Here’s an update on Warren Buffett’s bet against hedge funds.
To summarize what is going on, Warren Buffett bet a hedge fund that it would lose to the S&P 500 index over a 10 year period starting on January 1, 2008.
I mentioned in a post last year that Buffett was winning the bet. The hedge fund, with all its “research” and “expertise,” can’t beat a simple S&P 500 index fund. Since that time the S&P 500 index fund (Buffett’s horse in the race) has widened its lead.
For who those of us who understand how Wall Street operates, we always knew the odds were strongly on Buffett’s side from the beginning. The reality is that hedge funds, on average, have poor performance. They are the quintessential example of survivorship bias.
Here’s how the hedge fund game is played…..
Simply by chance a few of them will do well. They can then tout their three or five year track record. Investment banks that broker the hedge funds will add fuel to the fire. But alas, once money piles into the fund, its performance starts to disappoint. Why does it disappoint? It was never that good to begin with. The reason the particular fund got all that positive attention was because it put up good numbers – but that was simply out of sheer luck.
So Buffett’s bet here is a good one. The math is on his side, but more importantly he can make an example for the public. You can always find a hedge fund with a good track record. The problem is, that track record is probably a result of luck and will not persist into the future.
Photo by Carrie Kellenberger