[HN Gopher] Warren Buffett's bet against hedge funds at the Long... ___________________________________________________________________ Warren Buffett's bet against hedge funds at the Long Now Foundation (2008-17) Author : mooreds Score : 55 points Date : 2021-02-28 16:20 UTC (6 hours ago) (HTM) web link (longbets.org) (TXT) w3m dump (longbets.org) | the_drunkard wrote: | This bet is disengeneous as *most hedge funds operate under risk | neutral long /short strategies that seek to generate returns | irrespective of market conditions. | | Want to know what a good year for a PM at a major platform hedge | fund (P72, BAM, Millenium, etc... ) looks like? Probably in the | range of 8 -12% returns, which translates to 7-figure pay days. | | A more in depth explanation below from the article is linked | below. | | > Having the flexibility to invest both long and short, hedge | funds do not set out to beat the market. Rather, they seek to | generate positive returns over time regardless of the market | environment. They think very differently than do traditional | "relative-return" investors, whose primary goal is to beat the | market, even when that only means losing less than the market | when it falls. For hedge funds, success can mean outperforming | the market in lean times, while underperforming in the best of | times. Through a cycle, nevertheless, top hedge fund managers | have surpassed market returns net of all fees, while assuming | less risk as well. We believe such results will continue. | tinus_hn wrote: | That hedge fund manager that took the bet surely mustn't know | what he is talking about! | the_drunkard wrote: | Please read the article. It's explained clearly under Protege | Partners, LLC's Argument. | | > Mr. Buffett is correct in his assertion that, on average, | active management in a narrowly defined universe like the | S&P; 500 is destined to underperform market indexes. That is | a well-established fact in the context of traditional long- | only investment management. But applying the same argument to | hedge funds is a bit of an apples-to-oranges comparison. | | > Having the flexibility to invest both long and short, hedge | funds do not set out to beat the market. Rather, they seek to | generate positive returns over time regardless of the market | environment. They think very differently than do traditional | "relative-return" investors, whose primary goal is to beat | the market, even when that only means losing less than the | market when it falls. For hedge funds, success can mean | outperforming the market in lean times, while underperforming | in the best of times. Through a cycle, nevertheless, top | hedge fund managers have surpassed market returns net of all | fees, while assuming less risk as well. We believe such | results will continue. | kortilla wrote: | So is your argument that we just haven't been through a cycle | or else the hedge funds would have come out ahead? If they | didn't come out ahead after all of the turmoil, they are (on | average) worse than an index fund. | the_drunkard wrote: | > So is your argument that we just haven't been through a | cycle or else the hedge funds would have come out ahead? If | they didn't come out ahead after all of the turmoil, they are | (on average) worse than an index fund. | | No. The proposition of most platform hedge funds is not to | beat the market. It's to generate returns in any type of | environment on a risk neutral basis. | | So if you invest in a hedge fund, do not expect market | returns. Expect range-bound returns in any type of market | environment. | | Hedge funds are risk management vehicles for institutional | money. | jameshart wrote: | Every year there are hedge fund managers that outperform the | market. The trick is knowing at the beginning of the year which | manager that's going to be. | | Absent that crystal ball, a portfolio of hedge funds is a | strictly more expensive way of investing than an index fund. | internetslave wrote: | This is false. If you work in the industry there are | consistent winners. | JKCalhoun wrote: | And, as I understand from Bogle's (admittedly dated) book, | when that happens everyone rushes into the fund and it | begins to underperform due to its increased | weight/influence (see Peter Lynch's Magellan Fund). | CapriciousCptl wrote: | The lesson Warren's making isn't that you can't beat the market. | Of course, Warren himself is an example you can. It's also not a | statement about any individual hedge fund, which may have | "different goals only for sophisticated investors."