Hedge Fund Love & Hate: Loeb v. Buffett

What is your favorite criticism of hedge funds? My personal favorite was uttered by the one and only Warren Buffett:


Mr. Buffett provided an update on his bet on whether hedge funds could outperform a broad market index, and, in particular, the Standard & Poor’s 500-stock index.

The Berkshire chief almost gleefully noted how the wager stands as of now: After a few rocky years, the S.&P. index has now gained 63.5 percent since 2008, while an index of hedge funds has risen 19.6 percent.

Coming to the defense of hedge funds is Dan Loeb, founder of Third Point, who had a rather poignant reply as noted by DealBook:


On Wednesday, Mr. Loeb used his one-on-one interview at the SkyBridge Alternatives Conference, or SALT, to retaliate.

“I love reading Warren Buffett’s letters and I love contrasting his words with his actions,” he began. Lest anyone think it was a put-down, he quickly added, “He’s a very wise guy.”

But wise or not, Mr. Loeb had a few critical things to say about Mr. Buffett. “I love how he criticizes hedge funds, yet he had the first hedge fund,” Mr. Loeb said. “He criticizes activists, he was the first activist. He criticizes financial services companies, yet he loves to invest in them. He thinks that we should all pay taxes, yet he avoids them himself.”

Certainly a clever reply, but the silliness of the refrain, "hedge funds do worse than the S&P" is the implied assumption that they're comparable in the first place. No matter who offers an S&P 500 passive fund, it will have the exact same equity holdings and follow the exact same strategy. Hedge funds are the exact opposite, they have distinct holdings and follow a distinct strategy. Additionally, unlike an S&P 500 passive fund, hedge funds are used by investors for, presumably, hedging. These are wild differences and pretending that it's an apples to apples comparison is disingenuous.

What do you monkeys think? Is Buffett right in his comparison of hedge funds to a broad index?

 

You can bet your ass Buffet would not have made that bet if it wasn't at the bottom of the second deepest recession in history.

"Strength does not come from physical capacity. It comes from an indomitable will."
 
Best Response

Warren Buffet is legendary, not only as an investor, but as a PR person. As the wealthiest financier of our time, it's remarkable that no one in Middle America thinks of him in those terms. As in, they don't equate him to a Loeb, Paulson, Icahn, ect. They believe he is a cuddly, midwestern grandpa who makes virtuous business decisions that just happen to take form as investments. His frugality makes him even more appealing to this market. The fact that he has successfully separated himself from Wall Street, partially through bashing it, while utilizing the same investment strategies as some of the other great managers is applaud worthy from a PR perspective. However, it's surprising that more people like Loeb have not called him out for it.

As Loeb pointed out, he is a hypocrite who bashes hedge funds, while he operates a giant public fund himself - one which is successful through leverage. In this same letter that Loeb references, Buffet calls out investment bankers and private equity firms, but happily invests in banks (Wells) and partners with PE firms (3G).

I don't have an opinion on his character either way, but again, it is crazy how no one seems to have truly called him out for his bullshit besides Loeb.

 

I certainly agree with the common insight that Buffet's words and actions are badly out of sync. It's the definition of hypocrisy to bash derivatives, HF, activism, PE, tax rates while participating in all of the above.

However, if you'll permit me to use a hockey analogy, when your torching a team by 5 goals and some kid starts chirping, all you have to do is laugh and point to the scoreboard.

Money is the scoreboard, and Buffett is winning, by a long shot (he has had 30 years longer to accumulate capital than Loeb, to be fair)

Unfortunately, Hedge Funds on the whole are underperforming. Hence why Pensions, Sovereigns, Endowments and others are pulling back. Buffett's Returns are also coming back to earth, both suffering from a giant capital base that makes 20+% returns difficult.

 

Bashing hedge funds is just another manifestation of populist drivel, and Buffet should be one of the last people on earth to try to advance this agenda. As someone noted earlier Buffet is all about PR... which includes being a hypocritical schmuck.

 

Hedge funds usually underperform the market when the market is rising - that's just their nature. Not surprising that this has happened from 2008 onwards. This is possibly a reason for the prevalence of activist investors these days - they are trying to unlock value any way that they can.

 
fortheppl:

Hedge funds usually underperform the market when the market is rising - that's just their nature. Not surprising that this has happened from 2008 onward

Oh yeah, because hedge funds did really well as the market crashed. Greenwich was really celebrating. Hedge funds are just contrarian like that.
 

If I were to defend hedge funds, I would not argue that they are worse investments than ETFs. I think I know what you are getting at though. A couple things to note:

1.) You can't compare hedge funds to ETFs, they are different investment vehicles. Hedge fund investors want out-sized returns for sure, but they generally want an uncorrelated performance to the market. A broad US ETF, which is what I am assuming you're talking about, is essentially a proxy for the market. Therefore, it would not be right to compare the two. Also, practically speaking, if you were in a position to invest in both hedge funds and ETFs, it would be useless to compare aggregate hedge fund performance to ETFs. Why? Because the best hedge fund of funds and endowments may be able to diversify their hedge fund investments, but no entity invests in every type of hedge fund. An accredited investor most likely would pick a number of funds and strategies they deem fit, not a whole universe. This is directly opposite of a passive broad US ETF, which is essentially the return of the entire market.

2.) As for your questions about a suggested test to verify ETFs vs hedge fund returns, I don't think you're going to get an answer you want to hear. I'll take a stab at it anyway. There are two ways you could look at this situation. I'm going to use S&P returns and keep on assuming you're talking about a broad US market ETF.

One, you could compare historical returns. You'll find S&P and aggregate hedge fund performance is nearly identical, even after accounting for fees. Furthermore, hedge funds expressed lower volatility. In the last five years, however, the S&P outperformed hedge funds but has been more volatile. Leading us to next method of comparison...

Two, you could try predicting the future. So if you're going to try this exercise, you're going to have to account for a couple developments. Since the recession hit, the Federal Reserve entered into unprecedented territory. It started buying mortgages in addition to cutting rates and engaging in buying treasuries. A combination of monetary policy maneuvers has led to an unforeseen environment where volatility has been relatively low, until recently. Why is volatility important? In a more volatile environment, hedge funds perform better. The Fed stopped buying treasuries and is about raise rates, which will bring about a more normal market environment and presumably continued volatility. Another development to consider is that the hedge fund space has become oversaturated - meaning strategies have become crowded, which has lead performance going to down for many players. This crowding isn't going to necessarily continue. As investors pressure managers on fees and performance, and as bad years naturally come and go for certain funds, you could see a consolidation of the industry. This interplay between investors and hedge funds as a whole could lead to the better funds surviving and aggregate returns rising.

 

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