In his annual letter to Berkshire Hathaway shareholders, Warren Buffett made a strong case for passive investment strategies in the context of his famous 'Long Bet' with the hedge fund sector.
In 2005, Mr Buffett argued that active investment by professionals (in aggregate) would over 10 years underperform a low-cost index fund.
The veteran investor subsequently publicly offered to wager $500,000 that no investment professional could pick a set of five hedge funds that would deliver better returns to investors than a Vanguard S&P500 index fund over 10 years.
"I then sat back and waited expectantly for a parade of fund managers – who could include their own fund as one of the five – to come forth and defend their occupation," Mr Bufett wrote.
"After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?"
Following more than a year of "the sound of silence", co-manager of fund-of-fund manager Protégé Partners Ted Seides took up the challenge in 2008.
Nine years into into the bet, the five funds-of-funds chosen by Protégé Partners have returned 8.7 per cent, 28.3 per cent, 62.8 per cent, 2.9 per cent and 7.5 per cent.
The S&P index fund backed by Mr Buffett, on the other hand, has gained 85.4 per cent, for a compounded annual increase of 7.1 per cent.
The basket of hedge funds chosen by Protégé Partners has delivered an average of 2.2 per cent, compounded annually.
"Bear in mind that every one of the 100-plus managers of the underlying hedge funds had a huge financial incentive to do his or her best," Mr Buffett said.
"Moreover, the five funds-of-funds managers that Ted selected were similarly incentivised to select the best hedge-fund managers possible because the five were entitled to performance fees based on the results of the underlying funds."
"I’m certain that in almost all cases the managers at both levels were honest and intelligent people. But the results for their investors were dismal – really dismal.
"And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved – fees that were totally unwarranted by performance – were such that their managers were showered with compensation over the nine years that have passed. As Gordon Gekko might have put it: 'Fees never sleep'," Mr Buffett said.
With only one year left in the bet, Mr Seides has conceded that only a "severe market contraction" could see the hedge funds stage an "epic comeback".
At the conclusion of the bet, $1 million will be donated to the charity of the winners' choice – in the likely event of a Buffett win, the recipient will be girls advocacy group Girls Inc.
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