Buffett’s Lead Widens in $1 Million Hedge Fund Bet

In the sixth year of a 10 year performance bet, hedge funds are being walloped by the index fund.

The results are in for the sixth year of the competition that is otherwise sometimes known as the $1 million bet, and Warren Buffett – who was once way behind in the lead of this 10 year wager in regards to stock market performance – has now taken a sizable lead over his opponent, asset manager based out of New York, Protégé Partners. Buffett put a low-cost S&P index fund against the average returns of investors – after fees – of five specific hedge funds and the particular funds that they have chosen for this contest.

At 2013’s end, the Vanguard Admiral shares – which are Buffett’s choice for the S&P 500 index – were up for the six years that started on January 1, 2008, and it has risen by 43.8%. During the same period of time, protégé’s gains, on average, are estimated to be 12.5% (although it’s an estimate because some of the funds do not have final figures for 2013).

Based on the bet’s terms, the names of the funds of the five hedge funds have never been disclosed publicly, even though Buffett does know their identity. We have always assumed that Protégé is running one of the five hedge funds using their own fund.

As for the name the $1 million bet, it’s derived from the amount of money that will ultimately be donated to a charity picked by the winner. Buffett’s charity is Girls Inc. of Omaha, and Absolute Returns for Kids was chosen by Protégé.

It’s interesting how they came up with the $1 million. Both invested in zero-coupon bonds in the amount of $240,000 each. At the end of the contest, the bonds were expected to be worth $1 million.

But the current low interest rate climate of the Great Recession has made these zero-coupon bonds even more valuable. They have taken off, and by the end of 2012, they were already worth roughly $1 million, and their appreciation potential is almost nil at this time.

So Ted Seides and Warren Buffett reworked the bet. They agreed to sell the bonds and use the proceeds to purchase Berkshire Hathaway Class A stock. They made the switch right at the beginning of 2013, which we all know was an incredible year for stocks in America. The Admiral shares, including the dividend, rose by 32.3% during 2013 alone, and the Berkshire Hathaway stock, which doesn’t pay a dividend, beat the index by a hair and gained 32.7%. By the end of 2013, in total, the winning charity is expected to receive $1,270,000.

In the meantime, the majority of hedge funds were doing exactly what hedge funds do – hedging their bets by shorting stocks, investing in emerging markets, as well as other things, and in doing so, investors would pay the heavy costs. It appears that Protégé’s five funds followed this particular trend, since they only gained 11.8% in 2013.

“We’ve got our work cut out for us,” said Ted Seides this past weekend, as he thought about the remaining four years. The very next day in trading, the stock market dropped in value, so no matter where they were, their shorts made some money.