Investment lessons from Warren Buffett's hedge fund bet


Summary

Even though no investment can escape short-term market turbulence, Warren Buffett's hedge fund bet showed low-cost index funds remain an excellent vehicle for sustained long-term investment gains.

The Oracle of Omaha

Warren Buffett is an American investor, businessman and philanthropist, and regarded as one of the world's greatest investors. Since 1970, he has been the chairman and largest shareholder of Berkshire Hathaway Inc., an American multinational conglomerate holding company.

The Million-Dollar Bet

In 2008, Warren Buffett challenged the investment world to a million-dollar bet, claiming that no investment professional would be able to select a collection of five hedge funds that would beat the investment returns of a simple index fund over an extended period. The world's most famous value investor made the bet to publicise the reality that many investors pay staggering sums annually to investment managers, often though several layers of fees, for which they receive no long-term benefit.

Ted Seides, co-manager of Protégé Partners LLC, stepped up to Buffett's challenge. He claimed that top hedge fund managers have surpassed market returns net of all fees, while assuming less risk and asserted that he thinks these results will continue.

Outcome

At the conclusion of the bet, Buffett commented of the hedge fund investment: The results for their investors were dismal – really dismal. The hedge funds returned less than 3% per year over the term of the bet, while Vanguard's S&P 500 Admiral Fund handsomely rewarded its investors with an 8.5% annual return. Over the 10-year period this resulted in a 90% outperformance.

The outcome comes as no surprise, for anyone who understands the steadfast financial reasoning of investment legend Buffett.

Girls Incorporated of Omaha, a non-profit providing out-of-school-time programmes to young woman, was the ultimate beneficiary of the bet and the recipient of the proceeds.

Products do not solve family office challenges

Protecting and growing multi-generational wealth is an extremely challenging assignment. Family offices will forever be bombarded with esoteric investment products claiming to provide market beating returns at a fraction of the risk of the market. These products employ a seemingly endless array of tricks such as complicated trading strategies, timing of the market, rotations through asset classes, etc. However, Warren Buffett's bet has concluded that investors will be substantially worse off relative to a well-managed buy-and-hold investment strategy.

Conclusion

Even though family offices have access to a wide range of expensive and exotic financial products, a well-diversified portfolio of low-cost index funds remains an excellent vehicle for sustained long-term investment gains.



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