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Warren Buffett, CEO and Chairman of Berkshire Hathaway, famously made a $1 million bet a decade ago. He bet that a low-cost S&P 500 index fund would beat a basket of funds chosen by a hedge fund over the following 10 years.
Seides vs. Buffett
Ted Seides, the managing partner for Hidden Brook Investments, was the only investment manager willing to take Buffett up on his bet. Seides chose a basket of 5 funds-of-funds, which are funds that invest in multiple hedge funds. There are usually more than 100 different hedge funds, so that the basket’s results will not be too dependent on any one hedge fund manager’s performance.
Unfortunately, things did not turn out very well for Seides. Even with the Great Recession, he could not beat the S&P 500. In fact, he conceded defeat in December before the bet was even up. Astoundingly, during this recession, the S&P 500 at one point lost 50% its value from its 2007 peak. And even so, the hedge funds could not top the market’s performance over that period of time.
S&P 500 vs. Hedge Funds
According to The New York Times, since Buffett placed this bet, “A standard S&P index fund overseen by Vanguard is up 85%, easily outpacing the hedge funds’ return of 22%. Annually, the gap is just as wide: 7% for the index fund and 2.2% for the hedge funds.”
Of course, we are not privy to hedge fund performance so far this year. However, the stock market is up 14% year to date, so it’s probably beneficial that Seides threw in the towel.
Fresh from winning his $1 million bet, which he donated to charity, Buffett was asked if he simply got lucky. At the time, the market was entering its 9th year of a bull market. Buffett’s response– “The date of the start has nothing to do with it.”
Buffett believes passive investing works in any environment. Again, he offered to place a bet against any active investor for the next 10 years. Buffett went on to say, the S&P 500 “will absolutely kill every one of the fund of funds. Passive investment in aggregate is going to beat active investment because of fees.”
He explained that low management fees of 2% compared to hedge fund performance fees of 20% add up over time. Thus, the passive investment strategy ends up granting you a “very good” return over the long run.
Yusko vs. Buffett
Buffett confidently stated that he would be willing to repeat the bet with anyone who believes the hedge fund industry can beat the market over the next decade.
Some hedge fund professionals, however, firmly believe that Buffett lucked out with the timing of the bull run.
Recently, Morgan Creek Capital’s founder and chief investment officer Mark Yusko accepted Buffett’s bet. Yusko said, “It’s an important time in terms of the market cycle. I think it’s important to be aware about the propensity of investors to chase hot returns at the peak of the cycle. It is a better time to get hedged.”
Now to be clear, Buffett does not suggest that an S&P 500 index fund will beat every single hedge fund out there over the next ten years. Rather, he is arguing that a basket of hedge funds will most likely lose to a low cost S&P 500 index fund over a long period of time.
This same principle can be applied to actively-managed mutual funds. This is why Buffett concedes that most investors are better off purchasing a low-cost S&P 500 index that will at least match the market’s performance, in contrast to paying higher fees with no guarantee of superior performance.
Buffett has even stated on multiple occasions that when he passes away that his wife will receive low-cost S&P 500 index shares. He holds true to avoiding high-cost fees, even after his dealth.
Passive Index Funds
At this time, it appears that the passive indexing community is growing by leaps and bounds. In fact, robo-advisors, like Wealthfront, are on the rise, utilizing passive index funds. The hedge fund industry may experience difficulty retaining customers. I am very curious to see how Yusko’s bet against Buffett’s will turn out in ten years.