Buffett’s Challenge

Warren Buffet’s challenge takes a stab at hedge fund managers


If you’re as influential as Warren Buffett, you can get away with saying a lot. But challenging multi-billion dollar hedge fund managers? That’s pretty bold!

In this year’s letter to Berkshire Hathaway shareholders, Warren Buffett takes aim at his target: hedge fund managers.

Buffett’s annual letter to shareholders, which discuss the financial challenges within the companies and industries under the Berkshire Hathaway’s umbrella, are an absolute must read for investors. And in this year’s installment Buffett makes an interesting wager!

More specifically, Buffett criticizes the management fees charged by hedge fund managers. These fees are known as fund management fees and are the cost of having your assets professionally managed. Buffett’s claim is that even if a manager’s fund were to make substantial market gains over and above an index (which is what you are paying them to try and do), the majority of any gains achieved have gone back to he fund managers in the form of fees rather than being returned as profit to the investor.

So in a bold challenge, Buffett has made the following wager:

“I publicly offered to wager $500,000 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. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers — who could include their own fund as one of the five — to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?”

Whoa, hold on. Warren Buffett has very publicly challenged hedge fund managers to put their money where their mouth is!

And the exciting part is that the bet concludes at the end of 2017.

Buffett’s challenge is an interesting take on the active vs. passive debate: whether it is worth paying higher fund management fees for professionals to manage your portfolio, or whether it is better to place your funds in a lower-cost index fund that tracks a certain index or sector without having to pay the high management fees.

Through 2016, the S&P 500 has enjoyed a compound annual increase of 7.1%. Compare this to the collective hedge funds’ increase of 2.2%, net of fees.

Portfolio management fees can have a really big impact on the gains that someone experiences from their investments. Even just a one percent fee to cover the cost of gaining expert advice can tie a real anchor to an investment portfolio’s returns. One percent can cost hundreds or thousands of dollars over a lifetime of investing (thanks to compounding!)

So Buffett’s Challenge is really this: is it worth the fees associated with investing in a complex array of portfolios comprised of expensive, actively managed funds? Or is it better to place your money in an index fund replicating the S&P 500?

It’s an interesting, exciting public challenge and we’re all interested to hear the results!

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