Foolish as it may seem, a group of hedge fund managers have accepted an investing challenge from Warren Buffett. The “Oracle of Omaha” bet $1 million in charitable donations, paid to the organization of the winner’s choosing, that he could raise more in returns by sticking to the S&P 500 passive index.
While Buffet’s place in the world of enterprising investors is without question, Tim Armour pointed out a significant flaw in his active investment style that could spell failure for investors who choose to follow him too closely.
Common wisdom would suggest that passive index is safer since it requires small risk and promises returns larger than that. But Armour points out that this logic is really only beneficial in a bull market. The current expansion of markets is an abnormality, as the current bull market has been around far longer than normal. It will pass, and Armour sees a time when investors who made gains in the current environment fail drastically when a bear market introduces itself and wiser investors begin to significantly decrease the amount of risk they’re willing to shoulder.
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Instead of playing things safe in this way, Armour suggests investors look to investments where managers are willing to invest themselves. Managers have an intimate understanding of how their investment is being received by investors, and the willingness to risk their own capital shows a degree of faith that can attract more funding. Armour readily points out that investments where managers invest their own capital have a higher than average return than those who don’t.
About Timothy Armour
Having graduated from Middlebury College with a Bachelor’s Degree in Economics, Armour went on to work in investments and telecommunications for over 30 years. This experience with Capital Group led Armour to being named Chairman, Director, and Principal Executive Officer for Capital Research and Management Company.