Index Funds for Beginners - Should I Invest in Index Funds

- The Illusionary Allure of Hedge -

Nearly 10 years ago Berkshire Hathaway CEO (and arguably one of the best investors on Earth), Warren Buffett, issued a challenge to the hedge fund industry — a $1 million bet that they could not put together a portfolio of hedge funds that would outperform an S&P 500 Index fund over a 10-year period.

But it is in December 2007 that Buffett made a bet that the average of the stock market over the following 10 years would outperform the hedge funds that were using fancy investment strategies--and charging high fees.

“In order for hedge funds to justify their ‘2 and 20’ fee structures, their rates of return after fees must exceed what any investor can earn from a low-cost S&P 500 index fund,” Kass says.

Warren Buffett, the billionaire investor, made a bet five years ago in Fortune that an S&P index fund over 10 years would beat a selection of hedge funds picked by a New York money manager.

For the uninitiated, hedge funds are sophisticated investment vehicles generally open only to accredited investors – people with a net worth of at least $1 million, excluding the value of a primary residence, or earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, according to the Securities and Exchange Commission.

Hedge funds are limited to wealthier investors who can afford the higher fees and risks of hedge fund investing, and institutional investors, including pension funds.

Typically, you pay a management fee (and maybe even a performance fee) to the fund manager in addition to fees normally paid to the underlying hedge funds.

As hedge-fund profits wilted, institutional investors—such as pension funds and university endowments, which make up the bulk of hedge funds’ clientele—saw little reason to pay meaty fees for mediocre performance.

Both hedge funds and mutual funds are investment funds designed to provide return opportunities for investors through professional management and diversification among holdings.

For that reason, hedge funds above a certain size in the United States are regulated by the Securities and Exchange Commission, unless they work with accredited investors, that is, wealthy people who in theory understand investment risk.

- Hedge Funds with Biggest Returns -

As a matter of fact, hedge fund is one of the world’s top investment vehicles and you stand to get good returns on your investment annually if you invest in hedge funds.

Unlike mutual funds, hedge fund managers actively manage investment portfolios with a goal of absolute returns regardless of the overall market or index movements.

Index fund simply put are mutual funds or exchange traded funds (ETF) that are intended to track the returns on investment of a market index.

Rather, they seek to generate positive returns over time regardless of the market environment." A curious comment from a company accepting Buffet's challenge to pick a group of funds that will, well, beat the market.

Index performance as of March 5, 2019, shows the following gross annualized returns for the S&P 500 versus the Hedge Fund Research Index (HFRI) Fund Weighted Composite Index ®.

True, average annualised returns of the S&P 500 in the past five years, at 4.6%, still beat those of the average hedge fund, at 3%.

Institutional investors tend to have greater returns during periods of higher volatility, and during times where individual stock picks do not correlate very closely with the broader market.

There has been an increasing amount of scrutiny from both news outlets and retail investors about the hedge fund industry, and how the returns do not justify the exorbitant fees.

These are cumulative returns for the nine years, not yearly averages, and all I can say is "yuck." Not only is the hedge fund portfolio lagging the index fund by a wide margin, not a single fund that Protégé selected is outperforming the index fund.

 

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