Six Years Later, Warren Buffett Is Winning His Bet Against Hedge Funds

at the Fortune Most Powerful Women Summit in Laguna Niguel, CA.

In 2008, Warren Buffett made a $1 million wager with alternatives firm Protégé Partners. The money came from Buffet’s own pocket, not Berkshire’s. Around the country, the ears of pension funds began perking up in anticipation. The bet:

Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.

In other words, Buffett bet that, taking into account investment expenses, an index fund would outperform a fund of hedge funds over a ten-year period. The thinking is in line with what Buffet has publicly said in the past. And, six years later, Buffett is winning his bet.


(The winner of the bet, by the way, will donate the money to a charity of his choice).

This bet is of particular interest to pension funds because alternative asset classes have increasingly become part of their investment portfolios. Regardless of who wins the bet, however, the results will be largely symbolic.

But the over-arching philosophies behind the wager are still interesting to examine. For Buffett, his dislike of hedge funds comes down to fees.

Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.

A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.

On the other end, Protégé Partners defends hedge funds:

Mr. Buffett is correct in his assertion that, on average, active management in a narrowly defined universe like the S&P 500 is destined to underperform market indexes. That is a well-established fact in the context of traditional long-only investment management. But applying the same argument to hedge funds is a bit of an apples-to-oranges comparison.

Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional “relative-return” investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.

Pension360 has covered the emerging trend of pension funds, including CalPERS, reducing their investments in hedge funds.


Photo by Fortune Live Media via Flickr CC

Divesting From Gun Manufacturers Is Still On The Minds of Some Large Pension Funds


The politics of guns isn’t a topic too often broached at shareholder meetings.

But that’s exactly the topic that was the center of attention at Alliant Techsystems’ annual shareholder meeting on July 30, which included a shareholder resolution asking the Virginia-based defense and sporting goods company to comply with some of the Sandy Hook Principles—an initiative requesting that firearms manufacturers comply by certain guidelines, for example, developing better safety technology.

The message of the Sandy Hook Principles: comply or be sold.

And who filed that shareholder resolution? The Connecticut Retirement Plans and Trust Funds as well as the New York State Common Retirement Fund.

According to a press release, the resolution asked for the following from Alliant Techsystems:

* Promoting restrictions on firearms and ammunition sales, transfers and possession to keep guns out of the hands of children, persons with mental illness or mental health challenges, criminals, domestic or international terrorists and anyone else prohibited from possessing them under federal law;

* Supporting the establishment of a federal universal background check system for every sale or transfer of guns or ammunition conducted by the company;

* Reevaluating policies regarding the sale, production, design or conversion of military style assault weapons for use by civilians, including the distribution of any materials/information that may be used to assist in such conversions;

* Taking steps to promote the conducting of background checks for every sale or transfer of guns or ammunition by business clients, including gun show operators or gun dealers.

* Supporting a federal gun trafficking statute to ensure stronger punishment for individuals engaging in the trade of selling firearms to anyone prohibited from possessing them under federal law; and

* Promoting gun safety education at the point of sale and in the communities in which the company conducts business operations.

It’s only the latest in a string of “social Investment” decisions that imply institutional investors are considering divesting from gun manufacturers.

In February, a professor convinced his institution, Occidental College, to pass a resolution banning firearm investments by the school. It was the first college in the United States to do so.

A Pennsylvania volunteer group called Delco United is attempting to convince various municipalities to divest from guns, and in at least one case it worked: after a visit from Delco, the Pennsylvania State Association of Boroughs subsequently sold its holdings in Sturm, Ruger & Co.

Last year, CalPERS voted to sell about $5 million worth of securities related to gun manufacturers. CalSTRS, and others, followed suit. From Governing:

The $154-billion California State Teachers’ Retirement System, the country’s second largest government retirement plan, took a similar action.

CalSTRS and CalPERS took up the divestment issue at the request of state Treasurer Bill Lockyer, a member of both boards. Lockyer called the vote “largely symbolic” but stressed that it’s an important way to spur incremental change.

“We’re limited by the constraints of our responsibility and the rules that CalPERS has,” said Lockyer. “There’s only one way that we speak and that’s with money.

Funds in Chicago, New York state, New York City, Connecticut, Rhode Island and Massachusetts have publicly said they are exploring such divestments.

The Philadelphia Board of Pensions threatened to divest its $15.3 million share in various gun manufacturers if they didn’t sign on to the Sandy Hook Principles.

Chicago mayor Rahm Emanuel ordered the city’s funds to divest from firearms manufacturers, but only one fund complied.

But when it comes to social investing, is the probability of making a change worth the chance of “fiscal peril” posed by potentially higher administrative costs and lower returns associated with divesting? One prominent retirement researcher thinks not. From Governing:

Alicia Munnell, director of the Center for Retirement Research at Boston College, is an outspoken critic of social investing. After years of social investment decisions in regard to South Africa, the Sudan and other countries and causes, Munnell sees fiscal peril in forcing portfolio managers to add non-monetary considerations to investment decisions. “Introducing another dimension creates a risk that portfolio managers will take their eyes off the prize of maximum returns and undermine investment performance.”

As she sees it, the people making the social investment decisions are not the people who will bear the burden if anything goes wrong. “If divestiture produces losses either through higher administrative costs or lower returns,” she says, “tomorrow’s taxpayers will have to ante up or future retirees will receive lower benefits.”

