Buffett Wins Bet

NYPost: The Oracle of Omaha once again has proven that Wall Street’s pricey investments are often a lousy deal. Warren Buffett made a $1 million bet at end of 2007 with hedge fund manager Ted Seides of Protégé Partners. Buffett wagered that a low-cost S&P 500 index fund would perform better than a group of Protégé’s hedge funds.

Buffett’s index investment bet is so far ahead that Seides concedes the match, although it doesn’t officially end until Dec. 31.

The problem for Seides is his five funds through the middle of this year have been only able to gain 2.2% a year since 2008, compared with more than 7% a year for the S&P 500 — a huge difference. That means Seides’ $1 million hedge fund investments have only earned $220,000 [through 2016] in the same period that Buffett’s low-fee investment gained $854,000.

I am shocked that Seides put his money on five funds-of-funds, thus piling fees on fees. It was a loser bet. Mark Perry at Carpe Diem has more of the stats.

In one way, this is another win for index fund investing but there is still an anomaly. The S&P trounced the hedge funds but it still lost to an investment in Berkshire Hathaway! (see addendum) Admittedly the race was pretty close at times but after ten years Berkshire was up 91.5% and the S&P 500 up 69.1%.

Addendum: An astute reader with access to a Bloomberg terminal points out that an investment in the S&P 500 pays dividends while famously Berkshire Hathaway does not. Moreover, when you compare total returns the S&P 500 is up 110.7% over this period and Berkshire is up 91.8% so indexing over this period even beats Buffett!


Um, Buffett publishes book-value and market-value Berkshire returns since 1965 compared to the S&P 500 every year on the first page of his annual report.

For as much as you read and as much as you know, I'm surprised about your lack of context here and lack of expertise in finance and investing generally.

I'm surprised that you're surprised.

Apparently, Ted Seides reads Krugman.

How much of the S&P up-tick is related to the Trump Rally?

Most hedge funds have materially under-performed. I guess they, like Main Street, aren't "built" to thrive in markets dominated by ETF's and affected by financial fascism (near-zero rates for years, QE, massive (how much was defaulted?) asset purchases, bank bail-outs, etc.), which has been forced on America since 2008.

Buffett may have possessed insider info as to how his big-government friends would work it.

I assume that in the later part of his career Buffet has had plenty of insider info and influence on his side. The early part shows him either to be remarkably lucky or a genuinely highly effective investor. My money's on the second.

"Seides concedes the match, although it doesn’t officially end until Dec. 31". What a chump: nothing to gain, everything to lose. I wouldn't trust him to manage my money.

Buffett mentioned in a TV interview years ago that one of his strategies is to always keep about $1 billion in liquid assets in case an urgent buying opportunity comes along, as happened during the 2008 financial crisis. When you have billions of dollars in unencumbered assets at your disposal and the luxury of investing on 20+-year time horizons, you have opportunities available that simply don't exist for many other people. Much of the private equity and hedge fund world is focused on using leverage and earning returns within a five-year time horizon.

Is your first sentence supposed to relate to the second? What "context" and "expertise" is missing in Professor Tabarrok's post?

Alex thinks Berkshire outperforming the S&P 500 is an anomaly.

Investing 101 says the expected return from any company's stock is higher than the expected return from the S&P 500, but the variance of returns is A LOT higher for the single stock.

Buffett has self-consciously benchmarked his company's performance against the S&P 500 for decades. As his annual report shows, Berkshire has trounced the S&P 500 over the past 52 years (20.9% CAGR vs 9.8%), but the Berkshire investment has been a bumpier ride (standard deviation of annual returns 35% vs 17% for S&P 500).

It's an "anomaly" in that managed funds hardly ever beat the market in the long term, but Buffet has managed to do so. I think this is the argument being made here.

The fact that Buffet has done this a long time just makes him that much bigger of an anomaly.

But Alex is talking about 10 years! Saying "It is anomalous to beat the S&P 500 over 10 years." is just wrong. A lot of people do it during any 10 year period, quite a bit possibly due to luck.

Yes, a 52 year run leaves much less scope for ascribing this to luck, but that ain't what Alex is saying here.

