During the mid-2000s I was a partner in a private trust company that was in the midst of reinventing itself. For years the firm had used a regional large cap investment firm to manage client portfolios, but at my urging the firm adopted a markets-based investment approach using DFA funds in 2003. Our clientele and new business focus were mostly inheritors of wealth with portofolios of $5 million or more. This was during the "heydey" of hedge funds, and we encountered many a prospective client that scoffed at the DFA approach, insisting their investment needs required more sophistication, sophistication that only hedge funds provided. Despite academic evidence that most hedge funds were unlikely to outperform, the power of narrative, overconfidence and the allure of beating the market led many prospective clients to turn us away.
At the end of 2007 famed investor WARREN BUFFETT MADE A MUCH PUBLICIZED 10 YEAR BET WITH INVESTOR TED SEIDES. The two bet $1 million (to the winner's charity of choice) - Seides wagering on five hedge fund of funds, and Buffett taking the pedestrian S&P 500 index. Their bet came to a close in December. Buffett's pick returned 8.5% annualized.............Seides hedge fund basket returned a mere 2.9%. Even more noteworthy, not one of the hedge fund of funds Seides selected managed to beat the S&P.
History is written by the victors. Unfortunately, time dulls the memory of folks. And recent research on neuroscience reveals our brains chemically change to deal with conflicting information, i.e. we often create a narrative to fit our circumstance. The day is coming when lots of "sophisticated" people will again fall for the siren song of a "sophisticated" investment, one that will almost certainly leave them worse off ten years hence. Don't believe me? Just ask Warren.