March 21 (Bloomberg) -- Warren Buffett made a friendly bet four years ago that funds that invest in hedge funds for their clients couldn’t beat the stock market over a decade. So far he’s winning.
The wager that began on Jan. 1, 2008, pits the Omaha, Nebraska, billionaire against Protégé Partners LLC, a New York fund of hedge funds co-founded by Ted Seides and Jeffrey Tarrant. Protégé built an index of five funds that invest in hedge funds to compete against a Vanguard mutual fund that tracks the Standard & Poor’s 500 Index. The winner’s charity of choice gets $1 million when the bet ends on Dec. 31, 2017.
The Vanguard fund’s low-cost Admiral shares returned 2.2%, with dividends reinvested, from the start of the bet through Feb. 29, as stocks rebounded from a 12-year low in March 2009. The hedge funds fell about 4.5%, based on Protégé’s 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, which runs a mutual fund of funds designed to replicate the performance of hedge funds with lower fees and the flexibility for clients to pull money out daily. Since 2009, his Alpha Defensive Growth strategy has posted an annual average return of 8.2%, almost twice the return of hedge fund of funds.
Neither Buffett nor Scott Tagliarino, a spokesman for Protégé, would comment on the bet’s progress.
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 industry’s biggest investors in 2007, holding about 43% of assets.
Buffett’s 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% management fee and 20% performance fee that hedge funds typically charge, the funds of funds add another layer of fees, on average 1.25% of assets and 7.5% of any gains, according to data compiled by Bloomberg.