CNBC recently published an article with a pithy headline - "Buffett slams Wall Street 'monkeys', says hedge funds, advisors have cost clients $100 billion"
My first thought when I read this was:
“Et tu, Warren Buffett?”
How could a man who himself had made a fortune picking individual stocks now be joining the, It's better to invest in index funds chorus?
This seemed counterintuitive especially given that, after having outperformed the average manager for the last seven years, now would likely be the exact wrong time to switch from active to passive investing as these trends tend to go in cycles.
But then I went and read Buffett’s entire annual letter, and considered pages 21-24.
In his letter, Buffett highlighted two concerns in particular.
1) The high cost of hedge funds. A concern with which I fully agree.
2) The drag in performance caused by managing too much money for a strategy.
This struck me as, pardon the pun, right on the money. In fact, it was one of the key reasons I left Neuberger Berman and set up Integre Asset Management in the first place.
Back in the early 2000’s as the assets I co-managed at Neuberger Berman grew and grew I had two main problems.
1) Liquidity: It took days, instead of hours, to buy and sell positions. And our activity impacted the price more than before.
2) Position Size: Position sizes in the portfolio tended to be smaller as we had a harder time getting a full position at the price we wanted.
Northern Trust did a study on smaller managers showing that they had outperformed large managers by approximately 1-2% a year over two separate five year time frames with notable outperformance in down markets (2000-2005, 2005-2010).
So for those of you who don't want to switch from an active manager to an index fund at the exact wrong time -- i.e. after the average active manager has underperformed for the past seven years -- and know a boutique active manager that has a proven strategy and charges reasonable fees, I think Mr. Buffett’s letter implies some sage advice.
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