
Buffett wins $1M decade-old bet that the S&P500 would outperform hedgefunds - yurisagalov
http://www.aei.org/publication/warren-buffett-wins-1m-bet-made-a-decade-ago-that-the-sp-500-stock-index-would-outperform-hedge-funds/
======
wpietri
And I'm just going to self-promote a bit and say that the bet was registered
via a project I worked on, the Long Now Foundation's project Long Bets:

[http://longbets.org/](http://longbets.org/)

We've been going since 2002:
[https://www.wired.com/2002/05/longbets/](https://www.wired.com/2002/05/longbets/)

We are happy to host bets of long-term significance, and the minimum bet is
only $200/side. I am glad to personally help shepherd people who are serious
about bets to make sure you get through the process.

I would especially like to see HNers making bets about the things we argue a
lot about. Bitcoin! VR! Uber! If you're tired of people posting waffle on some
topic where you have a strong opinion, then challenge them to put money down.

~~~
timb07
If longbets.org was really serious about long-term bets, it wouldn't be
restricting years to only 5 digits. Haven't they heard of the Y100K problem?

~~~
0xJRS
What is the Y100K problem. More importantly, who would they pay out at that
point when both parties are dead

~~~
KingMob
What if you want to bet they find a cure for death?

~~~
wpietri
We would totally accept that bet. The closest bet we have right now is bet 11:
“At least one human alive in the year 2000 will still be alive in 2150.”

[http://longbets.org/11/](http://longbets.org/11/)

The tricky part is coming up with a clear agreement about what "cure" and
"death" mean here. But there's a lot of good discussion around e.g., the
extropians, so I think a solid bet could be created.

~~~
jandrese
Does "Brain in a Jar" count? How about a Ghost in the Shell? More likely this
is a bet on if Cyrogenics finally works out.

~~~
wpietri
You mean for that bet? Good question, and not one I'm likely to have to
answer. But from the arguments, the spirit seems to be about traditional meat-
brain-in-meat-body life.

Or do you mean for your own? This is between you and the person you bet with.
If you have a firm opinion, definitely find somebody on the opposite side and
see if you can put together a bet.

------
osrec
This does not surprise me.

My personal experience with hedge fund managers is that they are good salesmen
that peddle their financial expertise to clients, convincing them of their
financial rock-star status (usually gained through a lucky investment or two).
Paulson is a classic example. Wealthy individuals buy into it, especially
those that are less educated (e.g. those that have inherited money), and
happily allocate away their money to these guys. Once the funds grow to a
certain size, then they might consider pitching their investments to pension
funds, and their money pot grows, as does the nominal value of their fees. By
the time they have pension funds on board, their investments get less and less
risky, eventually looking more and more like a basket of standard commodities
or a standard equity index! Thus, the value they add also becomes smaller and
smaller.

In my opinion, the hedge fund industry is a bit of a farce, but there are a
small number of firms that do have a secret sauce that works sometimes (rarely
forever though). In my experience, the firms that tend to make consistent
money are the market makers, rather than the speculators.

~~~
blfr
Nothing works forever but there are funds like Renaissance Technologies'
Medallion which may just be getting heads for a long time but rather seem to
have some secret sauce that works for a long time. Usually though they're not
very large and don't seek out investments.

~~~
osrec
Yes, Renaissance is an exception. I would argue that their nature of their
strategies almost puts them into a pseudo market maker category (I've
personally never worked with/for them, but I hear much of their strategy is
statistical arbitrage, made possible by favourable transaction fee set ups and
fast, colocated execution infrastructure).

~~~
cma
Plus apparently some dodgy "creative" tax code interpretations around short-
term/long-term gains.

~~~
cheez
Is it dodgy? You buy a share in a fund, that fund buys and sells, should you
pay capital gains on every sale that fund makes? I don't think that has any
precedent. You pay tax when you sell your share.

~~~
cma
The type of strategy they employed isn't something small time investors could.
It was a complex option scheme essentially buying options on their own short
term trading.

~~~
dsacco
While what you're saying is true, in fairness there are two caveats:

1\. Virtually all profitable strategies run by hedge funds are inaccessible to
small time investors nearly by definition, because they have more capital and
lower capacity constraints,

2\. The partnership you're talking about with Deutsche Bank doesn't account
for most of their returns, and was only in effect in the last decade, not
decades before.

------
ModernMech
Reminds me a little of traffic. Yesterday I was cruising down the highway in
the leftmost lane, going about 80 with a line of other cars. The other two
lanes were actually more clear, but cars were going much slower.