* Instead, | it's that on balance, _by far most managers_ don 't beat the S&P | 500 on an after-fee basis. | | And if you include taxes in those fees and the benefit of | deferred tax liabilities it's even harder to beat an index fund. | | * It's reasonable to be skeptical about any fund having a goal | that's anything other then maximizing long-term returns. | JKCalhoun wrote: | Sounds like Warren Buffett is a boglehead? Or a cheerleader at | least. | | I confess to having drunk the Kool-aid and can report that I no | longer have investment anxiety. | burlesona wrote: | I think it's more like Buffet would say you should either | choose the optimal passive investment strategy (index funds), | or be a fully active investor yourself (picking your own | investment strategy), rather than paying significant fees for | someone else (hedge funds) to actively invest for you. | bidirectional wrote: | No, his bet is that these products which provide exposure to | hedge funds for retail investors are not worth it. If he wanted | to bet against hedge funds in general, then the bet would have | been constructed like that (i.e. average performance of funds | which aim to beat the market). | | > * It's reasonable to be skeptical about any fund having a | goal that's anything other then maximizing long-term returns. | | I really don't think it is. If I'm a sophisticated investor, I | may want to invest in funds which hedge against tail-risk, or | provide broad exposure to some specific sector, etc. Neither of | these things are about maximising returns relative to the | S&P500. There are strategies with negative expected returns in | the long-run, but when added to a portfolio can improve its | returns. Portfolio construction can get very complex. | CapriciousCptl wrote: | Well, no. From Warren himself: "I made the bet... (2) to | publicize my conviction that my pick - a virtually cost-free | investment in an unmanaged S&P 500 index fund - would, over | time, deliver better results than those achieved by most | investment professionals, however well-regarded and | incentivized those "helpers" may be." [1] | https://www.berkshirehathaway.com/letters/2017ltr.pdf. | | And, regarding being skeptical of things like "hedging risks" | and "complex portfolios," I don't know. I'm just not sure | enough hedge funds really do a great job handling tail risks | to not be skeptical of all of them as a group. And, surely | sophisticated investors can target specific sectors and build | arbitrarily complex portfolios (if they're into that sort of | thing) with passive things like ETFs for much lower fees on | their own. | bidirectional wrote: | That's clearly not a bet against hedge funds, but | 'investment professionals', which in this case are these | people offering pooled funds to the retail market. I agree | with it and I'm sure many people in the hedge fund industry | would agree with it. | | I'm not talking about all hedge funds managing tail risk | for their own portfolios, but funds which are designed to | do nothing but hedge against tail risk. They provide a | valuable service, and a small allocation to such a fund in | concert with a large holding in the S&P500 will often | outperform the S&P500, even if the fund itself loses money. | asdfasgasdgasdg wrote: | > That's clearly not a bet against hedge funds, | | This isn't clear to me. To me it seems rather that this | is a bet against hedge funds. I can see a way to your | interpretation but it does not seem as likely to me. | ckastner wrote: | > _If he wanted to bet against hedge funds in general, then | the bet would have been constructed like that (i.e. average | performance of funds which aim to beat the market)._ | | Quoting the shareholder's letter from 2016 [1], the actual | bet was "that no investment pro could select a set of at | least five hedge funds - wildly-popular and high-fee | investing vehicles - that would over an extended period match | the performance of an unmanaged S&P-500 index fund charging | only token fees. [...] For Protege Partners' side of our ten- | year bet, Ted picked five funds-of-funds whose results were | to be averaged and compared against my Vanguard S&P index | fund." | | [1] https://www.berkshirehathaway.com/letters/2016ltr.pdf | cuspycode wrote: | Am I missing something here? To me, Buffett's argument sounds | like a reformulation of Sharpe's Theorem[0] from 1991, which | states that active investors cannot in aggregate outperform | passive investors. This is an easily proved theorem, so what's | the catch here? Why would anyone bet against a theorem? | | [0] https://web.stanford.edu/~wfsharpe/art/active/active.htm | scotty79 wrote: | Because they think they can predict the future and their | business model relies on their customers believing that. | missedthecue wrote: | Isn't Warren himself proof that you can? He beat the index over | a very protract period of time. | jessermeyer wrote: | Under what time-horizon is the theorem valid for? | cuspycode wrote: | It's valid for any time period. The crucial point is that | the theorem talks about the aggregate returns. It's like if | you have 10 cars in a race, and 3 of them run at exactly | the same speed which is the average of all ten (i.e. they | follow the index), then the average speed of the remaining | 7 (the actively managed) must also match that speed, even | if their individual speeds can vary a lot. | fractionalhare wrote: | No, because Buffett is an individual. The theorem is a | statement of aggregate performance. | | It's not surprising there exist individual people who are | capable of beating