“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S & P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.” - Warren Buffet
> Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore the balance of the universe—the active investors—must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors.
This argument is wrong? edit: it's like saying this about strategies of chess players, one group is using strategy A and another is using strategy B:
Chess players using strategy A are known to perform about average (by the nature of their strategy). So this new strategy, B, has to perform about average too.
This neglects that there are other strategies than A and B. The whole world is not either passive investors or hedge funds.
And he's saying something even stronger: there is no subset of B players that is better than average.
So while he may well be correct in his prediction, he makes it sound like he has a mathematically tight argument for why he is correct. But the conclusion of his argument (that active investors will perform about average) is not the prediction of his bet (that hedge funds will perform about average, and because they have higher operating cost they will lose).
He's making the (correct) assumption that the speculative stock market where active investors expect to make their money is a zero-sum game. For there to be winners in "buy low, sell high" there have to be an equal amount of losers.
So, if there are going to be winners, there have to be an equal amount of losers. It's difficult to siphon money off of someone passively invested in an index fund, so the active investors are competing against themselves.
Because active investment has a much higher cost than passive, as a group they will be significantly worse off compared to passive investors. This is so self-evident as to be not even worth betting against.
Note that this isn't to say that there won't be big active winners individually. But in a chess tournament, if the top players use strategy A that wins 90% of the time, and others use strategy B that wins 51% of the time, that guarantees the existence of some other strategy that performs below average.
The stock market isn't necessarily a zero-sum game like chess because companies pay dividends, but that's rare and small enough to be insignificant compared to the amount of money gained and lost through speculation.
That's exactly part of what I'm saying. The other part is: Even though you can't siphon money off passive investors, you can siphon money off other active investors.
http://www.longbets.org/362