Very few people buy hedge funds, and no one buys FoF, to improve their Sharpe Ratio. The vast majority of customers want a single thing, outperformance, and this is what most hedge funds and FoFs promise. That's why Buffett propsed the bet the way he did and why Protege took him up on it.

For those Hedge funds that actually serve as hedges (since we know the term has broadened in general use far beyond long/short funds) they can set up their own bet with some billionaire who actually believes in academic humbuggery like the Sharpe Ratio.

This doesn't address what I asked in any way.

I agree. How many managers would be interested in 2 and 20 if the 20% was of zero?

For those who don't like using the S&P, what would you use? Do you think the hedgies would really stand by the "absolute return" concept and bet that they could earn 10% annually?

that might be true for a lot of people, but a lot of people are dumb. lots of smart people who manage a lot of money invest in hedge funds for precisely that reason (swensen comes to mind).

i guess i shouldn't have specifically referred to the sharpe ratio, as it's obviously flawed. but the fact is, it doesn't matter what risk/return measures you use, beating the s&p500 isn't even close to a necessity for making hedge funds a better investment than bonds/cash.

Some hedge funds don't buy stocks at all, other than the underying index for their beta. They port their alpha from totally outside of stocks.

7 year update just came out and Buffett is dominating so far. Per the article his Vanguard S&P 500 index fund is up 63.5%, hedge fund is up 19.6%.

http://fortune.com/2015/02/03/berksh...th-hedge-fund/

I realize that this one particular bet doesn't really prove anything, but as guy who dumps all his money in low cost vanguard funds this makes me at least feel comfortable that I haven't made a big mistake by passing on high cost money managers. Maybe it even made me a significant amount of money.

Who are you rooting for?

so do you get paid out of buffetts estate when hes dead?

His estate is managed for charitable contributions.


If you own Berkshire, like me, expect it will just keep chugging on, making more money every year.

You have missed out on great professional management like this:
http://www.cnbc.com/id/102356275

"A hedge fund manager told clients he is "truly sorry" for losing virtually all their money.


Owen Li, the founder of Canarsie Capital in New York, said Tuesday he had lost all but $200,000 of the firm's capital—down from the roughly $100 million it ran as of late March.

"I take responsibility for this terrible outcome," Li wrote in a letter to investors, which was obtained by CNBC.com."

Keep indexing.

Seems like Buffet got a little lucky the wrong person didn't take him up on this bet. Maybe the top hedge fund managers don't really need to risk bad publicity like this since they already have tons of investors that "believe" in them?

The 2/20 model makes it tough to beat the index but $ invested in hedge funds have goneup something like 300% a year in the last 20 years for a reason.

Where can I buy into this 300%/year fund

No...Hedge fund asset under management has goneup 300% a year over the last 20 years. As in hedge funds have greatly risen in prominence.

If you are a winning hedge fund with a sustainable edge, why take this bet with Buffett? Risk seems to outweight the reward.

Where does #EggHype fit in all of this?

I don't think you understand the bet. Managers are not betting on their own fund vs Buffett...

They still need access to the returns of the funds though.

A lot of funds might not want their returns public

Almost no funds want their returns public, because as a group hedge funds trail the market over time. The money going in isn't reflective of the returns the typical investors have gotten, and it's likely significantly worse than even "measured results" because of survivorship bias. IE. when 1 year/2 year/5 year/10 year returns are totaled up at the end of 2015 by the sometimes far from impartial HF industry observers, will they be including "Canarsie Capital" if it is no longer operating?

Survivorship bias also explains why the bet happened, because it likely influences the thinking of many longer term hedge fund and fund of fund managers. If you've mostly beaten the market over some small period, 5 or 10 years, odds are still more likely you are closer to a lucky coin flipper than one of the few elite investors who can actually beat the markets by significant amounts over long periods. But you don't know that, so you choose to believe it was all skill baby.

And if you have parleyed a streak of good fortune into a large fund, then are also likely a great self promoter. Which makes you perfectly delusional enough to make this dumb bet with Buffett, over-rating the ability of other HF managers just as you over-rate your own, and all the while thinking "what a great opportunity to get my name out there to help reach new investors for my next big fund", rather than "boy I'm gonna look really dumb in 5-10 years".

If someone like Paulson or the dude who bought the Bucks takes the bet, are they a fav?

I'll take Jim Simons or David Shaw.