I notice this one car, weaving in and out of traffic in these two lanes,
trying desperately to get ahead, constantly cutting people off. They did this
for 40 miles, weaving in and out, sometimes getting ahead of me by quite a
bit, sometimes falling behind.

If they had just stayed in the left lane and cruised, they would have arrived
at their destination at exactly the same time.

My point is, it seems to be human nature to be bad at estimating long term
averages, whether it be stock picks or just driving down the road. Checkout
lanes are another example that comes to mind.

~~~
perl4ever
Some people think you should not be in the left lane unless you are passing at
that moment. In some places, there are even signs saying "keep right except to
pass". Perhaps this person was driving aggressively because they were enraged
at the line of traffic on the left. Which is to say, they may not have been
doing it for a quantitative benefit as you assume. This might strengthen
rather than weaken the analogy to the stock market though...since it could be
that people invest in hedge funds not to increase their average return but to
reduce the regret of not owning "winners" and having something to talk about.

~~~
matthewmcg
It's not just some people. It is actually the law in most states (albeit a
seldom-enforced one).

Don't cruise in the left lane.

~~~
mercutio2
I wish this were true of most states in the USA. It’s certainly true in many
parts of Europe.

I don’t have an especially authoritative source, and the first map I found was
made seven years ago, but I don’t think things have changed much:

[http://jalopnik.com/5501615/left-lane-passing-laws-a-
state-b...](http://jalopnik.com/5501615/left-lane-passing-laws-a-state-by-
state-map)

Only the green states would map to “don’t cruise in the left lane”; the laws
in the majority only say you shouldn’t drive slower than normal traffic in the
left lane.

~~~
Sohcahtoa82
That map is out of date. Oregon is now in the green group.

~~~
mercutio2
Good to know!

------
lpolovets
For anyone interested in this bet, Ted Seides (the losing party) did a good
podcast on the topic:
[http://capitalallocatorspodcast.com/BetwithBuffett/](http://capitalallocatorspodcast.com/BetwithBuffett/)

My layman's understanding of hedge funds is they are better at hedging losses
than increasing gains. So in good years they might underperform the broader
market (e.g. gain 9% instead of 12%), but in bad years they should lose much
less (e.g. lose 5% instead of 15%).

I think this bet was largely a bet on the broader market dropping after a long
run-up (which would theoretically favor hedge funds), but instead the market
kept rising more and more.

~~~
goialoq
Yes, this was the origin of the term "hedge" fund, but in recent ~decade has
come to mean "actively managed investments" because the name sounded cool to
people who don't know that the word "hedge" means something intentionally
conservative and boring.

~~~
Iv
Yeah, it's hedgy.

------
dsr_
Has anyone done the analysis to see if the stock-picking by those managers was
worth anything at all?

Obviously it wasn't worth the fees they charged. But if all those fees had
been flattened down to the same expense as the Vanguard fund, would their
advice have been worth anything over the index? To a first approximation, it
looks like the answer is no.

~~~
TuringNYC
Investments can have a dual mandate - high returns BUT also low volatility.
Many hedge funds will admit their returns may not beat the S&P500, but will
counter that their returns have lower volatility -- achieving more
_consistent_ gains over time.

To answer your question, sounds like the answer is still no, but it is worth
noting that this whole conversation is ignoring the volatility side of the
conversation.

~~~
watsocd
You are correct except that doing this over 10 years somewhat removes the
'ignoring the volatility' argument.

~~~
icelancer
>>You are correct except that doing this over 10 years somewhat removes the
'ignoring the volatility' argument.

Only lessens it slightly. There are plenty of bad 10-year periods you wouldn't
be happy with if you were 50-55 years old with all your money in stocks, not
to mention an index fund tracking the S&P500 rather than the full index.

Obviously holding index funds that are primarily stocks is the play when you
are younger, but risk-adjusted returns matter a lot more for someone with big
money as they approach retirement. It's worth exchanging returns for lower
volatility down the line. Not that I think this bet could have turned out any
other way, of course...

------
crystalmeph
It's interesting that while the S&P did beat these hedge funds, Buffet's own
Berkshire Hathaway (BRK.B) seems to have beat the S&P handily[0], with an
increase of ~130% from $77.93 in 2007 to $179.89 today.

I know Berkshire isn't actually a hedge fund, but is very analogous to a giant
mutual fund, albeit one that takes a very active ownership role in the
companies whose shares it owns.

