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Samizdata, derived from Samizdat /n. - a system of clandestine publication of banned literature in the USSR [Russ.,= self-publishing house]
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Samizdata quote of the day Specifically, Buffett offered to bet that over a ten-year period from January 1, 2008, to December 31, 2017, the S&P 500 index would outperform a portfolio of hedge funds when performance is measured on a basis net of fees, costs, and all expenses. Hedge fund manager Ted Seides of Protégé Partners accepted Buffett’s bet and he identified five hedge funds that the predicted would out-perform the S&P 500 index over ten years.
As I reported last September on CD, Buffett’s now-famous bet was actually settled early and ahead of schedule, because the outcome was so one-sided in favor of the S&P 500 index over hedge funds
– Mark Perry
I have been following this for a while and given my views on hedge funds, I was not in the slightest bit surprised at the outcome. Factor in fees, costs, and all expenses and the difference becomes eye-watering. Personally I am a big fan of the Terry Smith school of thought (which is to say when it comes to investments “don’t just do something, sit there!”): with a few glorious exceptions, managed funds almost always over-trade.
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In a very casual aside on the reasoning that led him to Brexit, Dominic Cummings remarks that
(My bolding.) For transatlantic readers, ‘SW1’ = ‘inside the beltway”.
Yes, well, most hedge fund managers would claim that their returns are better on a ‘risk adjusted’ basis than equities. You could of course reduce risk by holding less equities and more in cash, in some proportion. I’d wager that that would also do better than hedge funds (or other approaches), but it is a more difficult question to answer. I work in investment advice and I invest my own pension savings 100% index tracking equity. I have a friend who is a senior hedge fund guy and it’s booze, drugs and hookers all day long. Earns 20 times what I do, and I am well paid compared to the average person. He isn’t going to have any of my clients’ money that is for sure.
Given that a percentage of investment goes into index trackers, I wonder to what extent the performance of an index is driven by the flow of money following the index, which is a situation where being in the FTSE 100 index per se generates a demand for a share rather than the fundamentals?
And when and how would such a ‘auto’-Ponzi-esque scheme end?
In 1989 I started a hedge fund. I knew of 5 or 6 others back then almost 30 years ago. They were extremely rare. Today there are tens of thousands.
Buffett’s bet was a no-brainer.
If you asked me if I would invest in a hedge found, the answer is yes: Seth Klarman’s Baupost Group. Even Buffet admires Klarman and I don’t even think Klarman has beaten the indices during this time period of the bet, although since he began in 1982 his long term track record is + 15% vs. the S&P 500 at 11.4% (that includes dividend reinvestment). I would invest with Klarman for one reason – he is counter-cyclical. The next time the market crashes (probably just before the 2020 election) Klarman will make a fortune. He always does.
“managed funds almost always over-trade.”
Tell me about it.
On a small scale, suffered this. The brokers managing my late father’s share portfolio did a number of sales/purchases whilst he was in his 89th year, was admitted to hospital & subject to a “do not resuscitate” notice. Of which they were immediately informed, as he had a meeting with his portfolio manager scheduled for the following week. He died some 5 weeks later. As his sole benefactor I challenged their actions with the broker & getting no joy with them, with the financial ombudsman. My grounds were simple. Ignoring the quality of the investment advice (poor – of the shares they’d switched into one, 20% of the funds moved, lost 1/3 of its value the following month) was trading at all, under the circumstances, justified? How long would a combination of income increase & projected share price rises take to pay for the transaction costs? Going on the portfolio history, around 3 years seemed indicated. So what was the likelihood of my father benefiting from the transactions in his lifetime?
The broker’s defence was 1)With a discretionary managed portfolio they were acting within the management terms 2) They were acting in accordance with their own policy of “balancing” portfolios across shares & sectors. Despite the result of the transactions put the portfolio with 17% holdings in the banking sector – up from 12%. And that the portfolio history showed it had been considerably out of “balance”, according to their own criteria, for the previous 5 years.
Needless to say, my submission was rejected. Thieves stick together. But the historical analysis of the portfolio was illuminating. Over the 20 odd years in their management the portfolio had underperformed the main indexes both on capital appreciation & income. And over half of the capital appreciation had disappeared in management charges, if one corrected for what the portfolio value would have been without those charges being made along the way.
