You Don’t Need Me

by Nick Hodge, Outsider Club You don’t need me. There’s an easy way you can invest — on your own — and outperform the smartest people and fastest algorithms in New York City. It’s easy. You don’t need to be a “savvy investor.” You don’t need a research team. You don’t even need a broker. In fact, all you need is a single fund. Let me explain… Buffett’s Bet In the heat of the crisis, on January 1, 2008 to be exact, Warren Buffett entered into a bet with Protégé Partners, a hedge fund of hedge funds. Here’s the terms of the bet as posted on LongBets.org:

Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.

The ten-year bet is now 70% over, and the numbers from last year have been tallied… So far, the Oracle remains prophetic. His vehicle, the Vanguard 500 Index (VFIAX) Admiral shares are up 63.5%. It’s up just 19.6% in the same time. Buffett has now been ahead for six straight years. The hedge fund led the first year of the bet — 2008 — when it lost “only” 24% to the Vanguard fund’s 37% loss. Buffett’s Argument Why is the hedge fund getting its ass whooped? Here’s Buffett’s rationale for taking his side of the bet:

A lot of very smart people set out to do better than average in securities markets. Call them active investors. Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore the balance of the universe—the active investors—must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors. Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested. A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.

The costs are huge, to be sure. But they surely aren’t the only reason the hedge fund is losing by a factor of three. Performance is clearly an issue.

8-Year Gold Chart
(Click to Enlarge)

Too many moves. Ill-timed timing. And QE-induced all-time stock highs likely all played parts. Can the hedge fund still win? According to Protégé Partners President Tom Seides, yes, there is a way: The odds now are that we’ll need to see a severe market contraction for our side of the ledger to stage an epic comeback. One lesson from 2008 is that no one wins when that occurs. Of course, that’s not entirely true.

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