Receiving much attention from the 2017 Berkshire Hathaway shareholder letter has been “The Bet”.
To recap, “The Bet” was with Protégé Partners, who picked five “funds of fund” hedge funds they expected would outperform the S&P 500 over the 10 year period ending December 2017.
The bet was made in December 2007, when the market was reasonably expensive and the Global Financial Crisis (GFC) was just around the corner.
Needless to say, Buffet won. The S&P 500 easily outperformed the Hedge Fund selection over the 10 year period.
I have some sympathy with this well written article.
Firstly I’d like to make three points:
- I’d never bet against Buffet!
- I would also not expect a Funds of Fund hedge Fund to consistently outperform the S&P 500, let alone a combination of five Funds of Fund.
This is not to say Hedged Funds should not form part of a “truly” diversified investment portfolio. They should.
Nevertheless, I am unconvinced their role is to provide equity plus returns.
- Most, if not all, investor’s investment objective(s) is not to beat the S&P 500. Investment Objectives are personal and targeted e.g. Goal Based Investing to meet future retirement income or endowments
Albeit, as the article points out (A Rhetorical Oracle?), key investment points are missed by the media’s focus on the drag race over a 10 year period.
Now, I have no barrel to push here, except advocating for the building of robust investment portfolios consistent with meeting your investment objectives. The level of fees also needs to be managed across a portfolio.
In this regard and consistent with the points in the article:
- Having a well-diversified multi-asset portfolio is paramount.
Being diversified across non-correlated or low correlated investments is important. Adding low correlated investments to an equities portfolio, combined with a disciplined rebalancing policy, will add value above equities over time.
The investment focus should be on reducing portfolio volatility through true portfolio diversification so that wealth can be accumulate overtime. If you like, minimising loses results in higher returns over time. A portfolio that falls 50%, needs to gain 100% to get back to the starting capital. This means as equity markets take off, as they have over the last 24 months, a well-diversified multi-asset portfolio will not keep up. Nevertheless, the well diversified portfolio won’t fall as much when the inevitable crash comes along.
It is true that equities are less risky over the longer term. Nevertheless, not many people can maintain a fully invested equities portfolio, given the wild swings in value (as highlighted by Buffett in his recent Shareholder Letter, Berkshire can fall 50% in value).
100% in equities is often not consistent with meeting ones investment objectives. Buffet himself has recommended the 60/40 equities/bond allocation, with allocations adjusted around this target based on market valuations.
In fact, I’d never suggest someone to be 100% invested in equities for the very reason of the second point in the article.
- Investment Behavioural aspects.
How many clients would have held on to a 100% equity position during the high level of volatility experienced over the last 10 years, particularly in the 2008 – 2014 period. Not many I suspect.
A well-diversified portfolio, that lowers portfolio volatility, will assist an investor in staying the course in meeting their investment objectives.
An allocation to alternative strategies, including a well-chosen selection of Hedge Funds, will result in a truly diversified Portfolio, lowering portfolio volatility. See earlier Post
Staying the course is the biggest battle for most investors. Therefore, take a longer term view, focus on customised investment objectives, and maintain a truly diversified portfolio.
This will help the psychological battle as much as anything else!
I like this analogy of using standard deviation of returns as a measure of risk, average volatility:
“A stream may have an average depth of ﬁve feet, but a traveler wading through it will not make it to the other side if its mid-point is 10 feet deep. Similarly, an overly volatile investing strategy may sink an investor before she gets to reap its anticipated rewards.”
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