The Investment Scientist

Warren Buffet on Hedge Funds

Posted on: October 31, 2010

These are Warren Buffet’s own words. As usual, they are as humorous as insightful.

“In 2006, promises and fees hit new highs. A flood of money went from institutional investors to the 2-and-20 crowd. For those innocent of this arrangement, let me explain: it’s a lopsided system whereby 2% of your principal is paid each year to the manager even if he accomplishes nothing – or, for that matter, loses you a bundle – and, additionally, 20% of your profit is paid to him if he succeeds, even if his success is due simply to a rising tide.

“…The inexorable math of this grotesque arrangement is certain to make the Gotrocks family poorer over time than it would have been had it never heard of these hyper-helpers. Even so, the 2-and-20 action spreads. Its effects bring to mind the old adage: When someone with experience proposes a deal to someone with money, too often the fellow with money ends up with the experience, and the fellow with experience ends up with the money

3 Responses to "Warren Buffet on Hedge Funds"

Very true but investors have definitely received alpha returns though. Further, Buffet’s successor is a “hedge fund guy” so there must be something to it!

Joel,

I don’t agree with your assertion that investors have definitely received alpha returns (from hedge funds.) There is research on the subject of hedge fund risk and returns by Princeton professor Burton Malkiel. Here I quote the abstract …

“Constructing a data base that is relatively free of bias, this paper provides adjusted measures of the returns and risk of hedge funds. We also examine the substantial attrition of hedge funds and analyze the determinants of hedge fund survival as well as perform tests of return persistence. Finally, we examine the claims of the managers of “funds of funds” that they can form portfolios of “the best” hedge funds and that such funds provide useful instruments for individual investors. We conclude that hedge funds are far riskier and provide much lower returns than is commonly supposed.”

Here is the hyperlink: http://www.princeton.edu/~bmalkiel/Global%20Hedge%20fund%20NEW.pdf

Hi,
Of course, there are issues concerning survival biases and other types of misleading data. There is enough stats to make whatever point you want to make. Hedge Funds, Fund of Funds, Hedge Fund Replicators, and so forth should not be where all your investable funds be located. It is just one avenue for individuals seeking to diversify. I also forgot to mention that Berkshire was also one of the original hedge funds in the nation. Take care and be well,
Joel

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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