A race against hedge funds puts Warren Buffett ahead

Billionaire investor Warren Buffett is running ahead on a bet with two hedge fund managers that the Standard & Poor’s 500 Index would beat an index of hedge funds. Buffett, whose flagship Berkshire Hathaway was added to the S&P index in 2010, contends that the active money management and high fees associated with hedge funds cannot beat the market. His proxy in the bet is the Vanguard S&P 500 Index fund, which, like most index funds, has low management expenses.

The hedge fund managers, Jeffrey Tarrant and Ted Seides of Protégé Partners in New York, contend that hedge funds have an advantage over the market because they can bet on rising and falling prices of all types of assets, including currencies, commodities, stocks, and bonds. In a statement they said hedge fund managers “with the ability to sort the wheat from the chaff” will reap big enough profits to outweigh their extra expense. Hedge funds typically charge 2 percent annual management fees plus take 20 percent of the profit. They constructed an index of five hedge funds of funds—essentially funds that pick and choose from among all hedge funds. That added additional fees, because hedge funds of funds tend to add a second layer of annual fees and also share in the profits.

The bet began Jan. 1, 2008 as a major financial crisis was breaking. In the first year, the hedge funds outpaced the market, losing 24 percent compared to a loss of 37 percent on the S&P 500 fund. But in subsequent years, as both hedge funds and the U.S. stock market gained, the market pulled ahead. As of late March the S&P 500 fund was up 2.2 percent for the whole period, compared to a loss of 4.5 percent for the hedge funds. The bet lasts for 10 years. The loser will make a $1 million contribution to the charity of the winner’s choice.