Katherine Burton of Bloomberg reports with an update on Warren Buffet's 2008 bet against a fund of hedge funds manager. The bet turns on which investment vehicle will produce higher returns over a decade: a fund of hedge funds index or mutual fund tracking the S&P 500 index. As of March 2012, the mutual fund was handily beating the hedge fund vehicle by returning 2.2 percent against the fund of hedge fund's negative 4.5 percent.
Leaving the peculiarties of the specific bet aside, only a sucker would bet that a diversified group of hedge funds would produce higher returns than the stock market over a decade. This does not reflect poorly on hedge funds, however. In general, hedge funds aim to hedge--not to produce higher returns than the market, but rather to produce better returns on a risk-adjusted basis.
More precisely, as I wrote in 2008, hedge funds "must be evaluated in the context of their contribution to the overall risk of an investment portfolio." Hedge funds should not be evaluated as to whether they beat the market, but how they improve the risk and return profile of an already existing portfolio of stocks, bonds, and other traditional investments. On that approach, there is ample empircial evidence finding that hedge funds do indeed add value to traditional portfolios. For example, a 2007 study suggests that an optimal allocation to hedge funds is somewhere around 20 percent after taking into account the unique risk-return properties of the funds.
Warren Buffet surely knows that hedge fund returns will likely trail the market on a non-risk-adjusted basis, which only makes the willingness of anyone to take that bet against him all the more remarkable.