Hedge funds as a whole haven't justified their fees and investors would have been better off since 2008 to hold index funds instead, the investment icon says in his annual letter to shareholders.

Famed US investor Warren Buffett has attacked the world’s $3.02 trillion hedge fund sector in his annual letter to shareholders of Berkshire Hathaway, arguing that managers haven’t justified fees gleaned over almost a decade of “dismal” returns.

Investors would be better served by holding index funds instead, Buffett said.

Known for his value-based investing philosophy, preference for sometimes traditional sectors and skeptical of tech stocks during the dotcom boom, Buffett’s views are treated with respect in an industry not always known for its adulation of high-profile money managers.

Examining a Vanguard S&P 500 Index fund, Buffett noted that since 2008, the average compound annual increase to date is 7.1 per cent, a return that “could easily prove typical for the stock market over time”.

“That’s an important fact: A particularly weak nine years for the market over the lifetime of this bet would have probably helped the relative performance of the hedge funds, because many hold large “short” positions. Conversely, nine years of exceptionally high returns from stocks would have provided a tailwind for index funds,” he wrote.

“Instead we operated in what I would call a `neutral’ environment. In it, the five funds-of-funds delivered, through 2016, an average of only 2.2 per cent, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000,” he said.

Buffett said hedge fund managers have earned fees – likely averaging slightly below the classic 2 per cent management fee and 20 per cent performance haircut – during those nine years of weak returns for hedge fundsl

“Under this lopsided arrangement, a hedge fund operator’s ability to simply pile up assets under management has made many of these managers extraordinarily rich, even as their investments have performed poorly,” he said.

The investor also criticized the fund-of-hedge funds model, because operators of FoFHs charge an added fixed fee of 1 per cent to manage such assets.

"When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients," said Buffett's letter.

"The problem simply is that the great majority of managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well," Buffett wrote.

Berkshire’s gain in net worth during 2016 was $27.5 billion, which increased the per-share book value of both its Class A and Class B stock by 10.7 per cent. Over the last 52 years (that is, since present management took over), per-share book value has grown from $19 to $172,108, a rate of 19 per cent compounded annually, his letter said.