Warren Buffett said: “I’ve never gone to bed with an ugly woman, but I’ve sure woke up with a few.”1 Such was our case with AIG.

The 1998–2000 bubble in technology stocks likely was a key indirect reason we purchased AIG’s shares. In 2000, the bubble burst and the stock market started to decline sharply. The Nasdaq Composite Index, which is laden with technology stocks, declined from a high of 5,048 on March 10, 2000, to a low of 1,114 on October 9, 2002—a decline of 78 percent. The Standard & Poor’s (S&P) 500 Index, which is more representative of the entire U.S. stock market, declined from a high of 1,521 on September 1, 2000, to a low of 801 on March 11, 2003. The magnitude of the collapse encouraged many investment committees and individual investors to seek investments that were less volatile than the stock market, and many committees and investors opted to invest in hedge funds that promised to short stocks and thus to sharply reduce downside volatility. According to BarclayHedge, the assets under the management of hedge funds increased from roughly $300 billion at the end of 2000 to more than $2 trillion by 2007.

Hedge funds typically charge their clients fees equal to 1 to 2 percent of the assets under management plus incentive fees of 20 percent of any profits. In my opinion, given this very high fee structure, hedge funds are bent to making obscure investments as opposed to, for example, purchasing blue-chip stocks. It would be ...

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