Warren Buffett has never been a fan of hedge funds and has just found a taker for his $1 million bet that a basket of five funds of hedge funds would not beat the market over ten years. At the same time, Business Week reported that the largest sovereign wealth fund, Abu Dhabi Investment Authority is halving its exposure to hedge funds.
According to the CNN website Protégé Partners is taking Buffett’s wager with each side putting up $320,000 in zero-coupon treasuries which will be worth a million dollars in a decade.
Buffett’s logic appears to be that over time hedge fund fees will weigh so heavily on overall performance that the basket will under perform the market. By creating a fund-of-funds the focus is on average performance rather than the next George Soros, and it will be interesting to see if Buffet wins his bet.
His argument would probably be that compounding plays such a critical role in the long-term performance of funds that eliminating management fees is more important than the investment skills that they provide in rolling up value over the years.
The Abu Dhabi Investment Authority seems to have reached a similar and presumably independent conclusion. Saeed Mubarak al-Hajeri, AIDA’s executive director, told Business Week: ‘AIDA is keen on identifying real management skills and real talent, and is not prepared to pay the usual fees charged by hedge funds for strategies that can be replicated in an index’.
Another argument against hedge fund out performance is that the leverage used in low-return but rising asset markets of recent years may act in reverse in falling markets characterised by deleveraging. Or in other words funds will be dealing with a deflationary rather than inflationary environment for key asset classes.
I am not so sure. George Soros is supposed to have made $3.5 billion betting against sub-prime loans last year, and Goldman Sachs, more of a hedge fund than an investment bank, managed to do something similar.
Perhaps both Buffett and ADIA are seeking alpha and their point is that the average hedge fund no longer has it. But maybe a top manager will actually be able to deliver out-performance even in a fund-of-funds if they pick the right managers which is quite a skill itself. Could you spot the next Soros?
Order my book online from this link