Private pension plans, which are governed by the Employee Retirement Income Security Act, are prohibited from social investing. Munnell believes public plans should follow suit. Not that there isn’t room for other groups to do social investing. “If rich people want to adjust their own portfolios, that is perfectly reasonable,” she says. “But for public plans to do it is not.”

Social investment advocates argue they have a moral responsibility to society. As Chicago Alderman Will Burns put it earlier this year, “The damage caused by these weapons is far greater than any return on investment.”

It’s a strong argument, and one that Munnell says makes her position “not a pleasant one.” When the genocides in Darfur were occurring and pension plans were talking of disinvesting, Munnell disagreed vocally with that policy. “I sounded pro-genocide. Now I sound anti-gun control. I’m neither. I just don’t think social investing is effective. It can harm the performance of public plans.”

Connecticut Treasurer Denise Nappier has a different view.

“These companies will enhance their long-term shareholder value if they are seen as a reasonable public voice in the debate over the proper response to the Newtown tragedy”, said the Treasurer in a statement to Institutional Investor. “At the same time, they will suffer if the public perceives them as unwilling to consider reasonable voluntary measures, such as the Sandy Hook principles.”

Photo by Mitch Barrie via Flickr CC License

California Cities Are Lining Up To Divest From Fossil Fuels, but CalPERS Isn’t Following


A movement is taking hold in California that encourages state and local governments to divest in companies that hold the largest reserves of oil, natural gas and coal.

Over two-dozen California cities—Oakland, Richmond, Berkeley, San Francisco and Santa Monica among them—have already made plans to divest from such companies. Now, the mayors of Berkeley, Oakland and Richmond are publicly asking CalPERS to follow them. From an Op-Ed published by the mayors in the Sacramento Bee:

As elected officials, we believe our investments should instead support a future where residents can live healthy lives without the negative impacts of climate change and dirty air. It’s time for CalPERS to take our public pension dollars out of dirty fossil fuels and reinvest in building a clean energy future, for the sake of our health, our environment and our children.

In actuality, there are more than morals at play here. The value of fossil fuel investments, and by extension CalPERS’ portfolio, may be at risk as well. From the Sacramento Bee:

The International Energy Agency has concluded that “no more than one-third of proven reserves of fossil fuel can be consumed prior to 2050” if the world is to limit global warming to 2 degrees Celsius. That goal “offers the best chance of avoiding runaway climate disruption.”

That means if the world’s governments take responsible action to prevent climate catastrophe, fossil fuel companies will have to leave some 75 percent of their reserves in the ground. These companies are valued by Wall Street analysts on the basis of their reserves. Meanwhile, fossil fuel companies continue to spend hundreds of billions of dollars on exploration for new reserves. A growing “carbon bubble” – overvalued companies, wasted capital and stranded assets – poses a huge risk to investments in fossil fuels.

CalPERS holds almost $10 billion in major fossil fuel company stocks and recognizes this financial risk. It recently adopted “investment beliefs” that include consideration of “risk factors, for example climate change and natural resource availability, that emerge slowly over long time periods, but could have material impact on company or portfolio returns.”

There’s actually precedent for pension funds following social movements and divesting in certain companies. In the 1980’s many funds divesting from companies doing business in South Africa as a way of protesting Apartheid—in that instance, California funds pulled nearly $10 billion worth of investments.

And it happened again last year, when numerous funds (including CalSTRS) divested from gun manufacturers in the wake of several school shootings.

But this time, CalPERS doesn’t appear to be interested in divesting from fossil fuel companies. The fund’s senior portfolio manager Anne Simpson addressed the issue in an editorial in the Sacramento Bee:

We all have a shared concern with climate risk, but our view is that the solution lies in engaging energy companies in a process focused on finding solutions, rather than walking away.

We at CalPERS talk to more than 100 companies on an annual basis to ensure the high standards of corporate governance that underpin effective climate change risk management, and we invest in climate change solutions across our global equity, private equity and real estate portfolios.

CalPERS was a founding member of the Investor Network on Climate Risk, a leading group of 100 institutional investors representing more than $10 trillion in assets, addressing a policy agenda that calls on governments and regulators to introduce carbon pricing and disclosure, so that risks can be tackled effectively.

CalPERS is also actively collaborating in the Carbon Asset Risk Initiative, led by the nonprofit Ceres, which draws together 70 global investors managing more than $3 trillion in assets. The initiative asks 45 large oil and gas, coal and electric power companies – including ExxonMobil, Royal Dutch shell, BHP Billiton, Rio Tinto and Vale – to assess the financial risks climate change poses to corporate business plans.

Of course, there is some evidence that divesting doesn’t actually accomplish the social goals these funds have in mind when they pull their money from companies. Liz Farmer at Governing explains:

There’s no proof that divesting actually effects change. In fact, a 1999 study concluded that apartheid-related pension divestments had no significant financial impact on companies doing business in South Africa.

What’s worse, targeting investments based on social causes has proven to be dangerous for pension plans. In 1983, a study found that 10 states that had targeted investments in mortgage-backed securities as a way of encouraging homeownership either inadvertently or deliberately sacrificed returns. In some cases, they gave up as much as 2 percent in returns all for the goal of making homeownership more accessible. In 1990, Connecticut’s pension fund bought a 47 percent interest in Colt Industries in an attempt to protect Connecticut jobs. The firm went bankrupt two years later and the fund lost $25 million.

This will be an interesting story to watch play out. CalPERS will likely come under scrutiny no matter what they decide to do. In any case, any investment decision that results from this campaign should be transparent and financially sound. Pension360 will keep you updated on future developments.