Warren Buffett's $1 million bet in January 2008 that an equity Index fund would beat a suite of fund of hedge funds over 10 years has recently received significant press coverage.
The bet was between Buffett and Protégé Partners, a New York hedge fund of funds. Protégé selected five funds of hedge funds to compete against Buffett's selection of a Vanguard fund tracking the S&P 500 Index. A charity chosen by the winner will receive the $1 million when the bet ends on December 31, 2017.
As on January 1, 2013, after five years and half way through the bet, Buffet's choice of index fund has finally moved ahead of the fund of funds for the first time, having returned 8.69% compared with the five fund-of-funds return of 0.13%. At the end of the previous year the Index fund lagged by 0.38%.
The identity of the underlying funds has never been disclosed. However the results of the Dow Jones Credit Suisse Hedge Fund Index have been used as a proxy, as it has roughly tracked the hedge funds chosen, after adjusting for extra fees.
A number of points need to be raised with respect to the performance of the hedge fund of funds. Firstly fund selection can be like stock selection, choosing the best manager is critical to performance.
Secondly Fund of Funds traditionally underperform single funds. They may provide great diversification, but that generally dampens returns even if it does provide much lower volatility.
The main point is that the Index fund had a very significant drawdown of almost -37% in 2008 while the hedge funds fell -24% and deep drawdowns significantly damage the value of compounding. For example, assuming an average return of 5.5% pa over 10 years, $100 accumulates to $170.81 over that time. However assuming a 40% market pullback in year 5 the value declines to $78.41. Even if the 5.5% returns commence again at this point until the end of ten years the value only rises to $97.1 0. Over the decade the investor loses 3%.
Read the entire article from Sean Webster, AFM Research and Database Manager here.
Attached Files:
Buffet Pulls Ahead (pdf format)
