In 2007 one of the wealthiest people on the planet, Warren Buffet, made a bet with a private investment company that a passive index fund would outperform a professionally managed portfolio of investments.
The terms were “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.”
The stake was $1,000,000 USD.
The five hedge funds that are represented in the table below invested in over 200 other hedge funds to create “fund-of-funds”. This means that it is fair representation of the performance an average investor is likely to experience when investing in a hedge fund.
Warren Buffet simply stuck the money in a low cost no-frills passive index fund which aimed to track the performance of the S&P500 index.
Last year (2017) the bet ended and these were the results:
|Year||Fund-of-Funds A||Fund-of-Funds B||Fund-of-Funds C||Fund-of-Funds D||Fund-of-Funds E||S&P500 Index Fund|
|Average Annual Gain||2.00%||3.60%||6.50%||0.30%||2.40%||8.50%|
The only shocking thing about these results was just how much the index fund beat the professionally managed hedge funds.
To really grasp just how terrible the professionally managed hedge funds performed I have run a couple of scenarios.
Let’s say you had $100,000 and invested $20,000 in each of the five Fund-of-Funds (so you are diversified). You would have made $36,300 after ten years.
Now if you had of invested that same $100,000 in the index fund you would have made $125,800! Over three times as much! Ridiculous.
Ok but what if we just stuck our money in the best performing fund? $100,000 with the Fund-of-Funds C.
After 10 years at 6.5% p.a. growth your $100,000 would now be $187,714.
The index fund over the same period? $226,098 (20% increase in performance)
That is a difference of $38,384.
So why is there such a stark difference between the performance of professionally managed money and a plain old index fund?
Buffet sums it up best with the following quote:
Performance comes, performance goes. Fees never falter.
The hedge funds charge fees no matter their performance on any given year. Over 10 years these fees really add up, so much in fact they just can’t compete with a low cost index fund.
Not to mention the fact you also have to select the best performing fund. With the benefit of hindsight that is easy but there are literally thousands of private fund managers vying for your money. The chances of you selecting one that will outperform the index is slim.
For the average investor a low cost index fund that tracks the broader share market makes a lot of sense. It removes the guess work and best of all the high cost of fees!