renaissance tho
As Rentec tidbits continue to leak over the years, you wonder how much of their gains are tax loophole engineering vs financial wizardry.
Or how much of their returns are just massive leverage being deployed and hidden from the rest of us? They constantly return investor money and cap the sizes of the private fund.
which means it is easy to beat the market, most of them lose only because of taxman takes the profit away?
Or how much of Medallion's gains are just front-run their clients in their public-facing fund.
> Instead, it's that on balance, by far most managers don't beat the S&P 500 on an after-fee basis.
Interestingly, most managers actually do match the S&P500, but before fees. I don't have a link handy, but there have been some academic papers on their performance.
Interestingly, most managers actually do match the S&P500, but before fees. I don't have a link handy, but there have been some academic papers on their performance.
The average active manager who mostly uses stocks in the S&P 500 matches the S&P 500, before fees, almost by definition. Given that the vast majority of passive investment is approximately tracking the S&P 500, active managers -- the complement of the passive set -- must also have the same average. The only way active managers could average something substantially different is if passive investments underperformed or overperformed, neither of which are the case.
Most funds end up so large that they can’t help but to be basically the s&p 500, just with slightly different weightings.
To majorly out perform or underperform you have to be drastically different.
To majorly out perform or underperform you have to be drastically different.
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> most managers actually do match the S&P500, but before fees.
so what exactly are you paying them their fees for then?
Either way, for an active manager to be worth their fees, they _have_ to beat the index by more than their fees plus a bit more to make up for the risk that they don't. Otherwise, you'd be better off in a passive fund.
so what exactly are you paying them their fees for then?
Either way, for an active manager to be worth their fees, they _have_ to beat the index by more than their fees plus a bit more to make up for the risk that they don't. Otherwise, you'd be better off in a passive fund.
No, his bet is that these products which provide exposure to hedge funds for retail investors are not worth it. If he wanted to bet against hedge funds in general, then the bet would have been constructed like that (i.e. average performance of funds which aim to beat the market).
> * It's reasonable to be skeptical about any fund having a goal that's anything other then maximizing long-term returns.
I really don't think it is. If I'm a sophisticated investor, I may want to invest in funds which hedge against tail-risk, or provide broad exposure to some specific sector, etc. Neither of these things are about maximising returns relative to the S&P500. There are strategies with negative expected returns in the long-run, but when added to a portfolio can improve its returns. Portfolio construction can get very complex.
> * It's reasonable to be skeptical about any fund having a goal that's anything other then maximizing long-term returns.
I really don't think it is. If I'm a sophisticated investor, I may want to invest in funds which hedge against tail-risk, or provide broad exposure to some specific sector, etc. Neither of these things are about maximising returns relative to the S&P500. There are strategies with negative expected returns in the long-run, but when added to a portfolio can improve its returns. Portfolio construction can get very complex.
> If he wanted to bet against hedge funds in general, then the bet would have been constructed like that (i.e. average performance of funds which aim to beat the market).
Quoting the shareholder's letter from 2016 [1], the actual bet was "that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. [...] For Protégé Partners’ side of our ten-year bet, Ted picked five funds-of-funds whose results were to be averaged and compared against my Vanguard S&P index fund."
[1] https://www.berkshirehathaway.com/letters/2016ltr.pdf
Quoting the shareholder's letter from 2016 [1], the actual bet was "that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. [...] For Protégé Partners’ side of our ten-year bet, Ted picked five funds-of-funds whose results were to be averaged and compared against my Vanguard S&P index fund."
[1] https://www.berkshirehathaway.com/letters/2016ltr.pdf
> If I'm a sophisticated investor, I may want to invest in funds which hedge against tail-risk
Do tail-risk-targeting hedge funds have a better incentive than 2-and-20? Honest question, I have no idea. I assume 2-and-20 drives shooting for the moon and closing the fund if it doesn’t work out.
Do tail-risk-targeting hedge funds have a better incentive than 2-and-20? Honest question, I have no idea. I assume 2-and-20 drives shooting for the moon and closing the fund if it doesn’t work out.
Well, no. From Warren himself: "I made the bet... (2) to
publicize my conviction that my pick – a virtually cost-free investment in an unmanaged S&P 500 index fund – would,
over time, deliver better results than those achieved by most investment professionals, however well-regarded and
incentivized those “helpers” may be."
[1] https://www.berkshirehathaway.com/letters/2017ltr.pdf.