the market, just like it's not surprising | there exist people who can play sports at an elite level. You | likewise wouldn't expect every human to be able to play at | the elite level. | | Aggregate performance should cluster around a point of | central tendency. | d23 wrote: | And as Buffet himself has said: as Berkshire grows in size | they will have a harder time beating the market simply | because they are becoming a bigger part of it. | missedthecue wrote: | I see | riffraff wrote: | what is being tested is not that the _average_ active investor | won't beat the market, but that it's impossible (or very hard) | to pick a set of active investors that would beat the market. | nabla9 wrote: | The fact that hedge fund managers live from the fees tells what | they really think about their skills. Never gamble using your own | money. | | Any truly successful fund closes itself from investors. If you | really generate profits, there is no reason to give it away after | AUM reaches certain level. | the_drunkard wrote: | > The fact that hedge fund managers live from the fees tells | what they really think about their skills. Never gamble using | your own money. | | Most hedge funds don't gamble, but some do have poor risk | management (e.g. Melvin Capital). | | The proposition of a hedge fund is actually very compelling to | institutional money: range-bound returns in any type of market | environment. This proposition bodes very well for say major | pension funds that want to avoid market risk while also | modeling out return + pension liabilities at an assumed rate of | return. | nabla9 wrote: | There should be another 10 year bet based this. | | Take some risk profile and then bet that low cost | automatically balancing stock/bond Vanguard fund beats 90% of | hedge funds over 10 years based on risk adjusted return. | pfortuny wrote: | But this risk-adjusted thing is just silly: either you have | the money or you do not. I do not care about the risk. | Galanwe wrote: | > But this risk-adjusted thing is just silly: either you | have the money or you do not | | Money is not a limiting factor, risk is. If you have a | low risk strategy, you won't have problems borrowing | money to invest in it. | | Its not silly, because the amount of reward depend on | amount of risk. | | So, if you compare returns of different strategies/funds, | you need to first rescale them to the same amount of risk | fractionalhare wrote: | Do you believe the following investments are equally | attractive? | | 1. You invest $100,000 into a fund which has a 1% chance | of returning 100% and 99% chance of returning -100% each | year. | | 2. You invest $100,000 into a fund which has a 20% chance | of returning 100% and a 80% chance of returning -100% | each year. | | The possible payouts are the same. The expected values | are not. Given the opportunity to invest in both with no | difference in fees or other structure, would you leave | your decision up to a coin flip? | [deleted] | the_drunkard wrote: | > Take some risk profile and then bet that low cost | automatically balancing stock/bond Vanguard fund beats 90% | of hedge funds over 10 years based on risk adjusted return. | | That would be a closer "apples to apples" comparison vs. | Buffett's bet. | Galanwe wrote: | > The fact that hedge fund managers live from the fees tells | what they really think about their skills. | | Hedge funds have both management and performance fees. | Management fees exist because whatever the result, there are | employees that worked to deliver it. I don't see why you think | that I appropriate. | nabla9 wrote: | From the investor point the work they do is not worth of it | as this bet demonstrates. | | Performance fees are never structured so that incentives | align. You will eventually get high-water mark (HWM) | performance fees just because there is random fluctuation. | bidirectional wrote: | I feel as though both arguments presented only in passing mention | that this is a bet on funds of hedge funds, rather than hedge | funds themselves. These are products which allow unaccredited | investors to invest in hedge funds indirectly, with the (massive) | caveats that they are paying two layers of fees and have no | ability to choose which funds they are interested in. | | This is _very_ different to a bet against hedge funds or even an | argument against them. Hedge funds are designed to serve | sophisticated investors with complex needs. | [deleted] | yyy888sss wrote: | The good news is fees are slowly coming down as it becomes clear | most funds provide no value (in stability nor excess return) over | an index. In Australia superannuation (retirement fund) fees were | $30 billion last year, or 1.6% of GDP. Thats still a lot of money | going to small number of people who are not providing much value | over the funds charging 0.1%. | wslack wrote: | Buffett won and it wasn't close: | https://www.investopedia.com/articles/investing/030916/buffe... | bschne wrote: | If I understand this correctly, A--E are not individual | actively-managed funds, but actively managed