Warren Buffett has scooped a cool $1 million after he won a wager that a US tracker fund would outperform of basket of hedge funds over a 10-year period.
The bet was made with Protégé Partners in 2007, a US investment firm that invests in hedge funds. Both sides agreed to hand over the winnings to a charity of their choosing.
Buffett comfortably won the wager. The tracker fund he chose – Vanguard 500 Index Fund Admiral Shares – delivered an average annual return of 7.1 per cent over the past decade. In contrast the basket of hedge funds selected by Protégé Partners produced an average gain of 2.2 per cent.
Buffett has been a fierce critic of the hedge fund industry throughout his career, which is why he decided to put his money where his mouth is in placing the bet. In his annual letter to shareholders last year, he said: ‘The bottom line: when trillions of dollars are managed (on Wall Street) charging high fees, it will usually be the managers who reap outsized profits, not the clients.’
Instead he recommends both large and small investors to ‘stick with low-cost index funds.’ He has also instructed the executors of his will to buy an index tracker for his widow. Buffett has also named his preferred choice – Vanguard's S&P 500 index fund.
Buffett has previously conceded that while active outperformance is not impossible, the odds are stacked against finding a fund manager that will consistently have an edge over the wider stock market they are attempting to beat.
'If 1,000 managers make a market prediction at the beginning of a year, it's very likely that the calls of at least one will be correct for nine consecutive years,’ he said.
'Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet. But there would remain a difference: the lucky monkey would not find people standing in line to invest with him.'
One of the biggest challenges a do-it-yourself investor faces is finding the cream of the crop among the thousands of funds all aiming to do the same thing - beat the market and their peers - as only a few will be able to consistently add significant value over long periods.
This was evident in research carried out by BMO Global Asset Management’s Multi-Manager team. Of 1,129 active funds in 12 major market sectors, only 9.6 per cent (109) delivered above median returns in each of the past three years to the end of September, BMO found.
Damning studies from respected bodies, including the Pensions Institute at Cass Business School, also conclude that investors are better off sticking to tracker funds, which simply aim to replicate the performance of a market index.
This, however, is not a view shared by Money Observer, which advocates mixing and matching between the two styles.
In defence of active management, there are fund managers operating in the UK who over various market cycles have proved their worth by consistently gaining an edge over both the benchmark index and active fund manager rivals.
The trouble is that there are far more mediocrities than gems, which can make finding a winner an uphill task.