Part of being an investor is taking some risks and, in essence, making bets on whether the market will go up or down, and which stocks will perform well with those fluctuations. Warren Buffett, the Oracle of Omaha, is much better at this kind of betting than most people, but even he isn’t perfect.
Ten years ago, an intrepid hedge fund manager placed an open bet that over the course of 10 years, a hedge fund portfolio could outperform the S&P 500. Buffett took the bet, and both parties pledged a cool $1 million to charity. And, while as of 2015 the bet was looking close to even, the 2016 figures have caused the hedge fund manager, Ted Seides, to concede defeat.
The Original Bet
Posted on Long Bets, here’s the wording of the original bet itself:
“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.”
According to the original bet, Buffett would pick Vanguard 500 Index Fund Admiral Shares as his bet. The specifics of the hedge fund portfolio were not released to the general public, however many people have guessed that one of the five is a fund of funds that Protege, the other party in the bet, runs.
Double down, or Buffett Wins
Over the course of the nine years that the betting has been going on, the hedge fund portfolio pulled ahead only twice. Note that the original bet dealt with the actual performance of each fund—not the number of years that it did better. However, with seven out of nine years of higher profits, the hedge fund is doomed to fail without some kind of major market crash. In short, Buffett has won.
The manager on the losing side of the bet recently released an article through Bloomberg admitting defeat and discussing what happened to bring about his loss.
“Nine years ago, Warren Buffett and I made a 10-year charitable wager that pitted the returns of five funds of hedge funds against a Standard & Poor’s 500 index fund. With eight months remaining, for all intents and purposes, the bet is over. I lost,” Seides wrote.
According to Seides, there are several factors that helped Buffett pull ahead, including the S&P offering unexpectedly higher returns and unexpected strength in the market. He also pointed to the fact that the S&P 500 is mostly made up of a particular kind of stock; namely, huge companies.
“Comparing hedge funds and the S&P 500 is a little bit like asking which team is better, the Chicago Bulls or the Chicago Bears. Like the Bulls and the Bears in the Windy City, hedge funds and the S&P 500 play different sports.” Seides wrote. He went on to say that the MSCI All Country World Index would have been a better measurement as his hedge funds matched it. “Forget the Bulls and Bears; Warren picked the World Series Champion Chicago Cubs! His excellent choice of the S&P 500 for the bet was the main reason he won.”
Seides did go on to say that he was still confident that his side of the bet was right and that if he doubled the bet, he was fairly confident he would win this time.
“My guess is that doubling down on a bet with Warren Buffett for the next 10 years would hold greater-than-even odds of victory. The S&P 500 looks overpriced and has a reasonable chance of disappointing passive investors. Hedge funds mitigate risk in bear markets, while seeking to participate in some of a bull market. Investing in hedge funds is a bet against continuing bull markets; investing in the S&P 500 is a bet on a continuing bull market,” Seides wrote.
At the time of writing, there’s no indication that Buffett is interested in continuing the bet past the original 10 year mark. Next year, when the final tally comes in, Seides’ company Protege will be paying the sum of $1 million to Girls Incorporated of Omaha.
If you want to read the full article by Seides, click here.