And, regarding being skeptical of things like "hedging risks" and "complex portfolios," I don't know. I'm just not sure enough hedge funds really do a great job handling tail risks to not be skeptical of all of them as a group. And, surely sophisticated investors can target specific sectors and build arbitrarily complex portfolios (if they're into that sort of thing) with passive things like ETFs for much lower fees on their own.
And, regarding being skeptical of things like "hedging risks" and "complex portfolios," I don't know. I'm just not sure enough hedge funds really do a great job handling tail risks to not be skeptical of all of them as a group. And, surely sophisticated investors can target specific sectors and build arbitrarily complex portfolios (if they're into that sort of thing) with passive things like ETFs for much lower fees on their own.
That's clearly not a bet against hedge funds, but 'investment professionals', which in this case are these people offering pooled funds to the retail market. I agree with it and I'm sure many people in the hedge fund industry would agree with it.
I'm not talking about all hedge funds managing tail risk for their own portfolios, but funds which are designed to do nothing but hedge against tail risk. They provide a valuable service, and a small allocation to such a fund in concert with a large holding in the S&P500 will often outperform the S&P500, even if the fund itself loses money.
I'm not talking about all hedge funds managing tail risk for their own portfolios, but funds which are designed to do nothing but hedge against tail risk. They provide a valuable service, and a small allocation to such a fund in concert with a large holding in the S&P500 will often outperform the S&P500, even if the fund itself loses money.
> That's clearly not a bet against hedge funds,
This isn't clear to me. To me it seems rather that this is a bet against hedge funds. I can see a way to your interpretation but it does not seem as likely to me.
This isn't clear to me. To me it seems rather that this is a bet against hedge funds. I can see a way to your interpretation but it does not seem as likely to me.
Sounds like Warren Buffett is a boglehead? Or a cheerleader at least.
I confess to having drunk the Kool-aid and can report that I no longer have investment anxiety.
I confess to having drunk the Kool-aid and can report that I no longer have investment anxiety.
I think it’s more like Buffet would say you should either choose the optimal passive investment strategy (index funds), or be a fully active investor yourself (picking your own investment strategy), rather than paying significant fees for someone else (hedge funds) to actively invest for you.
A close relative that's a professional analyst told me: if you have some unique insight on some specific market, use it on the market! (as long as it is actionable into investment choices) You can likely beat the market and experienced analysts, which often don't have that much technical expertise or outstanding insight (instead relying on economic and financial analysis). The few times I did... it worked.
> ...if you have some unique insight on some specific market, use it on the market!
One thing to be cautious of here is that people often overinvest when they have some sort of advantage, and become way too over-leveraged in one single area.
I remember a calculation from a college finance class. Imagine you have an otherwise "optimal" portfolio with 1% of its assets in a particular large stock, but you know that the real average returns of that stock are going to be ~2x what the market is expecting. So you recompute the efficient portfolio with this new information and find the new optimal weight of the stock and it's only something like 2-3% despite having a very strong information advantage over the market.
But most people would think this sounds crazy. "I've got a crazy inside stock tip that it's worth double what everyone else thinks? Shouldn't I put at least 10% of my money in there?" No. Diversity is a hell of a value-add in a portfolio.
One thing to be cautious of here is that people often overinvest when they have some sort of advantage, and become way too over-leveraged in one single area.
I remember a calculation from a college finance class. Imagine you have an otherwise "optimal" portfolio with 1% of its assets in a particular large stock, but you know that the real average returns of that stock are going to be ~2x what the market is expecting. So you recompute the efficient portfolio with this new information and find the new optimal weight of the stock and it's only something like 2-3% despite having a very strong information advantage over the market.
But most people would think this sounds crazy. "I've got a crazy inside stock tip that it's worth double what everyone else thinks? Shouldn't I put at least 10% of my money in there?" No. Diversity is a hell of a value-add in a portfolio.
Hedge funds won’t necessarily have technical experts in every field as employees making investment decisions, but they are paying those people for research. So “more knowledgeable than the average trader” doesn’t mean that you know more than the market is pricing in. That said, the hedge funds with big research budgets focus on large companies, leaving more opportunity in smaller stocks.
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Right, I see this all the time. I never see any examples of what this looks like. Did your friend give you anything regarding that?
Buffet’s latest letter mentions active investors as those who buy with intent to sell, whereas he passively buys without intent to sell.
