Back in 2008, America was in the midst of one of the worst recessions ever. The stock market was at a low point and investor confidence and sentiment were low. Those factors didn't stop Warren Buffett from making a one million dollar bet with a hedge fund called Protege Partners.
Terms of the Bet.
Warren Buffett bet on one index fund that invests simply in the S+P 500 while Protege Partners picked five "funds of funds" to invest in. The duration of the bet was for 10 years, so it still isn't quite over yet. But so far, Buffett's selection is destroying the money management firm.
Right now, the fund selected by Buffett is up more than 65% while the money management firm has increased in value by approximately 22%. The bet isn't over, but it would be extremely shocking if the hedge funds managed to catch up to such a huge deficit.
Fees Associated With Each Fund.
Investments in hedge funds typically come with a 2% money management fee and a 20% fee on any profits made in the investment. The fund that Warren Buffett selected charges a fee of exactly .05% per year. Those far lower fees mean that Warren does not have to outperform the index fund by as much to break even. Those greater fees are typical of hedge funds that frequently charge a premium for their services that often isn't deserved.
What Happened?
The S+P 500 returned 6.5% per year over the past eight years, which isn't amazing. But to beat that number, the hedge fund would have needed to reach a return of almost 10% per year over eight years, an almost impossible feat. And the feat is made even more impossible by the fact that each hedge fund diversifies itself, driving the total value of the fund closer to the mean.
And if you're close to the mean, why bother paying additional fees that aren't worth it? It doesn't make any sense.
Buffet Outsmarts Hedge Funds.
Warren Buffett knows that hedge funds charge substantial fees that often make it difficult to turn significant profit. He also knows that, over a wide time frame, an index fund will generally rise in value and provide a return to investors. Warren will likely donate his winning bet to charity, something that he does with a lot of his money.
