This article is probably the most important newsletter you will read, ever!

This week was the most exciting week for the world of investments. Berkshire Hathaway had a live webcast of their 51st shareholder’s meeting in Omaha. Not only that, Warren Buffett and Charlie Munger, chairman and vice chairman of Berkshire Hathaway took questions from shareholders on various topics for 7 hours.

The Things They Said Are Worth Their Weight In Gold, For Those Who Want Their Money To Work For Them

(Just in case you don’t know who Warren Buffett is, ‘He is the 3rd richest man on the planet’ and is known as the Oracle of Omaha as far as investments are concerned.)

PS – one share of Berkshire Hathaway is worth USD 220,139

The highlight of the event was his review of the investment on which he had bid 1 million dollars, almost 8 years ago.

The investment itself

Most people would be better of not trading stocks, better off buying a low cost index fund – Vanguard S&P500, where you don’t put your money at once, but over many years. You will do better than 90% of people who start investing in stocks at the same time. Warren Buffett

The Million Dollar Bet

Now let’s look at the bet itself, which Warren Buffett placed 8 years ago with Protege Partners. In summary, Warren Buffett Says the S&P 500 will outperform any basket of the best funds over a period of 10 years. Protege Partners of course does not agree and hence the bet, where a million dollars would be paid to charity by the loser.

“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.”

Buffett’s Argument

A lot of very smart people set out to do better than average in securities markets. Call them active investors.

Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore the balance of the universe—the active investors—must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors.

Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.

A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.

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

There is a wide gap between the returns of the best hedge funds and the average ones. This differential affords sophisticated institutional investors, among them funds of funds, an opportunity to pick strategies and managers that these investors think will outperform the averages. Funds of funds with the ability to sort the wheat from the chaff
will earn returns that amply compensate for the extra layer of fees their clients pay.

Look’s like Warren is Winning

A picture is worth a thousand words.

With 2 more years to go, it looks like Warren is winning. I don’t see how the hedge funds can beat these results in 2 years.

S&P500 performance in the last 25 years

Here is a Wikipedia article on the performance of the S&P500 over the last 25+ years.

In summary the row to look at in the results is the ‘Median row’. The annualised average results speak for themselves.

The current CAGR is calculated at 10.47%.

How you can benefit from Warren Buffett’s advice

Warren Buffett recommends investing in the S&P500 regularly over 10-15 years. Although the S&P 500 is not capital protected, we have a regular savings plan that invests in the S&P500 that offers 140% capital protection.

i.e. you can invest a small amount of money, either monthly, quarterly, half-yearly or yearly over a period of 15 years and the minimum guaranteed amount to you would be 140% of your contributions. If the market performs better as it has in the past, you will get the actual performance.

To find out more about this solution, fill-in the form here and write S&P500 in the remarks section.