0:[http://quotes.morningstar.com/chart/stock/chart.action?t=BRK...](http://quotes.morningstar.com/chart/stock/chart.action?t=BRK.B&region=USA&culture=en_US),
look at the 10-year chart.

~~~
tardo99
Yup this is the optimal strategy. I figure that one out a couple decades ago.

------
bincyber
Index funds will almost always outperform actively managed funds. They are the
best choice for the layman investor. An excellent book on this topic is The
Little Book of Common Sense Investing by John Bogle.

[https://www.amazon.com/Little-Book-Common-Sense-
Investing/dp...](https://www.amazon.com/Little-Book-Common-Sense-
Investing/dp/0470102101)

~~~
jk2323
"Rest Estate always goes up!"

"Index funds will almost always outperform actively managed funds."

Convenient investment vehicles should not stop you thinking. Index ETF were a
great idea. But now everybody is pouring tons of money into them. Not sure
this is a good idea, at least not on the scale how it is currently done. A
stock is priced by supply and demand. There are stocks where there is
basically very little real trading. Only ETF and some HFT funds. Yet, the
stock is rising with the index. What happens in a downturn? What happens if
this stock drops significantly more? Every ETF has to re-balance to reflect
this fact, easily leading to a feed-back effect.

Some people betting on it: [http://www.zerohedge.com/news/2017-04-09/horseman-
global-unv...](http://www.zerohedge.com/news/2017-04-09/horseman-global-
unveils-new-shorting-philosophy-using-etf-flows-catalyst)

~~~
misnamed
Index funds have to outperform active funds and traders in aggregate by
definition. It's not a claim or debate, it's simple math. After savings on
taxes and expenses, indexes represent the average + a fair bit more than other
options. There is no feedback effect, except that more people indexing will
lead to more trading arbitrage opportunities, which people will take and which
doesn't hurt indexers, who will continue to take the market average return
plus what they save in expenses and taxes. As an aside: the last place to get
financial advice is Zero Hedge. Try this instead:

[http://www.etf.com/sections/index-investor-corner/swedroe-
wh...](http://www.etf.com/sections/index-investor-corner/swedroe-why-index-
investing-wins?nopaging=1)

~~~
opportune
This is true in aggregate, with the additional caveat of _over an
asymptotically long timeline_. Part of the goal of hedge funds, or at least
some, is to hedge investments so that you might not get hurt as hard during a
recession as the market.

There can still be active funds that perform better than the market, or the
market as measured by an index ETF. Unfortunately with the way funds are
marketed, funds can often just employ survivorship bias so that all funds look
very good. Also, index funds do not have to outperform active funds/traders by
definition, because not only can active funds invest in assets outside of the
index (other stocks, real estate, futures, options, etc.), but active funds
can also have more profitable allocations. Obvious proof: if the value of
every stock in the S&P 500 were now worth 0, active funds wouldn't, ergo
active funds will not necessarily always be outperformed by indexes.

I think that for your average investor, indexes are the way to go at the
moment, but it's not impossible for there to be a world where active funds are
often better.

~~~
pedrocr
>This is true in aggregate, with the additional caveat of over an
asymptotically long timeline.

This is true over any timespan. At any point in time the active part of the
market holds the same stocks as the passive part of the market and thus has
the exact same risk and returns. This is as true over a century as it is over
a month.

>not only can active funds invest in assets outside of the index (other
stocks, real estate, futures, options, etc.), but active funds can also have
more profitable allocations

If your active fund is investing in different markets then it's not comparable
to the index. If there's an advantage in investing in those assets the
solution isn't to buy the active fund. The solution is to find the index funds
that will also give you exposure to the same assets and buy those instead
gaining the same advantage of the same returns with less fees.

------
mojoe
I feel like there's some cognitive dissonance surrounding hedge funds in
popular culture -- on the one hand you have people saying that any outsized
short-term gains seen by hedge funds are the result of some
selection/survivorship bias, and on the other hand you have people saying that
any outsized returns are the result of illegal privileged information (see the
TV show 'Billions').

I realize that there are enough hedge funds out there that both things can be
happening. It's too bad that there's so little visibility into the industry,
it would be fascinating to see some kind of hedge fund taxonomy.

~~~
alexasmyths
It doesn't have to be illegal.

Hedge Funds have access to CEO's, they'll go in and interview them.
Ostensibly, the CEO cannot say anything that is not 'public information' \-
but if you think about it, then why would the Fund even talk to the CEO if
'all info is public'?

