The Gospel according to Buffett
Posted by Robin Powell on May 3, 2016
There are few keener advocates of index funds than Warren Buffett. Over many years, Buffett has consistently stated that indexing is the logical solution for the vast majority of investors. He did it again at the Berkshire Hathaway shareholders’ meeting at the weekend — only this time he spoke on the subject at greater length and in even more emphatic language than he has in the past.
Just before lunch at Saturday’s meeting in Omaha, Buffett spent twelve-and-a-half minutes delivering what he jokingly referred to as a “sermon”. In it he spelled out his opinions on the merits of index funds compared to actively managed funds. I would strongly urge investors to watch the relevant section in full — it begins at around 2.42.20 — but here is a summary of what he said.
He’s winning his bet
Buffett famously placed a bet that, over a decade and net of fees, a Vanguard S&P 500 index fund would outperform the cumulative returns of five funds-of-funds picked by the New York hedge fund company Protégé Partners. On Saturday Buffett presented a chart which showed that, since 2008, the index fund has returned 65.7%, while the hedge funds have returned 21.9%. He’s winning his bet convincingly.
People just don’t get it
Buffett then lamented the fact that, even when presented with the evidence that paying for active fund management is a bad idea, investors still don’t want to believe it. He said this:
“It seems so elementary, but I will guarantee you that no endowment fund, no public pension fund, no extremely rich person (wants to believe that index funds are best).
“They just can’t believe that because they have billions of dollars to invest that they can’t go out and hire somebody who will do better than average. I hear from them all the time.”
Investment consultants are part of the problem
“Supposedly sophisticated people, generally richer people, hire consultants, and no consultant in the world is going to tell you, ‘just buy an S&P index fund and sit for the next 50 years.’ You don’t get to be a consultant that way. And you certainly don’t get an annual fee that way.
“So the consultant has every motivation in the world to tell you, ‘this year I think we should concentrate more on international stocks,’ or ‘this manager is particularly good on the short side’, and so they come in and they talk for hours, and you pay them a large fee, and they always suggest something other than just sitting on your rear end and participating in the American business without cost. And then those consultants, after they get their fees, they in turn recommend to you other people who charge fees, which.. cumulatively eat up capital like crazy.
“I’ve talked to huge pension funds, and I’ve taken them through the math, and when I leave, they go out and hire a bunch of consultants and pay them a lot of money. It’s just unbelievable.”
No one can predict the winners
“There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities. There are a few people out there that are going to have an outstanding investment record. But very few of them. And the people you pay to help identify them don’t know how to identify them. They do know how to sell you.”
Index funds are the answer
“(A passive investor) absolutely gets the record of American industry. For the population as a whole, American business has done wonderfully. And the net result of hiring professional management is a huge minus.”
“All the commercial push is behind telling you that you ought to think about doing something today that’s different than you did yesterday. You don’t have to do that. You just have to sit back and let American industry do its job for you.”
There are some very powerful vested interests who don’t like what Buffett has to say about indexing — notably fund managers, investment consultants, stockbrokers, platforms and fund shops. It also annoys financial advisers who advocate active management and who see fund selection as an integral part of their value proposition. It’s an awkward message, too, for the investment media. After all, without active management, what have they got left to talk about?
There are even those who argue that Buffett is a hypocrite and that he encourages people to index so there are more opportunities for him, as an active investor, to exploit. Personally I think that’s nonsense. Clearly he’s a very shrewd businessman. But the idea that the more popular indexing is, the easier it becomes for active managers to outperform, is another of those myths the fund industry likes to peddle.
My view is that Buffett is simply being realistic. He can see that, for all the marketing hype, trying to identify an active manager who will outperform in the future is, to quote Berkshire Hathaway’s Vice Chairman Charlie Munger, “like looking for a needle in haystack”.
At 85, Buffett is thinking about his legacy. He wants the best for his heirs, which is why he’s issued instructions that his personal wealth should be invested passively on his death. I also believe he genuinely wants to help ordinary investors.
Warren Buffett is, remember, the most successful investor of the modern era. When he offers such candid advice as he did on Saturday, it surely makes sense to pay attention.