Back in 2007, the greatest value investor of all time made a $1 million bet. Ten years ago, Warren Buffett bet Protege Partners that index funds would outperform hedge funds over the next decade. The bet was proposed by Ted Seides, a former Protege Partners executive. Apparently, Ted grew tired of Buffett repeatedly criticizing hedge funds for their high fees.
Strangely, Seides stated he agrees that the aggregate returns to investors in hedge funds will get eaten alive by high fees earned by managers. Not exactly a glowing endorsement for actively managed funds. Mr. Seides went on to say, “I am sufficiently comfortable that unusually well managed hedge fund portfolios are superior to market indexes over time.”
Unfortunately for Seides, it doesn’t appear that Protege Partners’ funds fall into that category. At least not for the past 10 years. Barring a market meltdown in 2017, Buffett will win this bet running away. His index fund of choice, the Vanguard 500 Index Fund Admiral Shares (VFIAX), gained 66% from the start of the bet in January 2008 through the end of 2015. The hedge funds selected by Protege Partners returned just 22% during this time. Results from the hedge funds haven’t been announced yet for 2016, but hedge funds as a group rose just 5.5% last year. This compared to the S&P 500 which rose by 12%, including dividends, in 2016. So it appears that Protege Partners is going to get boat raced by the savvy veteran Warren Buffett.
Take Advice From The Best
There is some irony in this bet with Buffett who is known as the most successful value investor of all time. Buffett built his wealth not by investing passively in the market, but by searching for and investing in undervalued companies. But his thoughts on high investment fees are clear. At Berkshire’s annual meeting last year, he said: “There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities.” Furthermore, when you trace back to Buffett’s investing partnerships that he ran in the ’60s, you’ll find that he charged no management fees. Buffet only took a percentage of the gains after the first 6%. So as an investment manager, we was truly being paid based on his investing abilities.
If you’re just getting started investing, my advice is to go back in time and invest in Berkshire. An investment of $1,000 in Berkshire in 1964 would have grown to nearly $13.4 million today. That’s a cool 1,338,900% return. Not too shabby. But if you haven’t befriended a crazy scientist with a DeLorean, what should you do?
Follow the Oracle of Omaha and invest in the S&P 500 index. It’s hard to beat over time and the low fees vs. that of actively managed funds make it even tougher to beat. Vanguard’s S&P 500 index fund (VOO) only charges a fee of 0.05%. Many actively managed funds charge fees in excess of 1%. This means they have to beat the market by that amount just to break even.
What Actively Managed Funds Outperform Their Index?
Index funds are great and extremely popular right now. But it can be beneficial to mix in a few of the top performing actively managed funds. Dodge & Cox Stock Fund (DODGX) is a fantastic fund with a great track record. I’ve invested in DODGX since I first started contributing to my 401k years ago. While it had a rough 2015, it bounced back in a big way in 2016 with a 21% return. You’ll pay more in fees than an index fund. But at 0.52%, the fees are on the low end for an actively managed fund. Especially for one with such a great track record.
Mathews Pacific Tiger Fund Investor Class (MAPTX) is another good one that I’ve held for a long time. This fund has a focus in Asian emerging markets. It’s a great fund to diversify internationally. The fees are a little bit higher at 1.07%, but this fund has a very good track record versus others in its category. Returns have outpaced Vanguard’s Pacific and Emerging Markets index funds. Even after fees are taken into account.
And don’t forget about Berkshire! Buffett’s pride and joy is basically one big mutual fund. It has 100% ownership of 43 different companies and holds stakes in several others as well. As the stock market has become more and more efficient with instant access to information through the internet, it has become increasingly more difficult for investors to beat the market. Yet Buffett still does, outpacing the S&P 500 for the past 1-year through 15-year periods. And best of all, there are no fees to invest with the greatest investor of all time.
Trailing Total Returns as of 2/23/17 (Returns are net of fees)
It’s tough to go wrong with index funds. They’re cheap, simple and consistently outperform many actively managed funds. When you’re just getting your feet wet, two funds is all you need. The S&P 500 or a total US market index fund is a great starting point. Supplement with a total international stock fund and you’re good to go. Vanguard and Fidelity both provide excellent low-cost options. You can make it a 3 fund portfolio and add a total bond fund if you want some stability.
As you get more experience and knowledge along the way, consider supplementing with some of the top mutual funds. Go with the ones that have a consistent track record of outperforming their category, such as the ones mentioned above. And for good measure, throw in some Berkshire while you’re at it. While the A shares trade at a cool $254,000, the B shares have a current price of $169. Check out my post on the investment platforms I use to invest with no trading fees. If you’re into picking individual stocks, or builiding an after tax ETF portfolio, these are a great way to build your positions while keeping fees low.
Readers, what fund would you choose if you had to make a $1 million bet for best performance? Do you primarily stick with index funds or do you supplement with actively managed funds and individual stocks?