Author Topic: Buffet Won a 10-year $1,000,000 bet that the S&P500 would outperform hedge funds  (Read 4254 times)

LivinOutWest

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Hedge fund managers are basically just salesmen trying to persuade people with no knowledge of investing to dump their money into a fund.  They charge fees to receive lower returns then investors can get by just dumping their money into index funds.  Although, I would be curious to see if hedge funds could better "hedge" against losses. Perhaps so many people dumping money into hedge funds makes it easier for the rest of us.

http://www.aei.org/publication/warren-buffett-wins-1m-bet-made-a-decade-ago-that-the-sp-500-stock-index-would-outperform-hedge-funds/
« Last Edit: September 17, 2017, 11:24:26 PM by LivinOutWest »

DarthCreationist

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I've seen that, too. But I cannot really understand why Warren Buffett himself, of all stock pickers in the world, would argue against stock picking and for investing into an index. :D
How is investing in his holding company fundamentally different from investing into a managed fund? It obviously would have paid off, yet he keeps arguing against managed funds.

mjr

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Buffet and co. buy businesses and turn them around.  They have resources and skills not available to the average punter.

secondcor521

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I've seen that, too. But I cannot really understand why Warren Buffett himself, of all stock pickers in the world, would argue against stock picking and for investing into an index. :D
How is investing in his holding company fundamentally different from investing into a managed fund? It obviously would have paid off, yet he keeps arguing against managed funds.

1.  Hedge funds and managed funds and fund-of-funds-buying-hedge-funds (I can't believe those exist, much less get any investment money) all have high fees and expenses.  BRK doesn't.
2.  Managed funds have a high turnover ratio, which increases taxes.  BRK does buy and sell, but their turnover is pretty low on a comparative basis.
3.  BRK tends to buy very large positions in companies or buys the entire company.  I'm not exactly sure how BRK turns this into an advantage, but it's certainly different from typical funds.

I am really surprised that the hedge fund manager picked funds-of-funds rather than hedge funds themselves.  I am not surprised at all that Buffett won the bet.  I am a little surprised that hedge funds and funds-of-hedge-funds continue to manage to exist.

Also of note is that the bet wasn't even close.

bacchi

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4) Buffet is able to use insurance float as a low/no interest margin loan to buy stocks and companies.

DarthCreationist

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But in theory, a holding company would have to pay a salary to its employees (CEO, analysts, secretaries) and an employee like Warren Buffett could probably charge millions per year (even if he is also the owner). I am not sure if this applies to BRK, or if he just works for his own good, but it doesn't strike me as a fundamental difference.

What is the decisive advantage of this company structure? Or would Warren Buffett's hedge fund be equally successful?

I can understand (4), though. (1) to (3) can be done by a hedge fund as well.

Dicey

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Interesting.
Not surprising.
Wonder what Girls Inc. of Omaha is gonna do with the $$$.

If they were really smart, they'd give it to Buffet to invest on their behalf. Wouldn't that be a story?

Cwadda

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I've seen that, too. But I cannot really understand why Warren Buffett himself, of all stock pickers in the world, would argue against stock picking and for investing into an index. :D
How is investing in his holding company fundamentally different from investing into a managed fund? It obviously would have paid off, yet he keeps arguing against managed funds.

Because he is one of the greatest investing minds in history. Of course HE can stock pick.

When he tells people to buy low cost index funds, he is speaking to the general population/common folk, which has very little knowledge of investing. He's not wrong.

Rufus.T.Firefly

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I've seen that, too. But I cannot really understand why Warren Buffett himself, of all stock pickers in the world, would argue against stock picking and for investing into an index. :D
How is investing in his holding company fundamentally different from investing into a managed fund? It obviously would have paid off, yet he keeps arguing against managed funds.

1.  Hedge funds and managed funds and fund-of-funds-buying-hedge-funds (I can't believe those exist, much less get any investment money) all have high fees and expenses.  BRK doesn't.
2.  Managed funds have a high turnover ratio, which increases taxes.  BRK does buy and sell, but their turnover is pretty low on a comparative basis.
3.  BRK tends to buy very large positions in companies or buys the entire company.  I'm not exactly sure how BRK turns this into an advantage, but it's certainly different from typical funds.

