A few outliers even claim Warren isn't a hedge fund manager but leverage, arbitrage, derivatives, event-driven and macro trading added much to returns and he shorted cocoa futures for a special situations deal as long ago as 1954. George and Warren generated alpha from low frequency trading in various hedge fund structures. Double Eagle - Quantum, Buffett Partnership - Berkshire Hathaway. Like many other hedge funds">hedge funds, they don't report returns to databases. Neither has a PhD or CFA but both have exceptional quantitative skills. I have never found a good manager that doesn't even if they run "discretionary" styles. Skilled managers do deliver reliable absolute returns. And prove that market prices are always wrong.
Portfolio performance is determined by your MANAGER mix not ASSET mix. The more people believing in efficient markets the more inefficient markets become. Trillions in index funds creates more alpha capture opportunities for those with skill. Mid-career professionals like Warren and George are thriving while hedge fund managers aged under 80 build up experience. Pensions worried about "longevity risk" benefit from investment talent working longer. Over 41 years George has turned $1,000 into $14 million AFTER FEES and Warren to $3 million from his actively managed hedge fund ETF. He charges LOWER fees than "cheap" unskilled index funds.
George's track record is better but Warren is richer. Why? The snowball of POSITIVE compounding for longer. Both were born in August 1930 and Warren ran his hedge fund from 1957 but George didn't set up his until 1969. Warren was lucky to be in Omaha while Dzjchdzhe Shorash was in Budapest, more affected by WW2. But Warren got into currency trading and global philanthropy later. George's outperformance is due to stronger international diversification and because reflexivity is ignored. Value investing is copied more than reflexivity investing. The boom bust of Eurozone sovereign credits and subprime CDOs are quintessential examples of reflexivity. Crises are PREDICTABLE. And profitable if you have expertise.
Alpha thrives off beta. Warren ran the partnership from 1957-1969 and then implemented his strategies via Berkshire Hathaway. He first bought BRKA shares in 1962 at $7.60 and now it's $120,000 for a 22% CAGR. But the Buffett Partnership did better with all 13 years positive. Gross returns of 29.5% were net 23.8% to investors after his 25% incentive fee on 6% hurdle. What if, instead of "retiring" in 1970, Warren had continued the partnership and performance had persisted? Investing $1,000 in 1957 would now be $100 million. Fees that Warren might have been "paid" for turning $1,000 into $100 million would be $1 billion. That's fine since clients have $99.9 million more than wasting time gambling on "low cost" passive.
Academics say Warren is just an ex-post lucky outlier but some talent spotters DID spot his talents ex-ante. The S&P 500 also began in 1957 but has performed poorly by comparison - $1,000 would now be $100,000, a huge opportunity cost. Investing for absolute return using competitive edges and outside the box thinking has existed for centuries. Long only relative return is the fad. Passive indexing is even newer. The trouble with owning dartboards is that you get the treble 20 and bullseye but you also tie up precious cash in 1s and 2s. With proper analysis, average hedge funds">hedge funds can be avoided just like average stocks. I prefer to identify the Phil Taylor of each strategy. How many darts must you throw to show skill? George and Warren have hit many treble 20s.
Hard to prove a conjecture but to disprove it ONE counterexample suffices. Warren, George and many others have destroyed efficient market hypotheses, random walk assumptions and the myth that long term policy asset allocation drives portfolio returns. BHB Brinson, Hood, Beebower, Singer and their acolytes have cost too many investors too much money and wrecked retirement plans. Prudent investors in fact want all their capital in attractive opportunities and that requires skill. George and Warren's alpha capture from security selection worked better than static beta bets. No-one says it's easy but if you work hard it is possible. Such investment teams CAN be identified at an early stage and can charge whatever hedge fund fees clients are prepared to pay.
Some hedge funds">hedge funds shut due to SUCCESS. Warren closed his in 1969 despite a strong track record as Stanley Druckenmiller did recently with Duquesne. The Buffett Partnership was set up when Benjamin Graham decided to end his Graham-Newman hedge fund, operating decades before AW Jones' "first" hedge fund. Warren is correct that the best investment book ever written in English is the Intelligent Investor. The second best is Alchemy of Finance though fortunately hardly anyone else bothers to try to understand it. The top financial book in any language is of course Fountain of Gold, written by the best hedge fund manager ever. I re-read them all regularly and every year my self-directed pension ends up with double-digit ABSOLUTE RETURNS. Coincidence? Burton Malkiel, Fama and French think I'm just lucky.
