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Buffett won. However, several caveats apply when using this bet to draw conclusions: 1. Buffett bet against aggregate performance of hedge funds as an investme

Buffett won. However, several caveats apply when using this bet to draw conclusions: 1. Buffett bet against aggregate performance of hedge funds as an investment vehicle. If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily. 2. Buffett used absolute returns as the performance metric, not risk-adjusted returns. A portfolio with lower absolute returns but a significantly better idiosyncratic risk profile (and correlation to market/beta) can be superior to a portfolio with higher absolute returns but also higher risk. Taken together, this means that Buffett's bet is a statement about the aggregate performance of the industry. It is not instructive for what performance is possible, or even for whether or not you should invest with the modal hedge fund (given the opportunity). It depends on investment goals and risk needs. It's also worth pointing out that "risk needs" is multi-dimensional, not just a sliding scale of how much e.g. leverage you're willing to accept. There is an entire sub-industry of hedge funds which explicitly expect to underperform on an absolute basis for long periods of time, but which service their clients with highly bespoke risk products. Clients are frequently well-informed and happy with this arrangement. I say this because there is a tendency for people outside the industry to come away thinking hedge funds are a scam. Which...well, many are, to put it bluntly. But it's a lot more complicated and this isn't really the smoking gun you'd think it is.

Judgmentality 6y ago
> 1. Buffett bet against aggregate performance of hedge funds as an investment vehicle. If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily. I don't think this is a caveat. I think this is the point. You don't compare yourself to the literally one guy who won the lottery, you compare yourself to everybody that bought a lottery ticket. > I say this because there is a tendency for people outside the industry to come away thinking hedge funds are a scam. Which...well, many are, to put it bluntly. I don't think anybody is assuming every hedge fund on Earth is a scam from this any more than they think lottery tickets are a scam. As you mentioned yourself: > Taken together, this means that Buffett's bet is a statement about the aggregate performance of the industry. I apologize if I'm being presumptuous, but is this not so obvious that it can be assumed?
- fractionalhare 6y ago
  I was probably a little unclear. Basically I'm saying all you can take away from this is a statement about aggregate performance. You're not doing this in your comment, but I frequently see people on HN extrapolate this bet to support the idea that there's no such thing as a hedge fund which beats the market, or which is a worthwhile investment, etc. You can't derive a conclusion about individual hedge funds from this. That might seem obvious to you, but maybe you'd be surprised then :)
  - Judgmentality 6y ago
    > That might seem obvious to you, but maybe you'd be surprised then :) Fair. I've been surprised by the ignorance of people before, including myself!
  - deleted 6y ago
    [deleted]
pfortuny 6y ago
The lesson I take from the bet is: you can only be very smart if you have a lot of money. Otherwise, do no try in the long run*. And I stick to that (because I just want to keep a living in the future, not to be rich). "Risk-adjustment" is just another metric which makes not much sense: either I have the money or I do not. Money now is worth more than possible money tomorrow. About "the highest performing funds of the past 10 - 30", which ones, the two first ones, the Medallion fund? those which cannot be used by ordinary people? I know Buffet is not exactly the paradigm of "ordinarity" but nevertheless, I think his intention with his stubborn support of "just the market" is to teach that "ordinary people can very seldom outperform the market".
- fractionalhare 6y ago
  > Risk-adjustment" is just another metric which makes not much sense: either I have the money or I do not. Money now is worth more than possible money tomorrow. If you think risk-adjustment doesn't make sense as an evaluation metric, you should just sell naked puts or calls on a stock which doesn't seem volatile. You're going to generate spectacular returns for a while. Then you're going to blow up. On the other hand a portfolio with relatively low idiosyncratic risk and low market correlation (beta) might be safely levered up to a higher absolute return than e.g. SPY with less overall risk and volatility. Like I said...it's complicated.
- betterunix2 6y ago
  "Money now is worth more than possible money tomorrow." That is antithetical to investing...
dhosek 6y ago
But that assumes that one could predict in advance what those highest performing funds would be. Of course the highest performing XXX will be above average. The point is that no one can consistently predict which ones will be the highest performing XXX. Worse still, regression to the mean indicates that if, in 2021 you invest in the highest performing XXX of the preceding X years, you're more likely to get returns below average. And let's suppose that there really is a fund staffed by a group of super-geniuses who can reliably pick the best performing stocks. There are two possibilities: They take on more and more investment capital until their returns end up getting closer to the mean or they don't accept new investments and the hypothetical new investor is left out in the cold.
- fractionalhare 6y ago
  No I didn't assume that, I fully agree with you. Funds which are capable of consistently (and safely) beating the market on an absolute basis eventually cap their AUM and return outside capital.
- kqr 6y ago
  > Worse still, regression to the mean indicates that if, in 2021 you invest in the highest performing XXX of the preceding X years, you're more likely to get returns below average. No, returns of the average. Regression to the mean means, well, what it says: it regresses to the mean, not past it. Your version is what we call the gambler's fallacy!
  - CyberDildonics 6y ago
    The gambler's fallacy is applying past events that have already happened to randomized trials in the future. This is not the same because outlier movement of macro demographics and financial policy does have an impact on the future. If the stock market were random on a macro scale it would average zero movement.
    - kqr 6y ago
      I agree with all of that and I still think expecting an unusual low after an unusual high is indicative of the gambler's fallacy.
mooreds 6y ago
> Buffett bet against aggregate performance of hedge funds as an investment vehicle. He let an expert pick the funds of funds. AFAIK, he didn't restrict which funds the expert picked. > If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily. This is like saying "If I only bet on the teams who won the world cup, I would always make money". Past performance is no guarantee of future returns. > this isn't really the smoking gun you'd think it is. If the bet wasn't the best way to show the relative value of these investments, is there a better way? Or is the answer really "if you need a hedge fund as part of your portfolio, you probably aren't coming to HN for investment advice"?
- fractionalhare 6y ago
  > Or is the answer really "if you need a hedge fund as part of your portfolio, you probably aren't coming to HN for investment advice"? Yeah, that's basically the answer. Retail investors don't typically need to optimize their portfolios with bespoke investment vehicles. Their exposure and goals aren't complicated.
rohit89 6y ago
> There is an entire sub-industry of hedge funds which explicitly expect to underperform on an absolute basis for long periods of time, but which service their clients with highly bespoke risk products. Clients are frequently well-informed and happy with this arrangement. Care to expand on this with some examples?
- fractionalhare 6y ago
  Sure - off the top of my head, basically any fund or advisor which specializes in derivatives volatility. Universa Investments is a specific example, but you can find more by searching for those criteria.
zimpenfish 6y ago
> If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily. Is that "funds which performed well before 2008" or "funds which have performed mostly well since 2008"? The former makes sense since the latter is largely hindsight/time travel but couldn't the challenged party have picked those funds for their side of the bet back in 2008 anyway?

