Buffett Criticizes Hedge Funds

The famous investor says the industry has entered a fad stage and investors will be disappointed.
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Some hedge fund veterans think Warren Buffett's dim view of their industry's growth is right on target, saying his prediction of lower investor returns amid fast growth echo their own concerns.

The man known as "The Oracle of Omaha" briefly took aim at the $750 billion industry this weekend, saying hedge funds were "in the midst of a fad," implying that the business was overheating. He also criticized hedge fund fees and said investors would be disappointed with results. "It is not going to be a great experi-ence in aggregate for investors," Buffett told

Berkshire Hathaway

(BRKA)

shareholders at the company's annual meeting.

Some fund managers agree, saying the $60 billion investors poured into hedge funds last year boosted assets under management but also diluted talent. The average hedge fund returned 15.44% last year, and is up 3.42% for the year to date according to the most recent figures from the CSFB/Tremont Hedge Fund Index. While hedge funds managed about half the 2003 return of the

S&P 500's

, the average gain at the end of March was nearly twice that of the benchmark index for the year to date.

"I think he's correct in both tone and substance," said David Kabiller, partner at AQR Capital Management, which runs $6.5 billion in its hedge funds. "It's difficult to believe that this much capital can come in and not have an impact to lower expected returns for the industry as a whole." He said Buffett gets plenty of credit for his skepticism over the run-up and subsequent collapse of technology stocks in the late 1990s and that current fervor for hedge funds may merit the same caution.

"Things that don't make sense do actually exist," Kabiller said. "They just aren't sustainable."

David Anderson, managing director at the $17 billion fund of funds manager GAM, which invests with 158 single manager funds, said investor demand was the force behind hedge funds' popularity.

"Last year was the first positive one we saw in three years in equity markets," he said. "Investors, whether they are institutional or high net worth, were saying they needed something that could perform even if equity markets were declining."

But Josh Feuerman, founder of a new hedge fund, BTN Partners, said not every new manager will be the next George Soros or Julian Robertson. At least 43 funds have launched since Jan. 1, according to the new fund tracking feature at the Web site, Hedge Fund Alert.

"People are trying to make money where they don't necessarily have skill," he said. "In the long-only world of mutual funds, I just need to find 50 or 60 stocks that I like, but in the hedge fund world, I need to find a basket of 50 to 60 equally unattractive stocks to bet against."

Despite his criticism, fans of Buffett note that he once ran his own hedge fund from 1956 through 1969, an era when hedge funds were low-profile and numbered in the hundreds, compared to the estimated 8,500 funds operating worldwide today.