Buffet Slams Wall Street Monkeys

Warren Buffett devoted more than four pages of annual shareholder letter to criticize active managers on Wall Street. He stated that they charge exorbitant fees for returns that fail to live up to lofty assumptions. An article on CNBC provided further details:

"When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients," stated the widely-read letter released on Saturday morning. "Both large and small investors should stick with low-cost index funds."

Investors seem to be heeding Buffett's anti-active advice, as more than $20 billion flowed out of U.S. active equity funds in January despite a rising stock market, according to Morningstar.

What do you guys think of this? Is Buffet right and is active investment on the decline?

Hi Anonymous Monkey, upload your resume and land a job

Members that upload a resume get 2.3x the number of interview invites through the Talent Oasis. Learn more.

Comments (26)

Feb 26, 2017

Index funds are awesome during a bull market! I bet people weren't so fond of them in late 2008. Some active managers are probably terrible though, but that doesn't mean that the concept per se is awful.

Feb 26, 2017

While I agree, the article goes in detail about a bet that Buffet made that started in 2008. Here is what his bet entitled:

"I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds - wildly-popular and high-fee investing vehicles - that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender

The compounded annual increase of the index fund was 7.1% while the average for the five hedge funds selected was 2.2%. Looking more specifically at the returns actually makes it seem more enticing to go into index funds during / following a recession rather than attempting to mitigate risk.

Feb 27, 2017

.

    • 1
Feb 26, 2017

It's easy for him to say when the past decade has been an incredible bull run. Let's see if his bet holds true 3 years from now.

Certified Investment Banking Pro - Learn more.
    • 1
    • 1
Feb 27, 2017

There was also a good deal of volatility during that timeframe which could have allowed hedge funds to capitalize. What is most amazing is that the 5 hedge funds chosen to compete against his chosen index fund averaged only 2.2%. Even in good years some of those funds were down or underperformed pretty badly.

Feb 27, 2017

this is another reason why I hate when Buffett opines. he built his entire net worth on a hybrid between active management and buying companies. his only saving grace is instead of charging 2 & 20%, he charges 25% of profits over 6% with no management fee. I don't have anything inherently wrong with this model, but it's kinda hard to run an Asset Management shop without ongoing revenue.

Certified Investment Advisor Pro - Learn more.
    • 4
Feb 27, 2017

Buffett acts like his shit doesn't stick which pisses off a lot of people

    • 1
    • 2
Feb 27, 2017

Buffett acts like his shit doesn't stick which pisses off a lot of people

    • 2
Feb 28, 2017

Why do you think he consistently seems to go after active management?

Best Response
Feb 28, 2017

because he's old and bored. 30 years ago he wrote a paper on how value investing is superior (google superinvestors of graham and doddsville). he has 2 guys running most of the money nowadays so he splits time between buying cherry coke and opining about politics, taxes, active/passive, and income inequality. I miss the old Buffett

Certified Investment Advisor Pro - Learn more.
    • 10
Mar 3, 2017

"so he splits time between buying cherry coke and opining about politics, taxes, active/passive, and income inequality."

HAHA - thank you for the laugh today.

Certified Asset Management Pro - Learn more.
    • 1
Mar 3, 2017

Buffett's advice is bang on for most people. Most active managers don't beat the market, and most people, my parents for example - a small business owner and a mid level manager at a large tech company - don't have access to people like David Tepper, Ray Dalio, Ken Griffin, et al... And even if they did have access, they wouldn't know how to evaluate a fund manager.

They also lack the technical competency to value investment products/vehicles properly, so they have no business buying individual securities.

Paying even a 1% management fee to some stooge asset manager is a total waste.

Mar 3, 2017

Could someone give the counter argument that index funds outperform actively managed funds over the long run and are therefore the better investment? I understand that actively managed funds usually suffer smaller losses during bear markets, but that does not seem like a sound argument to me.

Certified Corporate Development Pro - Learn more.
    • 1
Mar 3, 2017

the issue is lumping in all active in one bucket and all index in another bucket. there are certain strategies like low PE, high ROIC, high active share, some quant strategies (ran by the big shops like rentech, DE Shaw, 2 sigma, Citadel) and so on that (over long periods of time) can reliably outperform indices. on the whole, active will NEVER outperform passive, because all of passive + all of active is the market, and if the market is the median return, half of active managers underperform, and those that only barely outperform will turn into underperformers net of fees, so any given year, you have the majority of active managers underperforming net of fees.

and that's not true that active managers suffer smaller losses during bear markets, that only holds water if that active manager has been holding a lot of cash and is carrying less beta than the index. my point is that when the next bear growls, people will go back to active management partially because of this perception.

if you're young, in the accumulation phase, and don't get spooked by market declines, I'd put most of your money in something that doesn't require a lot of attention. if that's SPY, an active fund, a factor based ETF, whatever it is, just put it on autopilot. most investor success isn't based on whether you outperform or underperform the index by 50bps or even a point or two, it's regularly contributing a high % of your income to global stocks for decades.

if you can't stand the thought of potentially paying someone high fees if they underperform, then just buy an index fund (and I'd recommend something like VTWSX that gets the global market, not just US). if you believe there are certain strategies that can outperform over time, pick those funds and stick with them for a long time. or if you're unsure, split the difference. if you want to do it yourself, have the bulk of your money in something that doesn't require attention and then pick a few names you like and see what happens. most outperformance and underperformance comes from investor behavior, not from security selection, at least in my experience.

