Big Money Failure

Many people believe that the smartest money managers of all are those operating hedge funds. 

These are mutual fund-like products which have much more flexibility than regular mutual funds.  And they’re marketed to the rich.   Fees tend to be really high, and the funds tend to be….exclusive.  You generally need a lot of money if you want to invest in hedge funds.

Warren Buffett views hedge funds as products allowing the rich to steal from the rich. 

Hedge funds, he suggests, are anchored with atrocious fees that erode returns.  And in 2008, he bet $1 million that that nobody could pick ten hedge funds that, as an aggregate, would beat the simple S&P 500 index over the following ten years.

Many people are sold on the idea that hedge funds make reams of money for their investors because of their flexibility.  Fund managers can make bets that the markets are going to fall, and if the markets do, they can collect on those bets and make money.  Hedge fund managers can do the same thing with currencies—betting that a specific currency will rise or fall, and eventually collect on the bet.

But they can also lose a lot of money. 

The most famous hedge fund of all, Long Term Capital Management, was run by a couple of economic Nobel prize laureates.  Their fund performed spectacularly until it was driven into the ground.  From 1994 to 1998, Long Term Capital Management earned annual returns of 40 percent.  But it collapsed and folded in 2000.

When you see aggregate returns of hedge funds, data results for imploding funds (like Long Term Capital Management) don’t get calculated into the averages.  If a hedge fund dies a painful death, as this fund did, the long term returns disappear from the data base.  There are those who think that hedge funds, as a group, can beat the market, but they’re unaware that most Hedge Funds don’t last very long. 

When Princeton University’s Burton Malkiel and Yale school of management Robert Ibbotson conducted an 8 year study on hedge funds, fewer than 25 percent of the studied funds even lasted the full eight years.  And only those that do last (because they perform well) get their results number-crunched into the hedge fund data bases.

I don’t think I would ever bet against Warren Buffett. 

But somebody did.  A group at Protege Partners figured they could pick 10 hedge funds that (as an aggregate) would beat the ten year returns of the S&P 500 index.  We’re four years into the long bet.

Protege Partners feel that they can identify the best hedge fund managers, compile their funds into an index of hedge funds, and create tantalizing returns.  But four years into the contest, Warren Buffett is winning.

Having said that, I have read some conflicting reports from different news sources suggesting that the race is closer than we might think.

But again, to bet against Buffett?  Probably not a wise decision.