By: Laura Walton AFC®
We’re 9 years into this historic bet pitting passive index funds against actively managed hedge funds. Who’s winning? Or, more accurately, by just how much is the index fund trouncing the hedge funds?
My blog last March explained the bet: In 2007, Warren Buffett responded to a question about hedge funds (actively managed funds designed to beat the market, typically used by wealthy investors) by saying “most hedge funds just are not worth the fees they charge”. “In fact,” he said, “I’m willing to make a bet. I can pick a simple, boring investment that will beat any bunch of big hedge funds.”
Ted Seides of Protégé Partners, LLC took his bet. Ted chose a fund comprised of five different hedge funds while Warren chose Vanguard’s S&P 500 Index.
The bet is up December 31, 2017 – the end of this year! So, let’s see the scorecard to date:
Buffett’s fund, Vanguard’s S&P 500 Index, is the clear winner to date. He notes than $1 million invested in the hedge fund “fund-of-funds” would have only gained $220,000, while the index fund would have gained $854,000!
In addition to actively managed funds having a tough time picking winners consistently enough to beat their index fund benchmarks, hedge funds compound the disadvantage by charging out-sized fees. “2/20” is a common fee structure for hedge funds which translates into a 2% management fee (2% of the hedge fund’s assets) as well as a performance fee of as much as 20% of the annual gains.
So, why on earth would people choose to invest in a hedge fund? Turns out there’s a bit of economic behavior involved. Warren Buffet has a theory that speaks to that question – I’ll share it with you in next week’s blog- stay tuned.