I am really surprised that the hedge fund manager picked funds-of-funds rather than hedge funds themselves.  I am not surprised at all that Buffett won the bet.  I am a little surprised that hedge funds and funds-of-hedge-funds continue to manage to exist.

Also of note is that the bet wasn't even close.

Many ways this can work to your advantage. For example, if you own the company, you pick the CEO. If you're good at hiring the right people, you'll achieve better returns. This is just one of dozens of ways being the owner is different than simply being a shareholder.

Rubic

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One minor but crucial tidbit is often left out of the media
discussions about this wager.  The fund manager had to select
a minimum of five funds to invest in.

Why?

Remember that Buffett is basically a handicapper.  He looks
at the long odds, then bets when they're overwhelmingly in
his favor -- he considers events that wouldn't occur to
most mortals.

The stipulation to select a minimum of 5 funds reduced the
possibility that a hedge fund manager would select some
outlier, i.e. a fund that would outperform the S&P 500 by
random chance.

ixtap

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But in theory, a holding company would have to pay a salary to its employees (CEO, analysts, secretaries) and an employee like Warren Buffett could probably charge millions per year (even if he is also the owner). I am not sure if this applies to BRK, or if he just works for his own good, but it doesn't strike me as a fundamental difference.

What is the decisive advantage of this company structure? Or would Warren Buffett's hedge fund be equally successful?

I can understand (4), though. (1) to (3) can be done by a hedge fund as well.

The difference is that he puts himself in a position to affect the outcomes, not just let his money sit and hope for the best.

neil

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October 11, 2007: S&P 500 hits an intraday record high of 1,576.09.

The bet didn't exactly start at a new top, but close enough!

Bicycle_B

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But in theory, a holding company would have to pay a salary to its employees (CEO, analysts, secretaries) and an employee like Warren Buffett could probably charge millions per year (even if he is also the owner). I am not sure if this applies to BRK, or if he just works for his own good, but it doesn't strike me as a fundamental difference.

What is the decisive advantage of this company structure? Or would Warren Buffett's hedge fund be equally successful?

I can understand (4), though. (1) to (3) can be done by a hedge fund as well.

Can is different from does. 

Hedge funds normally do not have low fees or low turnover, so he does get advantages from those.  The low fees are in part due to high efficiency.  Buffett and a staff of less than 20 perform functions that in a normal firm of its size would require many more people.  He also eschews high salary, a personal decision, though one where his large equity stake means he can still benefit from it along with other shareholders.  I agree that the decisive part for 1 and 2 is execution, not company structure.  As for 3, buying whole companies or large stakes is again different for Buffett due to execution.  Historically he has gotten a purchase price advantage by offering to hold companies for a long time and retain trusted management.  This reinforces 1 and 2. 

Re 4, Buffett/Berkshire get float because their insurance company again has execution skills that are above average.  The structure part (owning an insurance company) is something a hedge fund could do, but the cost of the float is low because the insurance company has exceptionally low costs/high operating returns.  To some extent this is execution, but it's also structural because Berkshire's structure still gives company management (Buffett) greater latitude to take a long term approach.  Hedge fund investors can withdraw their money, corporate stockholders can't.  What makes Berkshire different is the fact that where normal stockholders demand quick results, Buffett has explicitly warned over and over that he won't promise short term results, and his success has given him latitude to focus long term. 

Many of the things Buffett does would make him excellent in a hedge fund setting too.   However, the structure of Berkshire makes it even easier for him to compound the advantages he has.  Partly I think that this is because it allows him to just work the way he likes to work.  Buffett himself has written that not having a hedge fund structure, and instead having the structure that Berkshire has, allows him to take the long term perspective that he states is a permanent advantage for Berkshire. 

My own thought is that once Buffett is gone, there will be a purer test of how much of the advantage is from structure, and how much from Buffett.  I'm guessing about 1/4 to 1/3 from structure; curious about what happens after he is gone.


dougules

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I don't think the bet is officially over until next year although yes it's already pretty much a done deal. 

The guy he bet against still won't admit he's wrong though.

https://www.bloomberg.com/view/articles/2017-05-03/why-i-lost-my-bet-with-warren-buffett

bacchi

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I don't think the bet is officially over until next year although yes it's already pretty much a done deal. 