Because a lot of nuance can be gained from in person interviews. Little
tidbits of information gleaned can make a difference.

I'm not hugely knowledgeable of that industry, so I can't speak of the 'for
sure' bad things happening, but I know at least one manager who does this.

Funny: he totally does not believe that they really gain an edge over the
public. Then I ask him why he bothers with the interviews and he doesn't have
a very good answer. It's almost funny. I suspect his fund partners have a
better clue.

So that's one thing.

Another - is that simply by having fewer regulator requirements, hedge's can
do all sorts of things that bigger funds cannot.

As far as 'hedge funds not doing as well as the S&P' \- well - the S&P
changes, and it's made of pretty good companies. Also - a lot of funds come
and go - it may not just be 'survivor bias' \- some may very well just be dam
better than others. Almost all of the gains in VC go to top funds, and there's
tons of churn in the bottom 50%, but that is a different dynamic.

~~~
Waterluvian
I think the rationale that you can gain nuance from in-person interviews about
public information is where science and mathematics turns into wizardry and
human bias nonsense.

If the evidence suggests access to CEOs like this works, there's probably
something else going on. Maybe a bit more winking and "I didn't say this
but..."

------
kpommerenke
It is not really surprising that a large group of hedge funds underperformed
the S&P500. In fact, William Sharpe made the argument a long time ago: in
aggregate, active investors hold the passive portfolio and earn the same
return as passive investors before fees, but lower returns after fees. In
aggregate, this is always and necessarily true:
[https://web.stanford.edu/~wfsharpe/art/active/active.htm](https://web.stanford.edu/~wfsharpe/art/active/active.htm)

~~~
misnamed
It's so simple and obviously true yet a shocking number of people think it
could be otherwise (e.g. if too many people index).

------
baron816
So clearly, for the individual, the optimal strategy is to simply invest in
index funds and just wait.

But a new question that is being raised is: "what happens if everyone only
invests in index funds?"

~~~
mrep
This has been answered a thousand times. Everyone will never invest in index
funds. What will happen is more and more people will invest in index funds
until there are so little people actively investing in the stock market that
the ones that do are able to beat it. However, them beating it will only net
(after their fees) the same returns as index funds thus striking a balance
where index funds match the performance of active investors.

If either index funds or active investors (after fees) make more money,
capital will move to the one that pays more until they balance again. We have
had way too many active investors for a long time which is why index funds
have constantly outperformed active investors but eventually they will balance
as more and more people move their money to index funds.

~~~
goialoq
You are missing the point. Once almost everyone invests in index funds, what
will determine the price of stocks?

~~~
sigstoat
> Once almost everyone invests in index funds, what will determine the price
> of stocks?

there are hundreds or thousands of index funds, all investing in different
subsets of the market. money flowing back and forth between those funds will
shift the relative value of their underlying sets.

also all the other answers, such as, that's unlikely to happen.

------
mcintyre1994
If anyone finds this surprising I'd highly recommend reading 'Smarter
Investing' by Tim Hale, which does a great job of advocating for index-based
positions. With the exception of C, those fund-of-funds have done incredibly
badly.

One of the interesting things Tim discusses is that this poor performance
compared to market tends to make investors second-guess their investments
(often for good reason looking at those returns), and buy into the fund that
did well last year instead. So you're also getting into a sell-low-buy-high
routine.

------
rwmj
Question for financial types: For a few years I've owned a small selection of
shares in FTSE companies (15 of them at the moment). I don't really do this
scientifically, I just look for large, well-established companies where their
shares look cheaper than long run, and buy those. (Partly I do this so I can
see everyday companies that I own a tiny bit of). Is this practically
equivalent to owning index-linked funds? Am I missing out? I plan to hold them
for many years, and it's mostly "play money".

~~~
Lon7
There's two parts to this answer.

First, the numbers thrown around are that once you own 15 diversified stocks
you have reduced your portfolio risk by 70 percent. That's not bad. At this
point your volatility may not be that different than a market index. Of course
it's different for every set of stocks, but I think this is a safe-ish
guideline. So in that sense you are not missing out a whole lot.

Second, and more importantly, it is very simple to put together 15 stocks with
a low volatility, but also with very low returns. This is because the vast
majority of the returns of an index come from a very small number of
outperforming stocks. It's like the 90-10 rule. 90 percent of an index's
performance comes from 10% of the stocks. Those aren't the exact numbers, but
when you only pick 15 stocks, it is very likely that you will totally miss out
on all outperforming stocks.

