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Comment by CapriciousCptl | Hacker News Reader

The lesson Warren's making isn't that you can't beat the market. Of course, Warren himself is an example you can. It's also not a statement about any individual hedge fund, which may have "different goals only for sophisticated investors."* Instead, it's that on balance, by far most managers don't beat the S&P 500 on an after-fee basis.

And if you include taxes in those fees and the benefit of deferred tax liabilities it's even harder to beat an index fund.

* It's reasonable to be skeptical about any fund having a goal that's anything other then maximizing long-term returns.

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Furthermore he’s making the point that you cannot tell in advance which managers, if any, will outperform the market over a given period.

Buffet himself has a couple factors that help him outperform which you and I likely don’t. For one thing, he often buys private companies (not a liquid market with constant price discovery like the public stock market). That’s not uncommon, even if it’s out of reach of most retail investors. More unattainable for the rest of us, he has the “Buffett Halo” effect: stocks often go up just because he bought them! This effect also induces companies to give him a discount on equity, because the existing shareholders benefit from the halo. Obviously Buffett must still work hard to choose stocks wisely, or the halo would evaporate over time.

2 points;

the “Buffett Halo” effect I dont think is fair to include. This is very real but its also temporary. Consider stuff like his failed Tesco investment. Long term we get back to fundamentals.

The big advantage I think worth mentioning is Buffet also buys control much of the time he invests. You and I buy shares to go along for the ride. He buys in on value + they ability to control direction + typically do share buybacks that further increases the per-share value and uses the companies own money to grow value further. This is a real game changer beyond the traditional value approach you and I will never have.

Sounds like Warren Buffett is a boglehead? Or a cheerleader at least.

I confess to having drunk the Kool-aid and can report that I no longer have investment anxiety.

I think it’s more like Buffet would say you should either choose the optimal passive investment strategy (index funds), or be a fully active investor yourself (picking your own investment strategy), rather than paying significant fees for someone else (hedge funds) to actively invest for you.

A close relative that's a professional analyst told me: if you have some unique insight on some specific market, use it on the market! (as long as it is actionable into investment choices) You can likely beat the market and experienced analysts, which often don't have that much technical expertise or outstanding insight (instead relying on economic and financial analysis). The few times I did... it worked.

> ...if you have some unique insight on some specific market, use it on the market!

One thing to be cautious of here is that people often overinvest when they have some sort of advantage, and become way too over-leveraged in one single area.

I remember a calculation from a college finance class. Imagine you have an otherwise "optimal" portfolio with 1% of its assets in a particular large stock, but you know that the real average returns of that stock are going to be ~2x what the market is expecting. So you recompute the efficient portfolio with this new information and find the new optimal weight of the stock and it's only something like 2-3% despite having a very strong information advantage over the market.

But most people would think this sounds crazy. "I've got a crazy inside stock tip that it's worth double what everyone else thinks? Shouldn't I put at least 10% of my money in there?" No. Diversity is a hell of a value-add in a portfolio.

Hedge funds won’t necessarily have technical experts in every field as employees making investment decisions, but they are paying those people for research. So “more knowledgeable than the average trader” doesn’t mean that you know more than the market is pricing in. That said, the hedge funds with big research budgets focus on large companies, leaving more opportunity in smaller stocks.

Right, I see this all the time. I never see any examples of what this looks like. Did your friend give you anything regarding that?

Buffet’s latest letter mentions active investors as those who buy with intent to sell, whereas he passively buys without intent to sell.

Buffett is pretty much the exact opposite of a boglehead. Buffett's strategy is to only pick winners. Jack Bogle was in the portfolio theory camp, buying companies regardless of if they appeared good or bad. Both can be profitable, but the boglehead strategy is much easier to do.

Apple at $1000 is not a winner. GameStop at $1 is a winner. If you are Buffet you can start doubting the price that the market sets for the stock. If you are a normal person you will probably be wrong more often than the market so don't bother contradicting it.

Buffett only invests in businesses he likes or could come to like. The best example recently is his divesting of airlines as he realized he no longer loved the business.

Further, it's impossible to know which hedge fund will beat the market. Using their past performance is not reliable over the long term.

Renaissance tho

As Rentec tidbits continue to leak over the years, you wonder how much of their gains are tax loophole engineering vs financial wizardry.

