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Buffett: Wealth managers 'reap outsized profits, not the clients'

(Bloomberg News) -- Billionaire investor Warren Buffett devoted a substantial portion of his annual letter to his investors to deepen his long-running critique of investment fees.

Over five pages, Buffett laid anew into the rich for being suckered by Wall Street investment advice, which he estimated has wasted more than $100 billion over the past 10 years.

“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,” he wrote. “Both large and small investors should stick with low-cost index funds.

”While Buffett was doubtful that the wealthy would take his advice, his argument has gained steam. After years of underperformance, hedge funds are facing a revolt by endowments, pension funds and other institutional investors that have decided they aren’t getting their money’s worth. Meanwhile, index funds have been on a tear. In 2016, passive strategies attracted $504.8 billion in new money, while active managers saw $340.1 billion in redemptions, according to data from Morningstar. Read Buffett’s annual letter to investors.

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Warren Buffett, chairman and chief executive officer of Berkshire Hathaway Inc., speaks during an event with Hillary Clinton, former Secretary of State and 2016 Democratic presidential candidate, not pictured, at Sokol Auditorium in Omaha, Nebraska, U.S., on Wednesday, Dec. 16, 2015. Buffet said at the rally that he was supporting Clinton's bid for president because they share a commitment to help the less affluent. Photographer: Daniel Acker/Bloomberg *** Local Caption *** Warren Buffett

Buffett also updated Berkshire Hathaway shareholders on a bet made almost a decade ago that a low-cost fund that passively tracked the S&P 500 would outperform a basket of hedge funds.

Buffett, 86, has been making his point for more than a decade, most visibly through a $1 million bet with Protege Partners. The billionaire challenged the asset manager to pick a group of hedge funds it thought would beat an S&P 500 fund over 10 years.

On Saturday, he gave an update: The bundle of hedge funds had compound annual returns of 2.2% in the nine years through 2016, compared with 7.1% for the index fund. The billionaire estimated that about 60% of the gains the hedge funds produced during that period were eaten up by management fees.

“That was their misbegotten reward for accomplishing something far short of what their many hundreds of limited partners could have effortlessly -- and with virtually no cost -- achieved on their own,” he wrote. Buffett will almost certainly win the wager when it ends on Dec. 31. Proceeds will go to charity.

The fund manager reported $277 billion in new money to its U.S. mutual funds and ETFs last year, while Fidelity and Franklin reported some of the largest outflows.
January 11

He also praised Jack Bogle, the 87-year-old founder of Vanguard Group. The pioneer of indexing was once an outcast in the investment world as he eschewed riches to provide real value to American investors, Buffett wrote.

“In his early years, Jack was frequently mocked by the investment management industry,” Buffett wrote. “Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me.

”Buffett’s remarks on indexing have been jarring for many of his followers, not least because he has spent a career finding ways to generate market-beating returns at Omaha, Nebraska-based Berkshire. The billionaire threw a bone to that crowd in his letter, reiterating his stance that it’s not impossible to beat the index.

“There are, of course, some skilled individuals who are highly likely to outperform the S&P over long stretches,” he wrote. “In my lifetime, though, I’ve identified -- early on -- only 10 or so professionals that I expected would accomplish this feat."

He also sought to distinguish between investment fees that money managers charge and the kinds of fees that Wall Street banks earn for helping to arrange deals.

“Berkshire loves to pay fees -- even outrageous fees -- to investment bankers who bring us acquisitions,” he wrote. “To get biblical (Ephesians 3:18), I know the height and the depth and the length and the breadth of the energy flowing from that simple four-letter word -- fees -- when it is spoken to Wall Street. And when that energy delivers value to Berkshire, I will cheerfully write a big check.”