portfolios of | actively managed funds? | | It would be interesting to see the distribution of returns | among the contained funds. I lean heavily passive personally, | but at least if a not-insignificant fraction of funds | outperformed the index and were dragged down by really bad | returns in others, it would give some indication as to why | people would even _try_ to actively pick where to put their | money... | dehrmann wrote: | Not that it would have changed the outcome, but it was also a | notoriously bad decade for hedge funds. They usually say it's | because of a lack of volatility. It'll be interesting to see | if it stays that way, and if the Robinhood crowd will change | things. | aidenn0 wrote: | Except that as you reduce the sample size, you _expect_ to | have some outperform and some underperform. If you 100x pick | stocks at random, you will expect to see some fraction of | those 100 picks way outperform. | | Any time you reduce the sample size, you increase the | variance, which gives the impression that skill is involved. | In fact from just looking at a single distribution of | outcomes it's not possible to tell if skill or luck is the | cause. | fractionalhare wrote: | There exist funds which have annualized a two-sigma return | over SPY for over 20 years. If you model returns as | approximating a normal distribution (e.g. just luck), and | you model years achieving a return at least two standard | deviations above the mean under a binomial distribution | (i.e. number of years they've been exceptionally lucky), | the likelihood of those track records existing are around 1 | x 10^-37. | | I would call that sufficient evidence to reject the null | hypothesis that the returns are normally distributed, which | is to say it's not luck. If you expand your sample size to | all investment vehicles throughout history, there still | haven't been anywhere nearly enough for such a track record | to emerge by chance. | | Elementary statistics is well equipped to distinguish | between a distribution signifying luck and a distribution | signifying skill. It's structurally the same as assessing | normality, noise, randomness, etc. | riffraff wrote: | > There exist funds which have annualized a two-sigma | return over SPY for over 20 years | | the problem is that _many_ funds have positive returns | until, suddenly, they don't. It's basically as hard to | pick a fund or money manager for the long run as it is to | pick a stock. | | Consider Neil Woodford[0], he beat the market for over | twenty years and was considered the best investor in | Britain. Then started a new set of funds, which went | terribly. It'd have been reasonable to let him manage | your money, but it would still not have worked out. | | [0] https://en.wikipedia.org/wiki/Neil_Woodford | fractionalhare wrote: | That doesn't refute the mathematics demonstrating that | people can reliably do this with skill rather than luck. | Eventually Brady's not going to be able to play football | professionally either. But he still does, and when he | can't do it anymore that won't indict his professional | record. | aphextron wrote: | And now we see that the point of hedge funds has nothing to | with long term investment growth, and everything to do with | short term personal enrichment. When you're playing with | other's money, you don't have to think about steady, decades | long growth. You just have to nail one big return and make | yourself rich on fees. | fgimenez wrote: | I chatted with an affiliate of the counterparty to the bet here - | a couple years before the bet ended but clearly when they were | gonna lose. They did say two interesting things I'll relay here | without necessarily agreeing: | | 1. Their major thinking is that the growth of index funds is | driven by volume of new investors, not necessarily market | performance. At some point we hit the diminishing returns of new | money into indexes. When that happens we'll see their | "guaranteed" growth slow and you'll need to turn to hedge funds | for alpha. He thought 10 years was enough for this to play out. | Obviously wrong on timing, but not necessarily wrong on outcome. | | 2. One of the conditions of the bet was that they have lunch once | a year to discuss bet progress. Given that charity lunches with | Warren are going for 4.5mm today, they essentially got 10 lunches | for 100k each. That is...quite valuable for a hedge fund manager. | | Now, nobody can sell a loss better than a hedge fund, so I take | with a grain of salt. But it is some food for thought. | tybit wrote: | On 1; Is there any data to suggest that inflows to index funds | are pouring significantly more money into companies within an | index than if people invested directly or with hedge funds? | newintellectual wrote: | It wasn't so much a bet against the concept of hedge fund as it | was against particular people's abilities. | jwally wrote: | There should be a fund that guarantees a return in excess of an | index (adjusted for fees). | | In exchange the fund managers would get fees and excess returns | on their clients