Buffett Says $100 Billion Wasted Trying to Beat the Market

  • Berkshire CEO: Jack Bogle, indexing pioneer, is a ‘hero’
  • Investment managers, not clients, reap rewards, Buffett says

Buffett Renews Criticism of Hedge Funds in Annual Letter

Billionaire investor Warren Buffett devoted a substantial portion of his annual letter to deepen his long-running critique of investment fees.

Over five pages, he updated Berkshire Hathaway Inc. shareholders on a bet made almost a decade ago that a low-cost fund that passively tracked the S&P 500 Index would outperform a basket of hedge funds. He also laid anew into the rich for being suckered by Wall Street investment advice, which he estimated has wasted more than $100 billion over the past ten years.

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients,” he wrote. “Both large and small investors should stick with low-cost index funds.”

While Buffett was doubtful that the wealthy would take his advice, his argument has gained steam. After years of underperformance, hedge funds are facing a revolt by endowments, pension funds and other institutional investors that have decided they aren’t getting their money’s worth. Meanwhile, index funds have been on a tear. In 2016, passive strategies attracted $504.8 billion in new money, while active managers saw $340.1 billion in redemptions, according to data from Morningstar Inc.

Read Warren Buffett’s annual letter here

Buffett, 86, has been making his point for more than a decade, most visibly through his $1 million bet with Protege Partners. The billionaire challenged the asset manager to pick a group of hedge funds that it thought would beat an S&P 500 Index fund over 10 years.

On Saturday, he gave an update: The bundle of hedge funds had compound annual returns of 2.2 percent in the nine years through 2016, compared with 7.1 percent for the index fund. The billionaire estimated that about 60 percent of the gains that the hedge funds produced during that period were eaten up by management fees.

“That was their misbegotten reward for accomplishing something far short of what their many hundreds of limited partners could have effortlessly -- and with virtually no cost -- achieved on their own,” he wrote.

Buffett will almost certainly win the wager when it ends on Dec. 31. Proceeds will go to charity.

Praise for Bogle

He also praised Jack Bogle, the 87-year-old founder of Vanguard Group. The pioneer of indexing was once an outcast in the investment world as he eschewed riches to provide real value to American investors, Buffett wrote.

“In his early years, Jack was frequently mocked by the investment-management industry,” Buffett wrote. “Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me.”

Buffett’s remarks on indexing have been jarring for many of his followers, not least because he has spent a career finding ways to generate market-beating returns at Omaha, Nebraska-based Berkshire. The billionaire threw a bone to that crowd in his letter, reiterating his stance that it’s not impossible to beat the index.

“There are, of course, some skilled individuals who are highly likely to out-perform the S&P over long stretches,” he wrote. “In my lifetime, though, I’ve identified -- early on -- only ten or so professionals that I expected would accomplish this feat.”

He also sought to distinguish between investment fees that money managers charge and the kinds of fees that Wall Street banks earn for helping to arrange deals.

“Berkshire loves to pay fees -- even outrageous fees -- to investment bankers who bring us acquisitions,” he wrote. “To get biblical (Ephesians 3:18), I know the height and the depth and the length and the breadth of the energy flowing from that simple four-letter word -- fees -- when it is spoken to Wall Street. And when that energy delivers value to Berkshire, I will cheerfully write a big check.”

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