Certified Investment Advisor Pro - Learn more.
    • 8
Mar 3, 2017

you're in wealth management so genuinely interested in getting your take on this. Have you seen any of your clients accumulate $5 million + in wealth from following the prescription of contributing 10-15% of their income (from their day job) to index funds for decades and letting it compound (aka the popular formula espoused by a million personal finance books and gurus). Reason I ask is because from my casual observation I've never met anyone who accumulated significant wealth this way unless they were a high earning professional or put it another way it's not that difficult to accumulate 5MM if you save 20% of your $300k income a year. Most of the wealthy people I know got their wealth from either owning a business or hit a home run through some non public investment like real estate or again some sort ownership stake in a company or companies or again successfully climbing very far up the corporate ladder. But I've yet to meet the guy with a large net worth who just steadily socked away his $75k income into an ira or 401k.

Mar 3, 2017

of course not. you don't get 5mm in assets if you make 75k a year, that's asinine. you will get to financial independence (and I'd argue the # needs to be closer to 20%), but you won't get to a "large net worth." I've seen many people get to financial independence (different # for everyone) with that formula (save double digits, put it in stocks, let it ride for 40 years).

beyond that, I'm not sure what question you're asking.

Certified Investment Advisor Pro - Learn more.
Mar 3, 2017

The guy you describe at the end can certainly become a millionaire, especially with some other income stream like a rental property, but won't become "wealthy" per se if your definition is $5MM+

Mar 3, 2017

But who has access to places like RenTeh, DE Shaw, Two Sigma, and Citadel? Buffett says that in the aggregate indexers will outperform active managers, and I find it hard to disagree with that statement.

Mar 3, 2017

of course in aggregate they will underperform, it's mathematically impossible for it to be any other way. my point is (as Buffett said in superinvestors...) there are certain strategies which, given enough time, persistently outperform. I don't argue with you on that, I've never said otherwise, my point is it's stupid to lump all active Management Strategies into one bucket as if it's homogeneous.

I've said it before, I'll say it again, if you have the money, you can get access to everywhere I've mentioned.

responding to your other point about your parents, that's a different question: should you have help or should you not have help?

"...they wouldn't know how to evaluate a fund manager.

They also lack the technical competency to value investment products/vehicles properly, so they have no business buying individual securities.

Paying even a 1% management fee to some stooge asset manager is a total waste."

if all of that is true and they have the temperament to stay invested, then yes, they should do it all themselves: buy index ETFs, use vanguard or DFA to control costs, and never seek the help of someone like me. however, my experience has been if someone doesn't have the intellectual wherewithal to evaluate securities or fund managers, they often (not always) don't have the stomach to invest by themselves.

if humans acted completely rationally all the time and were all interested in investing, my profession wouldn't exist. I don't think everyone needs an advisor, in fact most people don't, but I think the right advisor can absolutely add value. but that's another discussion for another day.

Certified Investment Advisor Pro - Learn more.
    • 3
Mar 3, 2017

I'll give you one. Does every active manager that strives for absolute returns has the same risk profile as an index fund?

Certified Sales & Trading Pro - Learn more.
Mar 3, 2017

Have you read The Snowball? A lot of what Buffet did to accumulate the first stages of his fortune is illegal today-- though in all fairness it wasn't illegal then, but it still explains his initial edge and why it can't be done again today.

As for the passive vs. active argument I think any basic investor can tell you passive has been the hot trend the past few years. Active can occasionally make sense for some investors in certain situations however.

The quickest example that comes to mind is an investor age 60 who is planning on retiring soon and can't afford 100% downside capture during a market pullback and isn't nearly as concerned with 100% upside capture--in that case it makes sense to use an active manager who is using a variety of capital appreciation and total return strategies to minimize downside capture should the markets turn bearish. They aren't entirely concerned with performance and because of this an active manager can fill that void much more efficiently than say, a CD ladder.

Certified Investment Advisor Pro - Learn more.
    • 2
Mar 3, 2017

This is such active management speak.

No, you don't need to pay exorbitant fees to an active manager to hedge your risk. You can do this by diversifying between stock/bonds/CDs based on your risk profile. Takes literally <1 hour to learn about this on the vanguard site or a quick google search.

Certified Corporate Development Pro - Learn more.
Mar 3, 2017

@FWU , I totally agree and could write an essay about how a person willfully maintaining a lack of financial literacy is literally more costly than a college degree via the fees they pay us advisors. I've lost more than a couple clients because I've explained how to use Morningstar, ETF's vs. mutual funds, active vs. passive, market cycles etc so don't think I'm rationalizing anything. For the record, it's fine with me, I'd rather serve as a Keynesian multiplier than a drain on their money when possible. I'll be the first to admit that the pricing strategy within advising is becoming antiquated. But before you go all Boglehead, also realize not everyone has the desire to take even a mere hour to educate themselves.

Unfortunately some people just don't care to learn it and their eyes glaze over when they hear anything financial. Now for me to build a portfolio and rebalance (I also use ETF models, not mutual funds), tax loss harvest, adjust allocations, smooth out their insurance, allocate their 401k (which I don't get paid on), come up with a personalized budget, make sure their wills and trust documents are intact, and get them specialized lending solutions they can't get at a retail bank-- well I think we can both agree that some compensation is deserved in those cases.

Certified Investment Advisor Pro - Learn more.
    • 3
Mar 5, 2017

"Do as I say, not as I do."

    • 1
Mar 5, 2017

1-Click to Unlock All Comments - 100% FREE

Why do I need to be signed in?
WSO is a knowledge-sharing community that depends on everyone being able to pitch in when they know something.
+ Bonus: 6 Free Financial Modeling Lessons with 1-Click Signup ($199 value)
Certified Equity Research Pro - Learn more.
    • 1
Mar 6, 2017
Certified Asset Management Pro - Learn more.