Buffett Seizes Lead in Bet on Stocks Beating Hedge Funds

Warren Buffett made a friendly bet four years ago that funds that invest in hedge funds for their clients couldnt beat the stock market over a decade. So far hes winning. The wager that began on Jan. 1, 2008, pits the Omaha, Nebraska, billionaire against Protg Partners LLC, a New York fund of hedge funds co-founded by Ted Seides and Jeffrey Tarrant. Protg built an index of five funds that invest in hedge funds to compete against a Vanguard mutual fund that tracks the Standard & Poors 500 Index. The winners charity of choice gets $1 million when the bet ends on Dec. 31, 2017. The Vanguard funds low-cost Admiral shares returned 2.2 percent, with dividends reinvested, from the start of the bet through Feb. 29, 2011, as stocks rebounded from a 12year low in March 2009. The hedge funds fell about 4.5 percent, based on Protges index returns for the first three years and results since then for the Dow Jones Credit Suisse Hedge Fund Index, which has roughly tracked the group of unidentified funds when adjustments are made for extra fees. Hedge funds of funds have underperformed because of high fees and mediocre manager selection, said Brad Alford, head of Alpha Capital Management LLC in Atlanta, who opened a mutual fund of funds in January 2011 designed to replicate the performance of hedge funds, only with lower charges and the flexibility for clients to pull money out daily. Neither Buffett nor Scott Tagliarino, a spokesman for Protg, would comment on the bets progress. Assets Decline Funds of funds have seen clients flee in the past five years. Some of the largest U.S. public pension funds, including those in Massachusetts, South Carolina and New York, started investing directly in hedge funds instead of going through an intermediary in an effort to reduce fees and boost returns.

The amount of money they control has fallen by about one-fifth to $630 billion as of the end of 2011, compared with a year-end peak of $780 billion in 2007, according to Hedge Fund Research. Funds of funds were the industrys biggest investors in 2007, holding about 43 percent of assets. Buffetts argument, like the large pension funds, is that funds of hedge funds cost too much, according to a statement he posted on longbets.org, a website backed by the nonprofit Long Now Foundation that fosters long-term thinking. In addition to the 2 percent management fee and 20 percent performance fee that hedge funds typically charge, the funds of funds add another layer of fees, on average 1.25 percent of assets and 7.5 percent of any gains, according to data compiled by Bloomberg. Wheat From Chaff Protg said in its statement that because hedge funds can make bets on rising as well as falling prices of stocks, bonds, currencies and commodities, they are able to beat the S&P 500even after fees, and that sophisticated investors such as fund-of-fund managers with the ability to sort the wheat from the chaff will earn returns that amply compensate for the extra costs. The returns of Protgs index from 2008 through 2010, reported in Fortune magazine a year ago by long-time Buffett friend and chronicler Carol Loomis, are similar to those of the Dow Jones Credit Suisse Hedge Fund Index, after adjusting for the added fees charged by hedge fund of funds. That index fell 2.5 percent last year, and rose 4 percent in the first two months of 2012. Protg took the lead in the first year of the bet as its fund of funds index lost 24 percent and Vanguards fund declined by 37 percent. Buffett narrowed the gap in subsequent years. The S&P fund returned 27 percent in 2009, compared with a gain of 16 percent for the hedge funds, according to Fortune. The stock fund rose 15 percent in 2010 as the hedge funds advanced 8.5 percent. Overtaking Hedge Funds

The 81-year-old Buffett, who is chairman of the holding company Berkshire Hathaway Inc. (BRK/A), ended last year neck and neck with the Protg funds as the Vanguard fund climbed by 2.1 percent and the Protg hedge funds lost an estimated 3.75 percent. The first two months of this year pushed the Vanguard fund ahead as stocks returned 9 percent, more than twice the gains of hedge funds. Buffett, who told Loomis in 2008 he placed his chances of winning at 60 percent, had originally suggested a bet against single-manager hedge funds. Had he found a taker, he would be trailing by about 6 percentage points based on the Dow Jones Credit Suisse index. If Buffett had bet returns of his own holding company against the performance of hedge funds, hed be even farther behind. Berkshire Hathaway shares have slumped almost 17 percent since the end of 2007.