The broader point is the widespread ignorance on the subject. Just read the rest of the comments on this post...

Most people probably can't read or understand financial statements. I feel like I'm just ok at this, definitely not an expert.

But that's what makes Buffett so great. His annual letter to shareholders lays out his business in a way that even an economics PhD should be able to understand. Contrast this with the relentless spin and PR that is a typical shareholder letter. There's not a lot of mystery about Buffett, but there is a lot of ignorance.

Brian, yes, some funds will beat the market over a ten year period, simply because there are a lot of funds and a lot of ten year periods, and some will come out ahead due to random variation.

However, the "anomaly" here is not that one fund out of many happened to beat the market. It's that one specific fund, run by a guy who made a bet about beating the market, beat the market over the specific period they were betting on. It's a low probability event happening within a sample of one (or two if you include the other guy's portfolio).

"lays out his business in a way that even an economics PhD should be able to understand." Roars of applause.

Dan is correct. This is a pure reading comprehension fail.

"Investing 101 says the expected return from any company’s stock is higher than the expected return from the S&P 500"

That is NOT what Investing 101 says. In fact, as stated, your statement is a mathematical impossibility.

Paraphrasing Bill Sharpe:

"What is known as the "beta value" of a specific share indicates its marginal contribution to the risk of the entire market portfolio of risky securities. Shares with a beta coefficient greater than 1 have an above-average effect on the risk of the aggregate portfolio, whereas shares with a beta coefficient of less than 1 have a lower than average effect on the risk of the aggregate portfolio. According to the CAPM, in an efficient capital market, the risk premium and thus also the expected return on an asset, will vary in direct proportion to the beta value."


Tabarrok is correct. Buffett's Sharpe ratio is the highest of any major investor.

That does not defend the weak part of the original statement. The markets have known stinkers. The real world limitation is that they are difficult to short, rather than that they all have greater than S&P 500 potential.

J.C. Penny?

I would think "Investing 101" would say that all this analysis of the past is irrelevant. Should an investor invest in or stay in Berkshire now...will Berkshire continue to beat the S&P 500? If Berkshire's exceptionally unique past returns are due to Buffett...and Charlie Munger..., these guys are 87 and 93 years old, respectively.

FWIW, another Nobel prize winner made his call a couple days ago.

"That doesn’t mean that there is no danger of a crash. But at the moment, the psychological preconditions for a spiraling downturn don’t appear to be in place."


Maybe the psychological conditions are not in place for a "spiraling downturn" but, the future could be a series of corrections (10% drops) that result in a low return over time. In fact, I believe Shiller has made that prediction about future stock market returns.

Of course, timing is everything. When this episode of rising asset prices ends with a thud, index investing will appear a bad bet. But then we will have another episode of rising asset prices, which will end with a thud, and another, and another. Pity the poor fellow who doesn't own the resources necessary to avoid liquidation after a thud.

Yep... Betting in indexing is essentially betting on the Fed.

IOW, you're banking on the purported ability of a central committee of Ph.D. economists to "run" the economy. It's been tried before.

Um, no. You're betting on the purported ability of a central committee of Ph.D. economists to support asset prices. They're not "running the economy" any more than the College of Cardinals runs the afterlife.

"They’re not “running the economy” any more than the College of Cardinals runs the afterlife." There's some good stuff on this thread today.


No, it's banking on a rich daddy to keep buying me cars no matter how many I crash.

Of course, the contributors to this blog believe markets don't make mistakes, governments do. Those with such a view also believe speculation is a word not a description of rising asset prices. Speculation is merely a symptom of something else, the something else being a long-term decline in the rate of return from productive capital. Owners of capital eschew investment in productive capital because the return can't compare to the return from rising asset prices. And the more owners of capital eschew investment in productive capital, the lower its rate of return, the lower productivity and economic growth, and the greater the reliance on rising asset prices. I'd call that a market failure, but I'm not as smart as the contributors to this blog.

You're overlooking that aforesaid central committee actively distorting the market.

Here is Seidel earlier this year. Basically he says that Buffett just got lucky that it was a good decade for the S&P. Classy! https://www.bloomberg.com/view/articles/2017-05-03/why-i-lost-my-bet-with-warren-buffett

Well he's right... Start the bet in 2001 and end it in 2008 and let's see the results...

