Buffett bets on the S&P 500 to beat a fund-of-hedge-funds

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The hedge fund industry can only exist because investors have faith that their fund managers will deliver above-average returns over time, despite the portfolios’ hefty fees.

Master investor Warren Buffett, who has long derided those fees as being way too high, now has made an interesting bet with a firm that runs so-called funds-of-hedge-funds: He’ll beat their net returns over the next decade simply by owning a mutual fund that tracks the Standard & Poor’s 500 index.

The bet is the subject of this article in Fortune magazine by Buffett’s long-time friend, writer Carol Loomis.

Buffett is going up against Protégé Partners LLC, a New York-based money manager that picks hedge funds for its clients.

Loomis writes: ‘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.’ Whichever side wins, the proceeds will go to charity.

Loomis, detailing the manager fees that will reduce the net returns realized by the hedge funds, figures that Protege can only win the bet by performing ‘much, much better than the S&P.

‘And maybe they will. Buffett himself assesses his chances of winning at only 60%, which he grants is less of an edge than he usually likes to have,’ she writes.

‘Protégé figures its own probabilities of winning at a heady 85%.’

Before you read Buffett’s bet as a ringing endorsement of the S&P 500 index’s potential over the next decade, remember that he has made his multibillions by adeptly picking individual stocks and companies -- not by settling for the market return.

As one of the fund managers tells Loomis: ‘Fortunately for us, we’re betting against the S&P’s performance, not Buffett’s.’

Read more on the Buffett/Protege bet here as well.