Were the charges justified? The charges for the final year were a bit over £2500 plus dealing commissions. I have a good idea of how much work might be required, because I spent several years of my working life doing just this. Managing client portfolios. Every share my father held had been bought on the broker’s recommendations, so no doubt they appeared in other portfolios they managed with the same investment criteria. So any buy/sell decisions would be collective across those portfolios, not unique to his. Managing such portfolios, when I did it – without the help of computer spreadsheets, databases & word processing. Just a mechanical calculator, the share prices & dividends on the back pages of the FT & the help of a copy typist – would have been a couple hours work, twice a year. With all the new gadgetry. Ten minutes to assemble a copy & paste client letter & print out a valuation.
Like I said, thieves.
Personally, I use a share trading company. They e-mail me a valuation every 2 weeks, but the current situation’s available on-line any time I need it. For the service, they charge me zero plus a minute trading fee. Since I’ve been managing my inherited portfolio I’ve consistently beaten the index. Once I’d culled the heap of crap I started with.
Moral to the story. Set of darts & a copy of the Pink’un will beat professional fund managers nine out of ten.
BIS, the defense your broker offered was probably sufficient: they were acting in accordance with the contract, and re-balancing is a standard practice (although I question its validity). If the contract didn’t require consideration of your father’s unique circumstances, which I doubt was the case, it’s essentially a mechanical process. Your only hope of winning the case would have been to show that they did not re-balance in accordance with their (alleged) policies, a difficult test to meet. I sympathize with your situation, but unfortunately the outcome was inevitable (even without resorting to allegations of “thievery”). Which is why I would never give any broker discretion over my account.
Which share trading company do you use? I’m in need of a new account and am looking around right now. Thanks.
When I did the job, Laird, there was a duty of care that portfolios were managed in the client’s interest. Each client was regarded as unique because one was managing the portfolio on the client’s behalf. And I occasionally had recommendations turned down, by my own superiors, because I hadn’t fully thought through what that interest was. We’d certainly never try & hide behind contact terms & “policy”. At that level of management (& management fees) you’re supposed to be providing a personal service, not an off-the-peg solution. But, then I’d met with my late father’s investment manager. He was a service salesman, not an investment expert. Got himself out of his depth in the conversation in the first five minutes. We were professionals. They ain’t.
I use IG.com. They register & hold the stock in a nominee name & deal with dividends etc. But portfolio management is you’re own affair. There’s a small fixed charge for transactions. In addition to straight trading, they offer a complete range of option, futures trading etc. Recently I’ve been playing around with spread betting on the €/£ exchange markets, shorting the € against the market trends. Picked up the price of a moderately expensive car for my trouble. If you can’t out-think children, what are you good for?
Indeed, that is why I have such a low opinion of most funds, and why so many fund managers loath Terry Smith, as he is very open about this and (by industry standards) alarmingly transparent. And as a result, yes, I have some dosh with Fundsmith 😉
I have a lot of sympathy for passive (and also contrarian) investment strategies, but the comparison proposed by Buffett does not seem fair: there are costs involved in tracking the S&P 500 index as well. Specifically, when company A drops out of the index and is replaced by company B, you must sell shares of A and buy shares of B.
Not only does that involve costs: it also goes against the contrarian principle of buying low and selling high.
It is even worse to sell low and buy high at a time when lots of other people are doing the same: see Mr Ed’s comment above.
“[Daniel Kahenman] he relates the story of a time he had been invited to speak to a group of investment advisers in a firm that provided financial advice and other services to ultra-wealthy clients. To prepare for the talk, Kahneman requested and was given a spreadsheet summarizing the investment results of 25 of the firm’s wealth advisers over eight consecutive years. The advisers’ scores for each year were the main factor in determining their bonuses.”
“Kahneman was taken aback by what he discovered. “While I was prepared to find little year-to-year consistency,” he writes, “I was still surprised to find that the average of the 28 correlations was .01. In other words, zero. The stability that would indicate differences in skill was not to be found.”
To which the behavioral theorist offered this kicker: “The results resembled what you would expect from a dice-rolling contest, not a game of skill.”
BIS, thanks. IG.com only deals in those binary options, not equities or bonds, right?
@Laird
No, the whole spectrum. Equities, bonds, the lot.
@ Jacob
I’ve a suspicion that because of the incentive to turn over portfolios to show you’re doing something & to justify charges.
The conclusion is that managing one’s own portfolio renders the same chance (at least) of producing gains, as having it managed by “experts”. And you save fees.