Judgmentality 6y ago

> 1. Buffett bet against aggregate performance of hedge funds as an investment vehicle. If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily. I don't think this is a caveat. I think this is the point. You don't compare yourself to the literally one guy who won the lottery, you compare yourself to everybody that bought a lottery ticket. > I say this because there is a tendency for people outside the industry to come away thinking hedge funds are a scam. Which...well, many are, to put it bluntly. I don't think anybody is assuming every hedge fund on Earth is a scam from this any more than they think lottery tickets are a scam. As you mentioned yourself: > Taken together, this means that Buffett's bet is a statement about the aggregate performance of the industry. I apologize if I'm being presumptuous, but is this not so obvious that it can be assumed?

fractionalhare 6y ago
I was probably a little unclear. Basically I'm saying all you can take away from this is a statement about aggregate performance. You're not doing this in your comment, but I frequently see people on HN extrapolate this bet to support the idea that there's no such thing as a hedge fund which beats the market, or which is a worthwhile investment, etc. You can't derive a conclusion about individual hedge funds from this. That might seem obvious to you, but maybe you'd be surprised then :)
- Judgmentality 6y ago
  > That might seem obvious to you, but maybe you'd be surprised then :) Fair. I've been surprised by the ignorance of people before, including myself!
- deleted 6y ago
  [deleted]

pfortuny 6y ago

The lesson I take from the bet is: you can only be very smart if you have a lot of money. Otherwise, do no try in the long run*. And I stick to that (because I just want to keep a living in the future, not to be rich). "Risk-adjustment" is just another metric which makes not much sense: either I have the money or I do not. Money now is worth more than possible money tomorrow. About "the highest performing funds of the past 10 - 30", which ones, the two first ones, the Medallion fund? those which cannot be used by ordinary people? I know Buffet is not exactly the paradigm of "ordinarity" but nevertheless, I think his intention with his stubborn support of "just the market" is to teach that "ordinary people can very seldom outperform the market".

