Buffett Assails Money-Manager Fees as Berkshire Reports Profit Rise

Billionaire also declares victory in his $1 million bet with another asset manager that low-cost index funds would out earn hedge funds over a decade

 Warren Buffett intensified his attacks on Wall Street money managers Saturday, saying that investors wasted more than $100 billion over the last decade on expensive advice.
.. “The bottom line,” Mr. Buffett wrote, is that “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.”
.. Book value, a measure of assets minus liabilities that is Mr. Buffett’s preferred yardstick for measuring net worth, rose 10.7% in 2016, compared with a 12% total return in the S&P 500, including dividends.
.. Berkshire’s BNSF railroad subsidiary. Net earnings at Berkshire’s railroad fell 16% in 2016 due largely to a drop in coal demand.
.. Ajit Jain, widely considered to be one of the leading candidates to take the Berkshire CEO job when Mr. Buffett is no longer on the scene
.. Berkshire, he said, is still willing to buy back its shares if prices fall below 120% of book value.
.. Mr. Buffett praised some companies, including Bank of America Corp., for buying back shares. “Some people have come close to calling [buybacks] un-American—characterizing them as corporate misdeeds that divert funds needed for productive endeavors,” Mr. Buffett said. “That simply isn’t the case.”
.. Berkshire has warrants to buy 700 million shares of Bank of America at $7.14 apiece. The stock closed Friday at $24.23, so Mr. Buffett is looking at a paper gain of about $12 billion.
.. He attributed America’s “miraculous” economic growth to “human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law.”
.. He instead saved his sharpest comments for pricey money managers who pledge to beat the market, saying that in his lifetime he has identified “ten or so professionals” who can do so successfully.
.. “If 1,000 managers make a market prediction at the beginning of a year, it’s very likely that the calls of at least one will be correct for nine consecutive years,” he wrote.
.. In 2007 Mr. Buffett bet $1 million that his chosen index fund, the Vanguard 500 Index Fund Admiral Shares, would outperform hedge funds over the next decade.
.. Mr. Buffett in his letter Saturday praised Vanguard founder Jack Bogle as a “hero.”
.. “If a statue is ever erected to honor the person who has done the most for American investors, the handsdown choice should be Jack Bogle.”

A Quiet Giant of Investing Weighs In on Trump

While Mr. Klarman has long kept a low public profile, he is considered a giant within investment circles. He is often compared to Warren Buffett, and The Economist magazine once described him as “The Oracle of Boston,” where Baupost is based. For good measure, he is one of the very few hedge managers Mr. Buffett has publicly praised.

.. “Exuberant investors have focused on the potential benefits of stimulative tax cuts, while mostly ignoring the risks from America-first protectionism and the erection of new trade barriers,” he wrote.

.. “President Trump may be able to temporarily hold off the sweep of automation and globalization by cajoling companies to keep jobs at home, but bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces,” he continued. “While they might be popular, the reason the U.S. long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off.”

.. “The Trump tax cuts could drive government deficits considerably higher,” Mr. Klarman wrote. “The large 2001 Bush tax cuts, for example, fueled income inequality while triggering huge federal budget deficits. Rising interest rates alone would balloon the federal deficit, because interest payments on the massive outstanding government debt would skyrocket from today’s artificially low levels.”

.. “The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making.”

.. Trump is high volatility, and investors generally abhor volatility and shun uncertainty,” he wrote. “Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”

.. hedge funds had returned only 23 percent from 2010 to 2015, compared with 108 percent for the Standard & Poor’s index — he blamed the influx of money into the industry.

.. “When money flows into an index fund or index-related E.T.F., the manager generally buys into the securities in an index in proportion to their current market capitalization (often to the capitalization of only their public float, which interestingly adds a layer of distortion, disfavoring companies with large insider, strategic, or state ownership),”

.. To Mr. Klarman, “stocks outside the indices may be cast adrift, no longer attached to the valuation grid but increasingly off of it.”

“This should give long-term value investors a distinct advantage,” he wrote. “The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.”

How the Internet Hurt Actively Managed Mutual Funds

Yet given that the ETF is over 20 years old, and Vanguard is more than 40 years old, the question arises…why  just in the past 5-10 years has the explosive growth finally shown up?

 The answer, in a word (or two): The internet. It was the internet that did it.
 To understand why, reflect back on what it was like 20 years ago to evaluate an actively managed mutual fund. The average consumer only knew how they were doing by getting a once-per-quarter statement showing account balances, or by pulling out The Wall Street Journal stock pages to see the prior day’s closing NAVs. While this approach was fine to monitor that the portfolio was growing–which it was, almost continuously, throughout the 1980s and 1990s–it did nothing to tell investors whether the funds were actually good, or whether the rising tide of a booming stock market was lifting all boats together (even the laggards).
But with the internet, for the first time, it was possible to look up not just the closing prices of the funds, but to benchmark them, with actual performance data.
.. And the lesson brought about by that transparency: It turned out that a lot of actively managed mutual funds weren’t beating a simple, passive index fund. And it didn’t require complex calculations and reading a 172-page prospectus to figure it out. A straightforward website could easily collect all the performance data automatically, and calculate the results instantly.
.. And the ability to buy investments directly on platforms like Schwab and E*Trade meant that a large swath of investors no longer had to pay an “adviser” (who was really a mutual-fund salesperson intermediary) to invest their dollars.
.. The coming Department of Labor fiduciary rule in 2017 will likely drive the trend even further, as advisers who hold out as such will actually be held accountable as advisers (at least with respect to retirement accounts). Which means the adviser has to justify that the actively managed fund really is worth the additional management fee over a lower-cost passive index ETF instead.