capital. | | This way instead of arguing over which approach is better, both | groups can benefit from one another. | | An example could work like this: | | Someone (Goldman, why not) starts a fund called the AlphaPlus | fund. Its a mutual fund. You pay a 10% up front commission to get | into it, and can withdraw your money whenever you want. Goldman | promises to return the exact same as the S&P 500 * _PLUS*_ 1% | apr. | | Say I hold for 5 years and want to get out. The S&P goes up 10% | per year during that time. Goldman owes me whatever an 11% rate | of return on whatever I invested up front. | | Say I hold the fund for 5 years and want to get out. The S&P has | a rate of return of -12% apr. Goldman owes me a -11% rate of | return on my principal. | | Goldman does this because they get a fat 10% upfront fee from me, | plus they can use their super-wizard skills to invest my money in | something that returns like 30% apr. Thus, their profit is fees + | however much they can beat the market by (and the 1% they owe | me). | | (edited to give better example given access to keyboard) | mettamage wrote: | Could you give an example? I am rereading your sentences but I | just don't understand what you're saying. I feel silly, but I | really don't get it. | nabla9 wrote: | You don't get excess returns without risk. If you want | guarantees, it will cost you extra. Nobody manages your money | for the kindness of their hearts. | | Several funds have performance fees. It's typically the high- | water mark (HWM) fee for profits above reference index returns. | missedthecue wrote: | Almost all hedge funds have a hurdle rate | bidirectional wrote: | This is called a hurdle and many funds use them. Buffet's bet | was against funds of funds which are basically indices tracking | certain hedge funds, not hedge funds themselves. | CapriciousCptl wrote: | Ironically Buffett started with exactly this over half a | century ago-- setting a cumulative hurdle rate of 6%-- meaning | he wouldn't take fees unless investors made at least 6%. He | beat the Dow (S&P 500 wasn't really a thing during the Buffet | Partnerships) every single year. | dang wrote: | Discussed in 2010: | | _The biggest bet on longbets.com: $1,000,000_ - | https://news.ycombinator.com/item?id=1439613 - June 2010 (32 | comments) | fractionalhare wrote: | Buffett won. However, several caveats apply when using this bet | to draw conclusions: | | 1. Buffett bet against aggregate performance of hedge funds as an | investment vehicle. If he restricted his focus to the highest | performing funds of the past 10 - 30 years, he would have lost | handily. | | 2. Buffett used absolute returns as the performance metric, not | risk-adjusted returns. A portfolio with lower absolute returns | but a significantly better idiosyncratic risk profile (and | correlation to market/beta) can be superior to a portfolio with | higher absolute returns but also higher risk. | | Taken together, this means that Buffett's bet is a statement | about the aggregate performance of the industry. It is not | instructive for what performance is possible, or even for whether | or not you should invest with the modal hedge fund (given the | opportunity). It depends on investment goals and risk needs. It's | also worth pointing out that "risk needs" is multi-dimensional, | not just a sliding scale of how much e.g. leverage you're willing | to accept. There is an entire sub-industry of hedge funds which | explicitly expect to underperform on an absolute basis for long | periods of time, but which service their clients with highly | bespoke risk products. Clients are frequently well-informed and | happy with this arrangement. | | I say this because there is a tendency for people outside the | industry to come away thinking hedge funds are a scam. | Which...well, many are, to put it bluntly. But it's a lot more | complicated and this isn't really the smoking gun you'd think it | is. | Judgmentality wrote: | > 1. Buffett bet against aggregate performance of hedge funds | as an investment vehicle. If he restricted his focus to the | highest performing funds of the past 10 - 30 years, he would | have lost handily. | | I don't think this is a caveat. I think this is the point. You | don't compare yourself to the literally one guy who won the | lottery, you compare yourself to everybody that bought a | lottery ticket. | | > I say this because there is a tendency for people outside the | industry to come away thinking hedge funds are a scam. | Which...well, many are, to put it bluntly. | | I don't think anybody is assuming every hedge fund on Earth is | a scam from this any more than they think lottery tickets are a | scam. As you mentioned yourself: | | > Taken together, this means that Buffett's bet is a statement | about the aggregate performance of the industry. | | I apologize if I'm being presumptuous, but is this not so | obvious that it can be assumed? | fractionalhare wrote: | I was probably a little unclear. Basically I'm saying _all_ | you can take away from this is a statement about aggregate | performance. You 