Buffett’s Big Bet

At the end of February, Warren Buffett decided to declare victory early on his ten year bet made with Protégé Partners.  The bet: What performs better over the ten year period starting at the beginning of 2008 – the S&P 500 or a group of five Fund of Funds (hedge funds).  The stakes: $1,000,000 to the charity of the winner’s choice.  The results, taken from Berkshire Hathaway’s annual client letter you can see below:Source: http://www.berkshirehathaway.com/letters/2016ltr.pdf

Source:  http://www.berkshirehathaway.com/letters/2016ltr.pdf

Buffett didn’t just win this bet, it wasn’t even a contest.  The last column shows the dramatic outperformance of the S&P 500, not just versus the average of the Fund of Funds above, but even vs. the best of them, Fund C, by quite the margin.

The above has caused Buffett to claim victory a whole year early.  How can he be so confident?  Well, the S&P is up 85.4% total and the average of the Fund of Funds is up just 22%.  In order for Buffett to lose the bet, the S&P 500 would have to fall -34.2% in 2017.  Not only this, but at the same time the S&P falls, the average of the Fund of Funds would have to stay flat.  So far out of the gate in 2017, the S&P is just going up.  Even if 2008 happened again, it wouldn’t be enough for the bet to be lost.

So it seems Buffett’s victory is likely safe.  What can we learn from this?

  • Hedge Fund Costs Matter – These investments, while intriguing, have fees gravitating around 2% each year plus 20% of the profits. Overcoming that type of performance hurdle is incredibly tough.
  • Smarts Doesn’t Equal Performance – A lot of the best and brightest talent in the investment world are found in the hedge fund space. However, from this bet alone, you can see that doesn’t mean investors will benefit from these smarts.
  • Don’t Worry – It’s hard to imagine a tougher start to a bet than this one had from Buffett’s point of view. Right out of the gate, the 2008 financial crisis happened.  However, patience and sticking with the strategy over time proved to be the place to be.
  • Even a Crystal Ball Wouldn’t Help – You could have beaten the S&P with the Fund of Funds lineup above. How?  Just know what the best performer would have been each and every year before it happened and load up on that one fund.  The result of that perfect foresight strategy would have been a 100.9% gain to date, which would have clearly won.  However, there are two issues there.  The first is taxes.  If you switch managers each year, you pay capital gains tax on the gain to switch.  When this is factored in (calculated at 20% each year), that gain to date number comes all the way down to 76.2%, which trailed the S&P.  The second issue is what if you picked just the second best manager each year.  You still were in the top half of funds, so the intuitive thought is you should have done fine.  The results show differently.  Now your pre-tax return comes all the way down to 37.3%, a huge miss vs. the S&P.

This bet is another reminder of what we know to be true over time: patience married with a sound, disciplined strategy is the way to go.


S&P 500

The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market, this world-renowned index includes a representative sample of 500 leading companies in leading industries of the U.S. economy.

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