This bet is fascinating to me because as far as I know it is the only really "prospective" evaluation of a fund that claims to beat the market. It is really easy for the fund managers to look backwards and point at all of their funds that beat the market in the past X years. But it is really hard to know how many funds there were that closed or aren't discussed to get those ones that beat the market.

As you point out, the funds don't really have any incentive to "prove" that they can beat the market, because even without proof they are taking in tons of money and making tons of money for themselves. And some of us (myself included) think that if they tried to prove their value, they would instead end up proving that they don't have any value.

Agree w/ this but I gotta think guys like Paulson, Lasry, Ackman and the big hedge fund guys worth billions would be favs over the index. I guess it is more risk than reward to take Buffett up on the bet. If you win you just did what everyone would expect you to do and if you lose you look like a jackass.

I've always understood it that hedge funds tend to get their best returns vs the index in bear markets. A market like we have had since the bet was made would be tough for them to outperform.

This is bad bet for Buffet.

Even assuming the classic CAPM model with only systematic risk as beta (piles of data that the market pays for more betas, liquidity is high on that list), all you have to do to be a favorite in this bet is to find high beta hedge funds.

There are definitely managers who beat the market. But they also have to beat their fees, and that makes it a bit harder to pick winners, especially when the best sometimes charge even more than 2/20. And then they have to be available for investment for a funds of funds manager, and some simply aren't. Do you think Paulson, Lasry, Ackman are all accepting new funds all the time?

And then finally the results of the funds you were able to pick, have to beat the S&P after you deduct your "Funds of Funds brilliant funds picker" fees.

This is a bad bet that he's pretty much won two thirds of the way through?

When you start "assuming the classic CAPM model" you might as well start "assuming astrology works". CAPM is built on a foundation of sand, when you conflate beta with "risk" your theory has about as much relevance to good stock picking as astrology does.

Your other mistake is nowhere do you include the impact of fees. No one is saying that there aren't managers who beat the market, many do. Over longer periods it's much harder to find managers who beat the market after their fees, and it's extremely hard to separate those who outperformed via luck from those who outperformed by possessing a repeatable skill. Hint: CAPM won't help you determine skill.

And again, even if you are a fund of funds manager who does have "skill" in picking only managers with solid skills at beating the market from your limited pool of funds open for investment, they have to beat the market by more than your fees. And we know your fees aren't cheap.

http://longbets.org/362/

Every hedge fund starts every year 2% or more behind the market because of their operating fees, in a market with a gross long term expectation of 8 or 9% annual returns.

If your fund of funds charges 1 & 5, and the underlying funds charge only 2 & 20, it starts every year 3% behind. It's like giving up a third of your potential gains immediately.

Worse are good years. If the market is up 30% this year and your hedge funds just match it, now you lose another 7.5% to fees, and finish 10.5% behind the market. To beat the market in a 30% up year using a hedge fund, it needs to have a 40% year. To beat it with a FoFs, the underlying hedge funds have to average over 46%!

And of course hedge funds do better in bear markets. it's the one time they aren't raping their investors taking additional profit share fees! a FoF down 10% vs a market down 20% is now up 7% relatively.

So the hedgies are praying for a down market to have any chance in this bet, but even if the next 3 years are down years they have to beat the market by 9% to cover fees + another 40% to catch up from behind. God forbid they get two down years followed by an up year that adds another mountain of fees to overcome.

Hmm, a collection of funds beating a down market by close to 50%? Sounds like something only a FoF sales manager would believe.

People forget Buffett ran a "hedge fund" in his younger days. It was actually an investment partnership (even more precisely a series of partnerships), but that's all hedge funds are nowadays as the term has been grossly distorted to mean any private investment partnerships.

And Buffett charged an even higher than average profit share, 25%! So how can he criticize these poor, well not poor let's use the word "maligned", hedge fund managers for charging excess fees?

The difference is that WEB never charged a fixed annual fee. If he had a down year, he made nothing.

And if he had an up year, he could also make nothing! He had a profit "hurdle rate" of 6%, telling his partners they could make 6% on their money without his help, so they shouldn't be paying for what was easily achievable.

So he never got a dime without making a significant positive return. If hedge funds fees were similarly structured, methinks as a class they'd be substantially better investments and have much better odds of beating the market.

Those are just terrible picks. Plenty of hedge funds out there with low base fees and get compensated (very richly) for alpha.

Paulson and Ackman aren't really the best examples. They have huge AUM which really hurts their ability to generate alpha. The funds that are likely to be truly generating alpha and outperforming the indices are the <$100m funds. The higher the AUM the more likely the fund is just buying various mega caps.