're not doing this in your comment, but I | frequently see people on HN extrapolate this bet to support | the idea that there's no such thing as a hedge fund which | beats the market, or which is a worthwhile investment, etc. | | You can't derive a conclusion about individual hedge funds | from this. That might seem obvious to you, but maybe you'd be | surprised then :) | Judgmentality wrote: | > That might seem obvious to you, but maybe you'd be | surprised then :) | | Fair. I've been surprised by the ignorance of people | before, including myself! | pfortuny wrote: | The lesson I take from the bet is: you can only be very smart | if you have a lot of money. Otherwise, do no try in the long | run*. And I stick to that (because I just want to keep a living | in the future, not to be rich). | | "Risk-adjustment" is just another metric which makes not much | sense: either I have the money or I do not. Money now is worth | more than possible money tomorrow. | | About "the highest performing funds of the past 10 - 30", which | ones, the two first ones, the Medallion fund? those which | cannot be used by ordinary people? | | I know Buffet is not exactly the paradigm of "ordinarity" but | nevertheless, I think his intention with his stubborn support | of "just the market" is to teach that "ordinary people can very | seldom outperform the market". | fractionalhare wrote: | _> Risk-adjustment " is just another metric which makes not | much sense: either I have the money or I do not. Money now is | worth more than possible money tomorrow._ | | If you think risk-adjustment doesn't make sense as an | evaluation metric, you should just sell naked puts or calls | on a stock which doesn't seem volatile. You're going to | generate spectacular returns for a while. Then you're going | to blow up. | | On the other hand a portfolio with relatively low | idiosyncratic risk and low market correlation (beta) might be | safely levered up to a higher absolute return than e.g. SPY | with less overall risk and volatility. | | Like I said...it's complicated. | betterunix2 wrote: | "Money now is worth more than possible money tomorrow." | | That is antithetical to investing... | dhosek wrote: | But that assumes that one could predict in advance what those | highest performing funds would be. Of _course_ the highest | performing XXX will be above average. The point is that no one | can consistently predict which ones will be the highest | performing XXX. Worse still, regression to the mean indicates | that if, in 2021 you invest in the highest performing XXX of | the preceding X years, you 're more likely to get returns | _below_ average. | | And let's suppose that there really is a fund staffed by a | group of super-geniuses who can reliably pick the best | performing stocks. There are two possibilities: They take on | more and more investment capital until their returns end up | getting closer to the mean or they don't accept new investments | and the hypothetical new investor is left out in the cold. | fractionalhare wrote: | No I didn't assume that, I fully agree with you. Funds which | are capable of consistently (and safely) beating the market | on an absolute basis eventually cap their AUM and return | outside capital. | mooreds wrote: | > Buffett bet against aggregate performance of hedge funds as | an investment vehicle. | | He let an expert pick the funds of funds. AFAIK, he didn't | restrict which funds the expert picked. | | > If he restricted his focus to the highest performing funds of | the past 10 - 30 years, he would have lost handily. | | This is like saying "If I only bet on the teams who won the | world cup, I would always make money". Past performance is no | guarantee of future returns. | | > this isn't really the smoking gun you'd think it is. | | If the bet wasn't the best way to show the relative value of | these investments, is there a better way? Or is the answer | really "if you need a hedge fund as part of your portfolio, you | probably aren't coming to HN for investment advice"? | fractionalhare wrote: | _> Or is the answer really "if you need a hedge fund as part | of your portfolio, you probably aren't coming to HN for | investment advice"?_ | | Yeah, that's basically the answer. Retail investors don't | typically need to optimize their portfolios with bespoke | investment vehicles. Their exposure and goals aren't | complicated. | rohit89 wrote: | > There is an entire sub-industry of hedge funds which | explicitly expect to underperform on an absolute basis for long | periods of time, but which service their clients with highly | bespoke risk products. Clients are frequently well-informed and | happy with this arrangement. | | Care to expand on this with some examples? | fractionalhare wrote: | Sure - off the top of my head, basically any fund or advisor | which specializes in derivatives volatility. Universa | Investments is a specific example, but you can find more by | searching for those criteria. ___________________________________________________________________ (page generated 2021-02-28 23:00 UTC)