1997: Will money managers in aggregate outperform the indices?

AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, I’m Tim Medley from Jackson, Mississippi.

WARREN BUFFETT: We’re glad to have you back, Jim — Tim.

How many years have you come?

AUDIENCE MEMBER: This is my 11th.

WARREN BUFFETT: Good.

AUDIENCE MEMBER: They’ve been 11 great years. Thank you very much.

At this meeting four or five years ago, you commented that money managers in the aggregate have not done better than various market indices. And you attributed this, in part, to the frictional cost inherent in an actively-managed portfolio.

I wonder if today you would update your thoughts on this. And do you think that this underperformance compared to index funds will continue?

And then a related question, if the two of you were giving advice to a classroom of equity mutual fund managers, are there two or three things in particular that you would want to suggest to them?

WARREN BUFFETT: Yeah. Well, I would say this. Money managers, in the last few years since I made that statement, have not disappointed me. (Laughter)

In aggregate, they have underperformed index funds. And it’s the nature of the game. They simply cannot overperform, in aggregate. There are too many of them managing too big a portion of the pool.

And for the same reason that the crowd could not come out here to Ak-Sar-Ben in the past years and make money, in aggregate, because there was a bite being taken out of every dollar that was invested in the parimutuel machines, that people that invest their dollars elsewhere through money managers in aggregate cannot do as well as they could do by themselves creating their own index fund, or it would be easier to have — just to buy into an index fund.

It’s — you know, they say in this world you can’t get something for nothing. But the truth is money managers, in aggregate, have gotten something for nothing. I mean, they’ve gotten a lot for nothing. And — (applause)

And people — investors have paid — and the corollary is investors have paid something for nothing.

And that doesn’t mean that people are evil. It doesn’t mean that they’re charlatans or anything. It’s the nature, if you got a 6 or $7 trillion, or whatever it may be, equity market, and you have a very significant percentage of it managed by professionals, and they charge you significant fees to invest with them, and they have costs when they change around.

They cannot do as well as unmanaged money, in aggregate.

And it’s the only field in the world that I, you know, that I can think of — Charlie’ll think of some others — but where the amateur, as long as he recognizes he’s an amateur, will do better than the professional does for the people whose money he’s handling.

And therefore if I were in a — teaching this class or speaking to that class, I would probably tell them that for their own psychological well-being they should probably leave the room. (Laughter)

Charlie?

CHARLIE MUNGER: Well, I pretty well said what I had to say on this subject in that talk I gave at USC. And anybody that wants to read that, why, can read it.

I will say that one of the things I like about the annual meeting is I get to interface with a whole lot of people that have even lower annual investment management expenses than Berkshire Hathaway the company does. I mean, if you stop to think about it, we’ve got our costs almost to zero, and many of you have gotten it to zero.

WARREN BUFFETT: Yeah, we — Charlie and I would be glad to take any money management organization in the world that manages — oh, just been handed a note that says, “Unfortunately, we don’t have extra annual reports on site. Those shareholders desiring one should call us or write.” So. And we’re also on the internet. You can run it off there, too.

So I apologize for not having them on the — here. But they’re easy to get. Just dial 346-1400 and there’s an annual report line, and you’ll have one sent to you.

We would be willing to take any money management organization in the world managing 10 billion or more, and in the case of brokerage houses who have their brokers in aggregate handling 10 billion or more, and we would be willing to bet that their aggregate investment experience over the next five years or ten years for the group that they advise will be less — will be poorer — than that achieved by a no-load, very low-cost index fund.

And we’d put up a lot of money to make that wager with anybody that would care to step forward.

Gambling may be illegal, but now you can do it through something called derivatives, you see? (Laughter)

We could create an instrument that would allow that, even though it might be against the laws of the state of Nebraska.

Charlie, would you join me on that or —?

CHARLIE MUNGER: Well, I certainly agree with you. I always say that the — exactly one-fifth have to be in the bottom 20 percent, and — (Laughter)

There are certain fundamental forces at work here that —

But it is a very peculiar profession where you have to be in a state of psychological denial to shave in the morning if you do the work. I don’t think that’s true for a handful —

WARREN BUFFETT: Well, it isn’t.

CHARLIE MUNGER: — of investment managers. I think we know investment managers who add value. But it’s a comparatively rare and small percentage.

WARREN BUFFETT: Yeah. There — we have identified, in the past even — I mean, on a prospective basis, not retrospective — managers who have added value. And there’s couple of them in this room.

CHARLIE MUNGER: Well, and there’s Lou Simpson of GEICO.

WARREN BUFFETT: Well, he’s the one I had in mind. (Laughter)

You can do it. You can’t do it with unlimited amounts of money, and a good record tends to attract money. Even a mediocre record presented by a good salesperson tends to attract money.

But there are people working with smaller amounts of money that — (coughs) — where the probabilities are that they will do better than — excuse me. (Clears throat)

Where the probabilities are that they will — (clears throat) — do better than average. But they’re very rare.

Incidentally, I apologize on this voice. I had to leave Gorat’s early last night, and there were a number of you I was hoping to see. But I just — it was gone entirely last night, and then I —

I’d like to tell you I did it by Cherry Coke, but I’ve managed to nurse it back to where it’s working again in reasonable shape.