Buffett is pretty much the exact opposite of a boglehead. Buffett's strategy is to only pick winners. Jack Bogle was in the portfolio theory camp, buying companies regardless of if they appeared good or bad. Both can be profitable, but the boglehead strategy is much easier to do.
Apple at $1000 is not a winner. GameStop at $1 is a winner. If you are Buffet you can start doubting the price that the market sets for the stock. If you are a normal person you will probably be wrong more often than the market so don't bother contradicting it.
Buffett only invests in businesses he likes or could come to like. The best example recently is his divesting of airlines as he realized he no longer loved the business.
Am I missing something here? To me, Buffett's argument sounds like a reformulation of Sharpe's Theorem[0] from 1991, which states that active investors cannot in aggregate outperform passive investors. This is an easily proved theorem, so what's the catch here? Why would anyone bet against a theorem?
[0] https://web.stanford.edu/~wfsharpe/art/active/active.htm
[0] https://web.stanford.edu/~wfsharpe/art/active/active.htm
There's lots of active traders that aren't hedge funds (day traders, prop shops, bored retirees, bored reddit users), so it's reasonable to test/bet/show if the hedge funds confidently putting themselves out as deserving 2 and 20 are worth it, or if it's predictable which specific funds, rather than the aggregate, are worth it.
what is being tested is not that the _average_ active investor won't beat the market, but that it's impossible (or very hard) to pick a set of active investors that would beat the market.
Isn't Warren himself proof that you can? He beat the index over a very protract period of time.
Warren Buffet also does a lot of deals not on the public market. If I'm not mistaken, a minority of Berkshire's money/value is invested in public stock.
This changes the equation somewhat since he can swoop in (dangling a billion dollar check) and do all sorts of research and investments that are unavailable on the open market.
He also (through Geico and other insurance holdings) gets to invest a ton of borrowed money at what amounts to a negative interest rate. (insurance premiums are, in aggregate, a loan to the insurance company until the customers need that money back. With the added benefit that you can repay less than you were given if your business ops are lean enough. That's why Geico pushes to do sales over the phone or internet, much cheaper than agents).
I am, of course, butchering this explanation. If you want an inside look at what he's doing, his letter to shareholders lays it ALL out.
This changes the equation somewhat since he can swoop in (dangling a billion dollar check) and do all sorts of research and investments that are unavailable on the open market.
He also (through Geico and other insurance holdings) gets to invest a ton of borrowed money at what amounts to a negative interest rate. (insurance premiums are, in aggregate, a loan to the insurance company until the customers need that money back. With the added benefit that you can repay less than you were given if your business ops are lean enough. That's why Geico pushes to do sales over the phone or internet, much cheaper than agents).
I am, of course, butchering this explanation. If you want an inside look at what he's doing, his letter to shareholders lays it ALL out.
50% of Berkshire's value / market-cap is in public stock. Everything else they own: Geico, BNSF rail, Berkshire energy, etc. each are the actual minorities.
> Isn't Warren himself proof that you can?
He's not really an "active" investor in the sense he uses the term, I think - his ethos is to buy and hold for a long time - almost the polar opposite of the "managed funds", isn't it?
He's not really an "active" investor in the sense he uses the term, I think - his ethos is to buy and hold for a long time - almost the polar opposite of the "managed funds", isn't it?
He used to be a hands on active investor during his early years by hiring and firing people in the companies he controlled.
Under what time-horizon is the theorem valid for?
It's valid for any time period. The crucial point is that the theorem talks about the aggregate returns. It's like if you have 10 cars in a race, and 3 of them run at exactly the same speed which is the average of all ten (i.e. they follow the index), then the average speed of the remaining 7 (the actively managed) must also match that speed, even if their individual speeds can vary a lot.
No, because Buffett is an individual. The theorem is a statement of aggregate performance.
It's not surprising there exist individual people who are capable of beating the market, just like it's not surprising there exist people who can play sports at an elite level. You likewise wouldn't expect every human to be able to play at the elite level.
Aggregate performance should cluster around a point of central tendency.
It's not surprising there exist individual people who are capable of beating the market, just like it's not surprising there exist people who can play sports at an elite level. You likewise wouldn't expect every human to be able to play at the elite level.
Aggregate performance should cluster around a point of central tendency.
And as Buffet himself has said: as Berkshire grows in size they will have a harder time beating the market simply because they are becoming a bigger part of it.
Buffett hasn't beaten the S&P 500 for a while now:
* https://www.fool.com/investing/2019/12/22/5-reasons-warren-b...