Warren wants to be judged on book value not stock price but you can't eat book value and I evaluate fund managers by what investors really receive. Partnerships are marked at NAV but the switch to BRKA subjected clients to irrational public markets. In 2008 BRKA book value dropped -9.6% but shareholders lost -31.8%. George made money that allegedly "challenging" year. While the stock has returned more than book value due to the valuation premium, volatility has been high. Warren's actual Sharpe ratio is lower than book value "Sharpe ratio", dropping sharply from 1.4 to 0.6.
The Oracle of Omaha and the Brain of Budapest have "quit" before and been searching for "successors" for a long time. George has been hiring "replacements" since 1981 and the extent of his fund management involvement has fluctuated since though never without close knowledge of and implied oversight of the portfolio. For each Li Lu or Todd Combs there was a Jim Marquez or Stanley Druckenmiller. No man is an island and both sought out strong colleagues and talented employees from early on. Jim Rogers and Charlie Munger added significantly. Accredited investors - anyone with $80 - can access Warren and Charlie's abilities through BRKB, a listed closed-end hedge fund. The active stockpickers at benchmark construction firms missed 45 years of massive growth but then add it to their "unmanaged" index!
Would Warren and George have bothered managing outside money if they hadn't been incentivized to do so and perform? It's skill that adds value. No alpha, no incentive fee. George's partnership fees were lower than Warrens's for gross returns above 25%. Since George and Warren's gross performance was in excess of 25%, George's fee structure was actually cheaper. Jim Simons and team have outperformed both for the past 20 years with much higher fees but the net returns of Medallion Fund were superior. The technological and personnel infrastructure requirements for high frequency trading cost more than for low frequency. If you don't like the fees, don't invest in hedge funds">hedge funds. Capacity for a good strategy is limited and demand exceeds supply of alpha. But it's expensive and dangerous waiting to find out WHETHER bargain beta might one day deliver.
Those "outrageous" fees? George charged 1% and 20% no hurdle whereas Warren charged 0% and 25% on 6% hurdle, then offered his money management skills for FREE in return for permanent, leveraged capital. But you would have done much better going with Soros Fund Management in 1969 and paying those "high" fees than you would with BRKA. I am delighted for people to be well compensated for delivering what I need, ABSOLUTE ALPHA, from their RARE abilities. If someone turns $1,000 into $100 million from skill not luck or riding the market, they deserve $1 billion. Especially when manager interests are aligned with clients by them being the largest investor in their fund. When George or Warren has a bad month, they PERSONALLY lose more than any client. That INCENTIVIZES them to do their best to minimize the downside.
This chart assumes fees compounded without the manager needing any profits to eat, live, pay employees, run the business etc. which of course they do. In recent years, with investor demands for larger teams, deep benches and operational infrastructure, fixed costs for hedge funds">hedge funds have risen to the 2 and 20 mode. Two people, a computer and a phone do not get institutional money today. Sad though to see an Omaha pension fund deep in a $600 million deficit when they could so easily have hired a local hedge fund run by Warren Buffett to get them into surplus. The Hungary retirement system is not in good shape either but they could have invested with George Soros and would now be doing fine. Why avoid the top absolute return managers when you have ABSOLUTE LIABILITIES to fund?
You CAN eat absolute returns and I'll take $100 million over $100,000 every time. I assume you would too. Sadly most "advice" focuses on asset allocation NOT manager and security selection. So what if the manager becomes a billionaire? They deserve it for the essential entrepreneurial service they offer. If clients get rich, it is fine by me if the manager gets richer. Plenty of "discount" funds are available but at what performance? Avoiding "high" fees for alpha is like saying to a Porsche dealer you will only pay $100 for a new car because that is what the raw materials cost. Or that Shakespeare was just a lucky fool who "randomly" chose words from the dictionary. I am writing this on Apple AAPL hardware using Microsoft MSFT software uploaded to a service owned by Google GOOG. Using those products may further enrich several people who are already billionaires. Does it matter? Or do SHARED incentives work?
No-one is forced to invest in hedge funds">hedge funds. Investors are free to make do with passive beta and relative return if they so choose. Some outliers even say alpha doesn't exist! For those "surprised" by the Euro crisis in Spain, Ireland, Greece, Belgium, Portugal etc., George saw the dangers long ago. Yet macroeconomic "stability" maven Robert Mundell keeps his "Nobel" Prize for now. Optimum currency areas aren't optimal so he should give it to George. If you flip a coin 10 times and get 8 heads it might be a fluke but NOT if you flip 1,000,000 coins and get 800,000 heads. Warren and George have flipped too many coins for their returns to be considered luck. They made their clients rich, deservedly got richer themselves and are giving their wealth away for the social benefit of the world. A rare financial win/win/win.
by Veryan Allen. Copyright 
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