Warren Buffett is putting his money where his mouth is.
He's betting hundreds of thousands of his own cash that a simple, passive investment in a major stock index will slay hedge fund returns over a decade.
Buffett, the world's most celebrated investor and billionaire CEO of Berkshire Hathaway, has been a vigorous critic of excessive money manager fees, commissions for active trading, and performance fees tied to some — but not all — managed funds, and a staunch advocate of index funds.
So he is putting up $320,000 against a fund of five hedge funds managed by Protégé Partners. The hedge fund managers will do the same against Buffett's S&P 500 position.
Buffett's huge success as a winning stock picker looms large in Protégé's respect for the Sage of Omaha.
"Fortunately for us, we're betting against the S&P's performance, not Buffett's," says Ted Seides, a principal of Protégé.
Protégé describes the terms of the bet as follows:
The bet began on January 1, 2008 and will be decided on the basis of net returns — minus fees, costs and expenses — at the end of trading, December 31, 2017.
The wagered money was invested in a bond with an expected yield at maturity of $1 million. The proceeds will be given to a charity designated by the winner.
Before the winning bet can be determined, management fees must be deducted, costs which Buffett says nibble away at returns.
Protégé says its total fees — normally a 1 percent annual management fee, and a fund of funds fee of 1.5 percent — are justified because their portfolio managers can return profits and beat the market even after those assessments are deducted.
By comparison, the fee for a typical index fund, like the Vanguard S&P 500 index fund, is a measly 15 basis points (0.15 percent), barely enough to dent an investor's wallet.
Historically, two-thirds of managed funds are outperformed by stock indexes. Yet from January 1, 2000 to the end of March, 2008, the S&P 500 returned 3.3 percent, an annualized 0.4 percent return.
Excluding dividends, the index's real return has been a 10 percent decline during this period.
Advocates of the index approach argue that the last eight years of only modest returns have not been typical because of terror attacks on U.S. interests here and abroad, the cost of the Iraq war, and other economic jolts, including the price of oil and the housing and financials meltdown.
Buffett calculates his chances of winning at a less-than-bullish 60 percent.
By contrast, Protégé says its chances of winning stand at 85 percent.
If the S&P 500 and Buffett win, the money will be donated to Girls Incorporated of Omaha.
If Protégé Partners wins, the money will be donated to Friends of Absolute Return for Kids, Inc.
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