One Last Look at Warren Buffett’s Hedge Fund Bet

Cheri Franklin |


In Warren Buffett’s 2017 letter to shareholders of Berkshire Hathaway, he lays out the details of his overwhelming victory in his 10-year bet on a Vanguard S&P 500 Index fund vs. a collection of five hedge funds professionally chosen by Protégé Partners. The S&P 500 fund beat all five hedge funds by margins ranging from 2.0% to 8.2% per year annualized returns.

Now some hedge fund advocates may argue that simple annualized return was the wrong metric because hedge funds strive to deliver higher risk-adjusted returns than the market, even with lower overall returns. Did this happen here? Well, only one of the five hedge funds had a higher Sharpe ratio than the S&P 500 fund. As for the average of the five, it was not even a close call (0.425 for S&P 500 vs. 0.260 for the hedge funds).

Other proponents of hedge funds may argue that hedge funds are for investors who already have a large exposure to the equity markets and are looking to diversify that exposure by adding hedge funds to increase the risk-adjusted return of the overall portfolio. Did this happen here? Nope! A 60/40 blend of the S&P 500 fund and the five hedge funds had a lower Sharpe ratio than the S&P 500 fund by itself. A far better diversifier of the S&P 500 was the Bloomberg Barclays U.S. Aggregate Bond Index, as a 60/40 blend increased the Sharpe ratio from 0.425 to 0.617.

Even though the S&P 500 had a rough start in 2008 (down 37%) it still managed to deliver an annualized average return of 8.5%, well in-line with its long-term historical average. Even Berkshire Hathaway, with an annualized return of 7.7% and a Sharpe ratio of 0.359 did not keep up with it. Of course, Mr. Buffett and Mr. Munger can rest on their laurels of delivering far higher returns over the past five decades. As Buffett has stated, “A fat wallet is the enemy of high investment returns.”