The guy he bet against still won't admit he's wrong though.

https://www.bloomberg.com/view/articles/2017-05-03/why-i-lost-my-bet-with-warren-buffett

Ha!

Quote from: ted_seides
Probabilities strongly suggested the S&P 500 would generate low returns in the future, which would have helped the relative performance of hedge funds.

But the S&P 500 defied the odds and rewarded investors with a historically normal 7.1 percent nine-year annualized return.

What are high expense earning professionals being paid for if not to defy the odds?

His other reasons are more of the same. He's a hedge fund professional using the "who coulda known?!?" excuse who doesn't realize that he's making an argument for not using a hedge fund professional.

Tyson

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I don't think the bet is officially over until next year although yes it's already pretty much a done deal. 

The guy he bet against still won't admit he's wrong though.

https://www.bloomberg.com/view/articles/2017-05-03/why-i-lost-my-bet-with-warren-buffett

The cognitive dissonance on display is rather awesome.

secondcor521

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I don't think the bet is officially over until next year although yes it's already pretty much a done deal. 

The guy he bet against still won't admit he's wrong though.

https://www.bloomberg.com/view/articles/2017-05-03/why-i-lost-my-bet-with-warren-buffett

The cognitive dissonance on display is rather awesome.

From the article:  "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."

From me:  My guess is that he's not going to double down on the bet even though Buffett would probably be willing to do so.  My further guess is that he hopes most of us don't notice this.

dougules

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I don't think the bet is officially over until next year although yes it's already pretty much a done deal. 

The guy he bet against still won't admit he's wrong though.

https://www.bloomberg.com/view/articles/2017-05-03/why-i-lost-my-bet-with-warren-buffett

The cognitive dissonance on display is rather awesome.

From the article:  "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."

From me:  My guess is that he's not going to double down on the bet even though Buffett would probably be willing to do so.  My further guess is that he hopes most of us don't notice this.

Somebody should set a reminder for 2028, and there's a pretty good chance he will be just as wrong. 

Telecaster

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One minor but crucial tidbit is often left out of the media
discussions about this wager.  The fund manager had to select
a minimum of five funds to invest in.

Why?

Remember that Buffett is basically a handicapper.  He looks
at the long odds, then bets when they're overwhelmingly in
his favor -- he considers events that wouldn't occur to
most mortals.

The stipulation to select a minimum of 5 funds reduced the
possibility that a hedge fund manager would select some
outlier, i.e. a fund that would outperform the S&P 500 by
random chance.

It is worse than that though.  Because Ted Seides who took the other side of the bet selected five funds of funds.    Presumably because he himself is a fund of fund manager. Typically, hedge funds require a big minimum investment to get in.  $1 million, something like that.   If you are say, a dentist with $100,000 to play with and want to get into some hedge fund action, you can buy shares in a fund that pools investor money to buy shares in hedge funds.  FWIW, former White House Communications Director Tony Scarimucci ran a fund of funds.  Of course,  in addition to the regular hedge fund fees, the fund of fund manager gets his beak wet too.  And these guys don't work cheap. 

Here's the thing:  Siedes got obliterated.   It wasn't close, it wasn't even in the same zip code.  It was Washington Generals territory.  None of the five funds even came close to the S&P, and most of them did shockingly worse.   Seides said something like "The S&P did better than we expected based on valuation."  Yep, and it could have done much worse than expected and Seides still would have gotten his clock cleaned. 




Rubic

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It is worse than that though.  Because Ted Seides who took the other side of the bet selected five funds of funds.

Agreed.  Seides took a bad bet and managed to make it worse.

My point though, was that Buffett structured the terms of the bet in such a way as
to not depend on the weakness of the second player's strategy.

dougules

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It is worse than that though.  Because Ted Seides who took the other side of the bet selected five funds of funds.

Agreed.  Seides took a bad bet and managed to make it worse.

My point though, was that Buffett structured the terms of the bet in such a way as
to not depend on the weakness of the second player's strategy.

Buffett's bet had really good odds against any fund with high expense ratios or that only has a small slice of the total market. 

Tyson

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The funny thing is that it seems like Seides actually believes he can beat the market and he was just unlucky this time.