fractionalhare 6y ago
> Risk-adjustment" is just another metric which makes not much sense: either I have the money or I do not. Money now is worth more than possible money tomorrow. If you think risk-adjustment doesn't make sense as an evaluation metric, you should just sell naked puts or calls on a stock which doesn't seem volatile. You're going to generate spectacular returns for a while. Then you're going to blow up. On the other hand a portfolio with relatively low idiosyncratic risk and low market correlation (beta) might be safely levered up to a higher absolute return than e.g. SPY with less overall risk and volatility. Like I said...it's complicated.
betterunix2 6y ago
"Money now is worth more than possible money tomorrow." That is antithetical to investing...

dhosek 6y ago

But that assumes that one could predict in advance what those highest performing funds would be. Of course the highest performing XXX will be above average. The point is that no one can consistently predict which ones will be the highest performing XXX. Worse still, regression to the mean indicates that if, in 2021 you invest in the highest performing XXX of the preceding X years, you're more likely to get returns below average. And let's suppose that there really is a fund staffed by a group of super-geniuses who can reliably pick the best performing stocks. There are two possibilities: They take on more and more investment capital until their returns end up getting closer to the mean or they don't accept new investments and the hypothetical new investor is left out in the cold.

fractionalhare 6y ago
No I didn't assume that, I fully agree with you. Funds which are capable of consistently (and safely) beating the market on an absolute basis eventually cap their AUM and return outside capital.
kqr 6y ago
> Worse still, regression to the mean indicates that if, in 2021 you invest in the highest performing XXX of the preceding X years, you're more likely to get returns below average. No, returns of the average. Regression to the mean means, well, what it says: it regresses to the mean, not past it. Your version is what we call the gambler's fallacy!
- CyberDildonics 6y ago
  The gambler's fallacy is applying past events that have already happened to randomized trials in the future. This is not the same because outlier movement of macro demographics and financial policy does have an impact on the future. If the stock market were random on a macro scale it would average zero movement.
  - kqr 6y ago
    I agree with all of that and I still think expecting an unusual low after an unusual high is indicative of the gambler's fallacy.

mooreds 6y ago

> Buffett bet against aggregate performance of hedge funds as an investment vehicle. He let an expert pick the funds of funds. AFAIK, he didn't restrict which funds the expert picked. > If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily. This is like saying "If I only bet on the teams who won the world cup, I would always make money". Past performance is no guarantee of future returns. > this isn't really the smoking gun you'd think it is. If the bet wasn't the best way to show the relative value of these investments, is there a better way? Or is the answer really "if you need a hedge fund as part of your portfolio, you probably aren't coming to HN for investment advice"?

fractionalhare 6y ago
> Or is the answer really "if you need a hedge fund as part of your portfolio, you probably aren't coming to HN for investment advice"? Yeah, that's basically the answer. Retail investors don't typically need to optimize their portfolios with bespoke investment vehicles. Their exposure and goals aren't complicated.

rohit89 6y ago

> There is an entire sub-industry of hedge funds which explicitly expect to underperform on an absolute basis for long periods of time, but which service their clients with highly bespoke risk products. Clients are frequently well-informed and happy with this arrangement. Care to expand on this with some examples?

fractionalhare 6y ago
Sure - off the top of my head, basically any fund or advisor which specializes in derivatives volatility. Universa Investments is a specific example, but you can find more by searching for those criteria.

zimpenfish 6y ago

> If he restricted his focus to the highest performing funds of the past 10 - 30 years, he would have lost handily. Is that "funds which performed well before 2008" or "funds which have performed mostly well since 2008"? The former makes sense since the latter is largely hindsight/time travel but couldn't the challenged party have picked those funds for their side of the bet back in 2008 anyway?