Nearly 10 years ago, Warren Buffett, issued a challenge to the hedge fund industry — a $1 million bet that they could not put together a portfolio of hedge funds that would outperform an S&P 500 Index fund over a 10-year period.
The key Buffett’s bet against hedge funds was the math of the fund manager taking 2% of the capital under management as payment for his skills along with 20% of the profits to reward himself again for the gains. These compounding negative expenses wear on capital much like a triple leveraged ETF deteriorates during volatility due to the capital destruction of negative compounding.
Over the last 15 years, 92.2% of large-cap funds lagged a simple S&P 500 index fund. The percentages of mid-cap and small-cap funds lagging their benchmarks were even higher: 95.4% and 93.2%. If the S&P 500 is such a difficult investing vehicle to beat then how can we have a chance of beating it?
If you want to beat the S&P 500 index you have to do the things that outperform it.
- Trade it using the lowest possible vehicle like an ultra cheat S&P 500 index fund or the $SPY ETF.
- Use leverage to gain more alpha, a leveraged ETF like $SSO or in-the-money call options.
- Hedge your long position with put options during down trends to make gains while your position pulls back.
- Use moving averages to trade the trend, using back tested systems to go to cash during down trends to out perform through limiting losses and be long in bull markets.
- Diversify your portfolio through more weighting for the stronger trending sector ETFs.
- Weight your portfolio with market leaders.
- Change your leverage based on the market trend.
To beat the S&P 500 you must trade the trend, hedge the downside, and use safe leverage at the right time.