Another great lesson of Warren Buffett

by admin on March 10, 2015

Warren Buffett

Warren Buffett is by far the greatest investor of all time. His way of thinking, perseverance, and tough negotiation skills are all qualities that set him apart from everybody else. As Warren Buffet’s prepares to retire (he is already 84 years old), he continues to give investors, (and frankly all of us) incredibly valuable lessons in investing, money allocation. and life in general.

When Warren Buffet turns 87, he will likely receive $1 Million from Protégé Partners, LLC. This time though the money won’t come as a result of one of his many brilliant investment decisions, instead it will come from a simple Vegas-like bet he made back in 2008, 7 years ago.

The bet was made with Protégé Partners, LLC who claimed that over a ten-year period the S&P 500 would underperform select portfolios from five hedge funds.  Buffett, who has long argued that the fees hedge funds command are onerous and should be avoided, bet that the returns from a low-cost S&P 500 index fund would beat the results delivered by the five funds that Protégé selected.

Each side put up roughly $320,000. The total funds of about $640,000 were used to buy a zero-coupon Treasury bond that will be worth $1 million at the bet’s conclusion in 2018.

The $1 million will then be donated to a charity. If Protégé wins, it has designated that the money be given to Absolute Return for Kids (ARK), an international philanthropy based in London. If Buffett wins, the intended recipient is Girls Inc. of Omaha, whose board members include his daughter, Susan Buffett.

Protégé partners are smart people, they managed around $3.5 billion at the time of the bet. Ted Seides, and two other men, CEO Jeffrey Tarrant, and Scott Bessent are partners. Each has a strong investment background, and two of the three have worked with well-known market practitioners. Seides learned the world of alternative investments under Yale’s David Swensen, and Bessent worked with both George Soros and short-seller Jim Chanos.

In a recent interview on NPR, the president of Protégé Partners, Ted Seides, said the selected funds were doing quite poorly. In fact, the S&P 500 fund run by Vanguard that Buffet is betting on rose more than 63%, while on the other side of the wager the hedge funds have only returned 20% after fees.

When the two sides made their respective cases for why they would win, Buffett noted that active investors incur much higher expenses than index funds in their quest to outperform the market. These costs only increase with hedge funds, or a fund of hedge funds, thus stacking the deck even more in his favor. “Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested,” Buffett argued at the time.

A number of smart people are involved in running hedge funds, but it turns out that you don’t need to be brilliant to do well in the stock market, in fact the smarter you are the greater your risk of making bad overly-confident calls.

Last December, the S&P Dow Jones Indices published “The Persistence Scorecard,” which measured whether outperforming fund managers in one year can continue to outperform the market going forward. “Out of 681 funds that were in the top quartile as of September 2012, only 9.8% managed to stay in the top quartile at the end of September 2014.”

Based on data provided by Morningstar Direct, fewer than 20% of actively managed U.S. Stock funds beat their benchmarks last year, and those that did managed to do so by only 180 basis points on average. Greggory Warren, CFA Senior Stock Analyst from Morningstar’s Ultimate Stock-Pickers said in March of this year “Our top managers did not fare much better, with only one of the four fund managers that we track beating the market by more than 180 basis points last year. “

Billionaire Hedge fund managers also got it wrong in 2014. Only a few of the 20 billionaire investors tracked by iBillionaire performed above the +15.30% gain posted by the S&P 500 in 2014. In aggregate the iBillionaire index climbed +11.67%, underperforming the S&P 500.

So why does this matter? Why can’t hedge funds outperform the market or even deliver alpha? This is the same question The Teacher Retirement System of Texas and MetLife, Inc. are asking. Hedge fund managers, who are among the highest paid managers on Wall Street, have come under pressure from clients to adjust agreements since the 2008 financial crisis. Traditionally, the firms charged investors 2 percent of assets as a management fee along with 20 percent of profits as an incentive. Despite the pressure, many firms continue to stick to the “2 and 20” model, and some management fees are as high as 4 percent with a 27 percent cut of profits.

As hedge funds trail the Standard & Poor’s 500 Index for the sixth straight year, some clients have complained that managers still provide little information about their holdings and tie up their investors’ cash while lagging behind benchmarks. The California Public Employees’ Retirement System said in September it would divest its $4 billion from hedge funds after officials concluded the program couldn’t be expanded enough to justify the costs.

Warren Buffett knows all this, he knows how Wall Street operates and that’s why, for him, it was a no-brainer to think that a simple index fund could out-perform most hedge funds out there. One of the underlying problems is that hedge funds have so much power, ironically power given by anyone with a 401k. Mutual funds manage the money in a typical American’s 401K and other retirement plans. They don’t get paid based on performance, instead they are paid based on the amount of money they manage regardless of gains or loses. They are also willing to take on more risk because they don’t have anything at stake since what they are “managing” is not their money.

My advice to you, based on the deep wisdom of Mr. Buffet is, the next time you are considering an investment option, look for a couple of things: funds with low or no management fees, and funds that are managed by people whose personal capital is also invested in the fund. Here is a good place to start.

Summary Portfolio Performance

Since inception (01/19/12), the model is up 40.5%, versus the S&P 500 54.9%. The return of the S&P 500 in February 2015 was 5.49%, as compared with 6.86% for my Dividend Paying Large Caps portfolio.  So far my portfolio is up Year to Date 4.61% vs 2.21% for the S&P 500.


In February, Lukoil (LUKOY), JC Penny (JCP) and Adidas (ADDYY) performed well. They were up 20%, 16.9% and 12.8%, respectively. Lukoil benefited from the ceasefire deal reached with Ukrania in January.

JC Penny as I mentioned last month it is not out of the woods yet, but revenues have stopped declining. Adidas benefited from the good news out of Europe, as well as the news that Adidas is actively searching for a new CEO. Longtime Chief Executive Herbert Hainer, who has led the company through years of success, has recently struggled to meet profit targets, sparking investor pressure for change at the top, once a replacement has been confirmed, I expect a spike of the stock price.


In February, my worst performing stock was Ralph Lauren. Ralph Lauren Corporation’s stock suffered the biggest one-day plunge in its history on February 4th.  After the apparel company blindsided investors with a disappointing fiscal third-quarter report and outlook, the stock plummeted -18.22% to the lowest closing level since July 12, 2012. The previous worst one-day performance occurred on November 5, 1998, when the stock tumbled 15.707% in the wake of disappointing quarterly results.

Acquisitions in February 2015

In February, I added two positions to my portfolio: Priceline (PCLN) and Expedia (EXPE). Both are companies that I believe will benefit extensively from industry consolidation, the good health of the travel industry in 2015, and the natural migration to new technologies. More on that here.

Liquidations in February 2015

In February, I liquidated Bed Bath & Beyond (BBBY), a great company, but the stock was flying high. Since I sold this position the stock dropped -4.71%. I found better opportunities in the market and they paid off well in February. Both Priceline and Expedia and are significantly higher since I purchased them. Priceline is up 14.19% while Expedia is up 4.53%.

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