Warren Buffett blasts hedge funds and high fees in annual letter

Billionaire Warren Buffett, whose stock picks over several decades have enriched generations of Berkshire Hathaway Inc. shareholders, delivered a black eye to the investment industry on Saturday, urging ordinary investors to buy plain-vanilla index funds.

Annual investment letter outlines world's most famous investor's views on the market

Buffett has a longstanding bet that an S&P 500 index fund will beat all hedge funds over the long term, a bet he is solidly on track to win. (Nati Harnik/Associated Press)

Billionaire Warren Buffett, whose stock picks over several decades have made exponential gains for people who put their money into his company, told investors today that many would be better off buying cheap index funds than trying to "beat" the market.

In his widely read annual letter to shareholders of his Berkshire Hathaway holding company, the so-called Oracle of Omaha urged average investors to buy regular index funds instead of trying to chase the next hot sector or plow their life savings into high-fee hedge funds.

"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," said Buffett's letter.

"The problem simply is that the great majority of managers who attempt to overperform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well," Buffett wrote.

"Both large and small investors should stick with low-cost index funds," he added.

Burgeoning empire

Since 1962, when Buffett bought a failing textile company and turned it into a burgeoning insurance conglomerate based out of Omaha, Neb., Berkshire shares have averaged a compounded annual return of about 20 per cent per year, including dividends. That contrasts with just under 10 per cent for the S&P 500 over that time period.

All in, that means a compounded total gain of 1.9 million per cent since 1964 for Berkshire shareholders, dwarfing the compounded return of just over 12,000 per cent for the S&P.

Buffett, 86, used his investment savvy to build Berkshire into a powerhouse conglomerate and become the world's second-richest person. Buffet estimated that the search for outperformance has caused investors to "waste" more than $100 billion over the past decade — and "I believe my calculation of the aggregate shortfall is conservative," he said in his letter.

On Saturday, he called Vanguard Group founder Jack Bogle "a hero" for his early efforts to popularize index funds.

Buffett said most stock investors are better off with low-cost index funds than paying higher fees to managers who often underperform.

In 2014, Buffett said he plans to put 90 per cent of the money he leaves to his wife, Astrid, when he dies into an S&P 500 index fund, and 10 per cent in government bonds.

During the financial crisis, Buffett bet a founder of the asset management company Protege Partners LLC $1 million that a Vanguard S&P 500 index fund would outperform several groups of hedge funds over years.

The index fund is up 85.4 per cent, Buffett said, while the hedge fund groups are up between 2.9 per cent and 62.8 per cent.

On Saturday, Buffett said he has "no doubt" he will win the bet. He plans to donate the money to Girls Inc. of Omaha.

While Buffett said no pension funds or "mega-rich individuals" have taken his advice on index funds and that "human behavior won't change," some investors are following his lead.

Despite a roaring stock market in the United States, actively managed mutual funds bled $342 billion last year, their second straight year of outflows.

Passive index funds and exchange-traded funds, meanwhile, attracted nearly $506 billion of new money.

But Tim Armour, CEO of Capital Group Companies, which runs the American Funds and invests $1.4 trillion, said index funds can expose investors to losses when markets turn sour. The funds are one of Berkshire's biggest investors.

"We don't dispute the data that has led Mr. Buffett and others to form their views," Armour said in a statement. "However, a fairly simple fact has gotten lost in the debate. Simply put, not all investment managers are average."

Berkshire earnings

Overall, Buffett took a rosy view of the U.S. economy, noting he expects it to do fairly well under Republican President Donald Trump despite his long-standing support for Democrat Hillary Clinton.

"I'll repeat what I've both said in the past and expect to say in future years: Babies born in America today are the luckiest crop in history," he said.

Berkshire on Saturday also said fourth-quarter profit rose 15 per cent from a year earlier, as gains from investments and derivatives offset lower profit from the BNSF railroad and other units.

Berkshire also owns dozens of stocks including Apple Inc., Coca-Cola Co., Wells Fargo & Co. and the four biggest U.S. airlines, and more than one-fourth of Kraft Heinz Co.

This year's letter and Berkshire's annual report gave no clues about who will succeed Buffett as chief executive officer, a question shareholders and Wall Street have speculated about increasingly in recent years.

But Buffett lavishly praised Berkshire executive Ajit Jain, widely considered a leading CEO candidate, for smoothly running much of the conglomerate's insurance businesses.

Jain joined Berkshire in 1986, and Buffett put him in charge of National Indemnity's small, struggling reinsurance operation.

Since then, Jain has "created tens of billions of value for Berkshire shareholders. If there were ever to be another Ajit and you could swap me for him, don't hesitate. Make the trade!"

Berkshire, which became one of the top 10 Apple investors in 2016, has gained about $1.6 billion on its Apple investment after shares of the iPhone maker surged.

Berkshire's airline investments suggest that Buffett has overcome his two-decade aversion to the sector after an unhappy — though, he has said, profitable — investment in US Air Group.

Buffett did not mention Trump by name in his letter.

But he did, however, talk up the vibrancy of U.S. society and its inclusion of immigrants, one of the most polarizing issues under the Trump administration. And he said the future of American business and markets is bright.

"One word sums up our country's achievements: miraculous," Buffett said.

"From a standing start 240 years ago — a span of time less than triple my days on earth — Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers."

Corrections

  • A previous version of this story incorrectly stated that Berkshire Hathaway started as an Omaha-based insurance company. In fact, it was a textile company based in Massachusetts before Buffett bought it. He moved the headquarters to Nebraska and turned it into a holding company for a variety of businesses, including insurance, manufacturing, railroads and many others.
    Oct 20, 2017 2:59 PM ET

With files from Reuters

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