He had a good run though. See "Buffett's Alpha":
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3197185
* https://www.fool.com/investing/2019/12/22/5-reasons-warren-b...
He had a good run though. See "Buffett's Alpha":
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3197185
The second point in your linked article is the exact point I / he was making.
I see
Because the real world very rarely matches the precise conditions to which a theorem applies.
Not saying it would be a good bet, and not the theorem isn't a good heuristic, but it's not as clear-cut as you're saying.
Edit: I also clicked on the link and it doesn't claim to be a theorem or have a formal proof, it just gives heuristic arguments against using active management, which, again, good rules of thumb, but not ironclad proof in the sense you meant.
Not saying it would be a good bet, and not the theorem isn't a good heuristic, but it's not as clear-cut as you're saying.
Edit: I also clicked on the link and it doesn't claim to be a theorem or have a formal proof, it just gives heuristic arguments against using active management, which, again, good rules of thumb, but not ironclad proof in the sense you meant.
Because they think they can predict the future and their business model relies on their customers believing that.
The good news is fees are slowly coming down as it becomes clear most funds provide no value (in stability nor excess return) over an index. In Australia superannuation (retirement fund) fees were $30 billion last year, or 1.6% of GDP. Thats still a lot of money going to small number of people who are not providing much value over the funds charging 0.1%.
I chatted with an affiliate of the counterparty to the bet here - a couple years before the bet ended but clearly when they were gonna lose. They did say two interesting things I'll relay here without necessarily agreeing:
1. Their major thinking is that the growth of index funds is driven by volume of new investors, not necessarily market performance. At some point we hit the diminishing returns of new money into indexes. When that happens we'll see their "guaranteed" growth slow and you'll need to turn to hedge funds for alpha. He thought 10 years was enough for this to play out. Obviously wrong on timing, but not necessarily wrong on outcome.
2. One of the conditions of the bet was that they have lunch once a year to discuss bet progress. Given that charity lunches with Warren are going for 4.5mm today, they essentially got 10 lunches for 100k each. That is...quite valuable for a hedge fund manager.
Now, nobody can sell a loss better than a hedge fund, so I take with a grain of salt. But it is some food for thought.
1. Their major thinking is that the growth of index funds is driven by volume of new investors, not necessarily market performance. At some point we hit the diminishing returns of new money into indexes. When that happens we'll see their "guaranteed" growth slow and you'll need to turn to hedge funds for alpha. He thought 10 years was enough for this to play out. Obviously wrong on timing, but not necessarily wrong on outcome.
2. One of the conditions of the bet was that they have lunch once a year to discuss bet progress. Given that charity lunches with Warren are going for 4.5mm today, they essentially got 10 lunches for 100k each. That is...quite valuable for a hedge fund manager.
Now, nobody can sell a loss better than a hedge fund, so I take with a grain of salt. But it is some food for thought.
For 1) alpha is what you don't want when investing in index funds. Index funds can only stop working if they stop being able to track the market. That can happen if they're such a big part of the market that trading is effectively broken, but 10 years would definitely not be enough to reach that point.
On 1; Is there any data to suggest that inflows to index funds are pouring significantly more money into companies within an index than if people invested directly or with hedge funds?
Absolutely. The ETF space has exploded enormously over the past decade as the Fed pumps trillions of dollars into risk assets.
Having spent most of my career as a hedge fund trader, I absolutely agree with Buffet. But I think a decade of the largest monetary interventions skew the numbers massively in favor of a long only passive investor.
Having spent most of my career as a hedge fund trader, I absolutely agree with Buffet. But I think a decade of the largest monetary interventions skew the numbers massively in favor of a long only passive investor.
I cannot comment on a full macro basis, but it is definitely true that being listed on an index such as S&P 500 will spike the market cap. TSLA was a recent example here. Matt Levine has an interesting piece on this (as usual) regarding trading on index inclusion as securities fraud: https://www.bloomberg.com/opinion/articles/2021-01-05/dystop...
Discussed in 2010:
The biggest bet on longbets.com: $1,000,000 - https://news.ycombinator.com/item?id=1439613 - June 2010 (32 comments)
The biggest bet on longbets.com: $1,000,000 - https://news.ycombinator.com/item?id=1439613 - June 2010 (32 comments)
> Nevertheless, the evidence from more than fifty years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice
> the year-to-year correlation between the outcomes of mutual funds is very small, barely higher than zero. The successful funds in any given year are mostly lucky; they have a good roll of the dice.