So Wall Street can't stop talking about this year's annual letter to shareholders of Berkshire Hathaway. In it, the Oracle of Omaha castigated institutional investors for blowing $100 billion in fees paid by pension funds, university endowments, and other major investors in hedge funds despite the poor performance these 'wizards' have delivered compared to index funds and tried and true value investors like himself:
Now, to my bet and its history. In Berkshire’s 2005 annual report, I argued that active investment management by professionals – in aggregate – would over a period of years underperform the returns achieved by rank amateurs who simply sat still. I explained that the massive fees levied by a variety of “helpers” would leave
their clients – again in aggregate – worse off than if the amateurs simply invested in an unmanaged low-cost index fund.
Subsequently, 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. I then sat back and waited expectantly for a parade of fund managers – who could include their own fund as one of the five – to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?
What followed was the sound of silence. Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their stock-selecting prowess, only one man – Ted Seides –stepped up to my challenge. Ted was a co-manager of Protégé Partners, an asset manager that had raised money from limited partners to form a fund-of-funds – in other words, a fund that invests in multiple hedge funds.
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I’m certain that in almost all cases the managers at both levels were honest and intelligent people. But the results for their investors were dismal – really dismal. And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved – fees that were totally unwarranted by performance – were such that their managers were showered with compensation over the nine years that have passed. As Gordon Gekko might have put it: “Fees never sleep.”
The underlying hedge-fund managers in our bet received payments from their limited partners that likely averaged a bit under the prevailing hedge-fund standard of “2 and 20,” meaning a 2% annual fixed fee, payable even when losses are huge, and 20% of profits with no clawback (if good years were followed by bad ones). Under this lopsided arrangement, a hedge fund operator’s ability to simply pile up assets under management has made many of these managers extraordinarily rich, even as their investments have performed poorly.
Still, we’re not through with fees. Remember, there were the fund-of-funds managers to be fed as well. These managers received an additional fixed amount that was usually set at 1% of assets. Then, despite the terrible overall record of the five funds-of-funds, some experienced a few good years and collected “performance” fees. Consequently, I estimate that over the nine-year period roughly 60% – gulp! – of all gains achieved by the five funds-of-funds were diverted to the two levels of managers. That was their misbegotten reward for accomplishing something far short of what their many hundreds of limited partners could have
effortlessly – and with virtually no cost – achieved on their own.
I have been very much of the opinion, for years now, that major institutional investors are terrible at managing the money of their shareholders. You folks who own mutual insurance policies, have pensions, are a part of the university endowments, own 401(k)s, and so own... this is your money and you exert almost no say in how badly your money is being invested and how much of it is blown on ridiculous fees.
That is why I am, and have been, an advocate of shareholder's rights and shareholder's control. It isn't just about disclosure and transparency. It is about real power. There is a vast quantity of wealth, in the trillions, produced by your hard work. You have zero control over what is done with that money. You should.
A while back I wrote a piece asking about how ordinary people, especially Democrats, can begin to reassert control over their money and acquire real power outside of politics:
If it were me in charge, I'd be thinking about a shareholders union. You might not know this, but actually the American public owns more corporations more broadly than any of you realize. Pension funds, mutual funds, mutual insurance companies, and other entities control vast shares of American and foreign businesses. However the rights exercised by these shareholders are some of the least democratically administered wealth in the world. It is literally a vast, vast fortune under the tight control of very few people. Seems to me like a person who owns a bit of apple stock should have some say on where it puts its factories, for example. Vanguard Mutual Funds is a huge Apple shareholder, the largest in fact. Vanguard is owned by its mutual funds and its mutual funds are owned by their shareholders... who number in the millions. Pension funds too. Somebody ought to think about organizing those shareholders to have more say so and votes on major decisions like mergers, wages and salaries, etc. If you all own Vanguard and Vanguard owns Apple, you should get some say-so at Apple is how I see it. And if laws are an impediment, well that sounds like a perfect public policy issue. And my kind of populism!
Just think of what we could do with all that money. The affordable housing we could invest in (rather than waiting for government). The renewable energy we could invest in (rather than waiting for government). The wages we could raise (rather than waiting for government). We sit idly by, letting University endowments do whatever they want without any supervision, giving tons of your money to stupid fees and investing in shit that doesn't build America, and getting crappy returns on all of it in the bargain.
At my own NYU, which has a rather small endowment of $3.6 billion, control over the endowment is exercised by a team appointed by the administration. In a job advertisement for a director of investment, it specifically asked for someone to help hand the money over to hedge funds:
The director of investments will help manage NYU’s $3.5 billion endowment, with a special focus on hedge funds and any other assigned asset classes, the posting said.
How about the Director of Investments... err... do some actual investment? Like maybe in the booming NYC real estate market by building some affordable housing? Like... in New York where it is sorely needed and would make a better profit than what hedge funds deliver (without the stupid fees) and provide relief to the much needed housing crisis to boot? Students, faculty, and donors to the endowment should have stakeholder say in what is done with all that cash. At the minimum, such a person should at least be doing Buffet style work and making real investments in American businesses and seeing to it that employees of those companies are paid well and treated fairly since the unions seem incapable of delivering at the moment. Or goddammit, just do what Buffet advises and deliver better returns for the university community:
The bottom line: 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. Both large and small investors should stick with low-cost index funds.