Buffett’s Shareholder Letter 2016

I always find it entertaining to read Warren Buffet’s shareholder letter. There are lots of wits, wisdom and folksy humor in it. Buffet is able to explain complex things in such a simple and easy-to-understand way. I particularly like this adage:

When a person with money meets a person with experience, the one with experience ends up with the money and the one with money leaves with experience.

In 2016’s letter, Buffett shared the details of his bet against hedge fund. The table below shows the performance of S&P index fund vs 5 funds-of-funds (a fund that invests in multiple hedge funds).

Funds of Funds vs SP500.PNG

Source: Berkshire Hathaway’s shareholder letter 2016

S&P achieved a compounded annual return of 7.1% from 2008 to 2016 for a total gain of 85.4%. The average of the 5 funds-of-funds achieved only a compounded annual return of 2.2% for a total gain of 22%. Even the best among these 5 funds-of-funds achieved only total gain of 62.8% (for compounded annual return of 5.6%), which is more than 20% point below the overall gain of S&P index.

The only year that S&P index was the worst performer compared to the funds-of-funds was 2008 during GFC. The funds of funds were likely to have some short positions which cushioned their losses in long positions. But their losses still ranged from -16.5% to -30.1%. Their short positions should be small relative to the overall portfolios.

From 2009 to 2016, the US market was generally bullish except some panic in 2011. During that period, P/E ratio of US market rose from mid teens to more than 24x now. Every year, S&P recorded positive returns. Compared to the funds of funds, S&P index was the best performer in 2009, 2010, 2012, 2013, and 2016. That’s 5 out of 8 years!

Why did the fund of funds underperform S&P index substantially?

  1. Hedge fund fees – typically 2% management fee and 20% performance fee
  2. Fund-of-funds fees – typically 1% fee on top of the fees in point #1 above
  3. Negative alpha (picked wrong stocks)
  4. Shorting when the market was bullish from 2009 to 2016

Which mutual fund or unit trust to invest?

I was often asked which mutual fund or unit trust to invest? I can’t provide them an easy answer.

As you see in the performance table above, there are funds of funds which will select the best hedge fund to invest, but they still can’t do a good job. They are not dumb, mind you. They are hardworking and intelligent professionals with many years of experience and work in many reputable companies.

The challenge of selecting which mutual fund or unit trust to invest is further complicated by the fact that year to year performance of the fund can fluctuate. Every fund has its own investing strategy, which may work well during one period and not so well during another period.

In his book “The Most Important Thing”, Howard Marks highlighted that even the best funds out there underperformed the market one-third of the time. If you tell your choice of fund to a novice, he/she is likely to assess your suggestion based on next one to two years of performance, which is certainly quite short. If it happens to be the period in which the fund’s strategy doesn’t work well, then it’s likely to underperform the market average. An inpatient investor is likely to switch fund, which could be a mistake.

What will be my answer to the above question? I’ll reserve it for other post.


2 thoughts on “Buffett’s Shareholder Letter 2016

    1. 3 out of the 5 fund of funds selected for the bet seriously underperformed the SP500. They could not even return positive when SP500 was in double-digit positive years. These FoF must have included non-US stocks, such as emerging markets stocks. Even the best one in the list underperformed SP500 by 20+%. It’s a complete defeat.


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