Or how much of their returns are just massive leverage being deployed and hidden from the rest of us? They constantly return investor money and cap the sizes of the private fund.

it's quite likely that their method of arbitrage has limited quantities in the market (whatever it is), and thus, cannot be deployed with unlimited capital.

>cannot be deployed with unlimited capital

Nothing can be.

which means it is easy to beat the market, most of them lose only because of taxman takes the profit away?

Or how much of Medallion's gains are just front-run their clients in their public-facing fund.

No, his bet is that these products which provide exposure to hedge funds for retail investors are not worth it. If he wanted to bet against hedge funds in general, then the bet would have been constructed like that (i.e. average performance of funds which aim to beat the market).

> * It's reasonable to be skeptical about any fund having a goal that's anything other then maximizing long-term returns.

I really don't think it is. If I'm a sophisticated investor, I may want to invest in funds which hedge against tail-risk, or provide broad exposure to some specific sector, etc. Neither of these things are about maximising returns relative to the S&P500. There are strategies with negative expected returns in the long-run, but when added to a portfolio can improve its returns. Portfolio construction can get very complex.

Well, no. From Warren himself: "I made the bet... (2) to publicize my conviction that my pick – a virtually cost-free investment in an unmanaged S&P 500 index fund – would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those “helpers” may be." [1] https://www.berkshirehathaway.com/letters/2017ltr.pdf.

And, regarding being skeptical of things like "hedging risks" and "complex portfolios," I don't know. I'm just not sure enough hedge funds really do a great job handling tail risks to not be skeptical of all of them as a group. And, surely sophisticated investors can target specific sectors and build arbitrarily complex portfolios (if they're into that sort of thing) with passive things like ETFs for much lower fees on their own.

That's clearly not a bet against hedge funds, but 'investment professionals', which in this case are these people offering pooled funds to the retail market. I agree with it and I'm sure many people in the hedge fund industry would agree with it.

I'm not talking about all hedge funds managing tail risk for their own portfolios, but funds which are designed to do nothing but hedge against tail risk. They provide a valuable service, and a small allocation to such a fund in concert with a large holding in the S&P500 will often outperform the S&P500, even if the fund itself loses money.

> That's clearly not a bet against hedge funds,

This isn't clear to me. To me it seems rather that this is a bet against hedge funds. I can see a way to your interpretation but it does not seem as likely to me.

> If he wanted to bet against hedge funds in general, then the bet would have been constructed like that (i.e. average performance of funds which aim to beat the market).

Quoting the shareholder's letter from 2016 [1], the actual bet was "that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. [...] For Protégé Partners’ side of our ten-year bet, Ted picked five funds-of-funds whose results were to be averaged and compared against my Vanguard S&P index fund."

[1] https://www.berkshirehathaway.com/letters/2016ltr.pdf

> If I'm a sophisticated investor, I may want to invest in funds which hedge against tail-risk

Do tail-risk-targeting hedge funds have a better incentive than 2-and-20? Honest question, I have no idea. I assume 2-and-20 drives shooting for the moon and closing the fund if it doesn’t work out.

> Instead, it's that on balance, by far most managers don't beat the S&P 500 on an after-fee basis.

Interestingly, most managers actually do match the S&P500, but before fees. I don't have a link handy, but there have been some academic papers on their performance.

The average active manager who mostly uses stocks in the S&P 500 matches the S&P 500, before fees, almost by definition. Given that the vast majority of passive investment is approximately tracking the S&P 500, active managers -- the complement of the passive set -- must also have the same average. The only way active managers could average something substantially different is if passive investments underperformed or overperformed, neither of which are the case.

Most funds end up so large that they can’t help but to be basically the s&p 500, just with slightly different weightings.

To majorly out perform or underperform you have to be drastically different.

> most managers actually do match the S&P500, but before fees.

so what exactly are you paying them their fees for then?

Either way, for an active manager to be worth their fees, they _have_ to beat the index by more than their fees plus a bit more to make up for the risk that they don't. Otherwise, you'd be better off in a passive fund.

Skeptical in what way?

I imagine the parent means reasonable to be skeptical about whether the fund is "worthy of your money" and by extension whether "anyone should put money into the specific fund".

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