Monday, June 9, 2008

Buffet bets against hedge fund industry

Fortune reports that Warren Buffet has bet Protege Partners, a New York-based fund of funds that five funds selected by Protege will not outperform the S&P 500 over the next 10 years. The $1 million bet is looking at performance net of all fees, costs, and expenses. Buffet, to quote the article, feels that it is the high cost structure of most hedge funds that makes them "onerous and to be avoided."

In making this bet, Buffet appears to agree with the findings of a Merrill Lynch research report dated February 22, 2008, that makes the case that hedge funds' returns are becoming more correlated with the broader market. Quoting the report: "Our analysis continues to show that 2000’s non-correlated asset classes are now often highly correlated to the S&P 500, and their diversification benefits now seem to be greatly reduced, if not completely eliminated."

High fees and the perception that risk and return for fund managers is uncoupled, because managers don't share losses equally with investors when the fund loses money, drove media scrutiny and animosity when the industry expanded so rapidly from 2004-2006. Going forward, the fee structure could continue to raise media, not to mention investors' eyebrows, particularly, if funds find it difficult to match historical returns in the current market.

The bet itself is overseen by the Long Now Foundation of San Francisco, which exists to encourage long-term thinking. The organization operates a betting mechanism for long-term bets and wagers include whether commercial air travel will be pilotless by 2030.

It's pretty hard to bet against Buffet, but Protege has shown keen foresight in the past. For example, they invested in Paulson & Co.'s funds, which were among the few to reap rewards from the subprime and real estate crises.

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