I would think that the majority of funds lost out to the S&P 500 for the stock part of their portfolio during the 2001 to 2008 period too. Funds that held cash or bonds in 2008 obviously went down less, but comparing a fund without 100% security holdings to one that by construction has 100% stock is not a story about stock picking, but rather a story about avoiding the market, and those are very different stories.

Um, that's not a 10-year period. Buffett is good at this stuff and knows that as T increases, it becomes harder and harder to stay ahead of the market.

Um, there's nothing magical about a 10 year period. It's all about timing market swings. If you're looking for some mystical time span, seven years better matches market swings.

Buffet is good at using political connections to manipulate asset prices. He's the one who lobbied for the bailout right after a multi-billion dollar investment in flailing Goldman Sachs.

You can beat the market through sound investment decisions...or you can use political connections.

A real expert at "timing market swings" would have simply levered up and beat the S&P. If you believe in market timing, the fact that the market did really well over a certain period of time is no excuse for failing to beat it once you consider leverage. The sour grapes inherent in your comment don't obscure the fact that very few people can consistently time the market over a 10-year period and fewer still can consistently time the market over longer periods.

But would Buffet have made that bet? If the answer is yes, that lends credence to the "Buffet was lucky" theory, if the answer is no...

BH is essentially a mutual fund heavily weighted in consumer products (a good call during an anemic recovery), and tax-avoidance products (life insurance and residential real estate), which will inevitably be popular under a Democratic president, warranted or not. Note how Buffett himself is frequently talking up the need to raise taxes -- for BH, this is advertising.

BH is heavily into airline stocks now, which suggests to me that even Buffett has his blind spots. :-)

Buffett likes moats and airlines have a pretty good one. He is also investing in franchise car dealerships for the same reason.

"The S&P trounced the hedge funds but it still lost to an investment in Berkshire Hathaway!"
That's the thing about index funds - you buy everything. If you could pick the right individual stocks or avoid the wrong ones, you'd do much better. FANG outperforms QQQ, while the DJIA is dragged down by energy stocks. But, of course, that is easier said than done.

Buffett doesn't just buy stocks. He buys companies and manages them. It isn't a random walk.

Yes, punter capitalism can't outperform the markets under the weak efficient markets hypothesis, but investors-managers can. That's the premise behind private equity but most fail to deliver.

A bigger concern is once a majority of assets are invested in index funds, the management of the companies in the index will be able to take advantage of the captive investors by absorbing company profits in bonuses and perks.

Actually, he buys companies with great managers and mostly leaves them alone.

He has built a conglomerate in an age where most other conglomerates were dismantled in favor of firms focusing on "core competencies".

The guy allocates capital, and he maybe the best in the world at this. He describes Berkshire at this point as having internalized all this capital allocation, none of which takes place on Wall Street, avoiding all the friction (fees and taxes) attendant to transacting on the Street.

Brian has it exactly right. I'm a long time shareholder. It's not only purchasing good companies but the large float Berkshire gets from their insurance operations. The stock investing portion of the company is relatively small compared to the other parts.

Buffet is a skilled investor, but "cumulative advantage" should also appear on this page.

It is a great luxury when publicly announcing an investment greenlights follow-on investment by others.

By placing the bet, Seides was able to convince five biollionares to invest in his fun and collect more than $10M in fees personally. He deducted the cost as charity, but could have made it an advertising expense.

The correction needs a correction. To judge the performance of index investing, you need to measure the performance of an index fund. It's substantially less than the performance of the index plus dividends of index companies. My guess is BH wins after all.

But BH fans should cool the greatest ever hyperbole. A lot of companies beat the S&P by more and/or over longer time frames.

>Addendum: An astute reader with access to a Bloomberg terminal points out that an investment in the S&P 500 pays dividends

Seriously, Tyler_Cowen? It's "astute" to remember that stocks pay dividends and compare by total returns? How about it's "not helpful" to compare by stock price?

Buffet should listen to me on investing. I will make him a millionaire.

funds of funds are a joke

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