Here's an article that talks about this in more depth and uses real numbers:
[http://www.efficientfrontier.com/ef/900/15st.htm](http://www.efficientfrontier.com/ef/900/15st.htm)

~~~
icelancer
>>This is because the vast majority of the returns of an index come from a
very small number of outperforming stocks.

This is the only thing the parent commenter needs to read to understand why
indexing is not equivalent to owning 15 stocks that theoretically reduce
portfolio risk (my guess is that the stocks are highly correlated and have too
high of weight towards IT and not enough towards boring fields like
industrials).

~~~
rwmj
Actually the opposite. Being in IT, I never buy IT stocks. They're mostly
everyday brands and industries.

~~~
icelancer
>>Being in IT, I never buy IT stocks.

That, ah, is even worse. Your diversification... isn't. Just because you have
a job in IT doesn't mean that's adequate exposure. There is a large difference
between a paycheck and investments in the large cap IT sector.

------
brianliou91
Although there is still tons of money going to actively managed funds it seems
to be more and more common knowledge that index fund investing is ultimately
the smartest thing to do for personal finance.

Does anyone know what the risk factors are (if any) to this type of passive
investing if EVERYONE begins to do the same thing?

~~~
charlesdm
I had an interesting conversation with a very smart investor last year, and
basically his idea was that while active managers will sell certain specific
stocks (less volatile stocks) to fulfill redemptions in the event of a decline
and/or crash, ETFs will generally just hit an (automated) sell on everything
across the board. So proportionally they will sell off significantly more
volatile small and midcaps vs large caps.

Every since I have had that conversation, I no longer invest in passive index
funds or ETFs.

~~~
tanderson92
This is incorrect, especially with ETFs. With an ETF, the seller/buyer (the
individual, not the fund) pays all of the transaction costs. So buying and
holding an ETF doesn't expose you to the problems which the behavior of
panicking investors^ _. The same is not always true for mutual funds.

_ caveat: Vanguard index funds may be special and this doesn't apply to the
same extent because the ETFs are a dual share class of the larger mutual fund.

~~~
charlesdm
But you are still exposed to the market, which can decline significantly.
People will withdraw money from their passively managed funds when the market
starts tanking. We have no idea what will happen in the next 'fear trade' when
everyone starts dumping shares.

Stocks can go crazy and this could create a death spiral on the ETFs, because
an ever more frequent decline can lead to significantly more volatility in
small and midcaps, and more people withdrawing funds from their ETFs, which in
turn will cause more liquidations.

All reasoning (to some extent) is lost as to which assets to liquidate.
Actively managed funds will generally liquidate assets that don't cause too
much swings in share prices in a downturn. Liquidating $50MM worth of Google
won't make a big difference, but liquidating $50MM worth of SmallCap generally
will put significant pressure on the share price. On the flipside: imo it does
create a significant buying opportunity when it comes to small cap stocks.

Tl;dr: in my view, the more money that ends up being managed passively, the
easier it will become to beat the market as an active investor.

~~~
tanderson92
There are two concerns: transaction costs (tracking error relative to index
return) and index return.

Those who believe in generally efficient markets want to capture the market
return, however volatile, with as little tracking error as possible. Since the
ETF holders don't actually _sell_ any stocks when the prices decline, their
returns are temporarily depressed. If and when prices recover so too will
their value.

There is nothing unique about ETFs in this respect. Your critique is more
about index funds in general, not ETFs specifically. ETFs practically differ
from mutual funds only in things like transaction costs.

re your tl;dr: Sharpe's theorem shows that active investors will underperform
passive investors after costs. Notice that this does not depend on the number
of passive investors (and certainly at this point we're nowhere near any of
the percentages of passively managed assets which people say may be worrying).

Overall, I do not think your critique is well-informed by the facts.

~~~
charlesdm
To each their own investment style (and there are many), but markets (in my
view, and in the view of many others) are not efficient. (More than) half of
what determines the stock price is psychology and herd mentality. It's not
just numbers, and more an art than it is a science. Larger cap stocks however
are generally priced more correctly than small- or mid cap stocks.

Second to that is that your returns will also depend on the risk you are
willing to take. Investing through index funds and ETFs will correlate with a
certain alpha, but that doesn't mean returns can't be higher if you are less
diversified (and thus taking more risk).

Depending on the type of companies you are investing in, you might be
comfortable taking a bigger risk with the goal of achieving a higher return.

Say you're working in technology and truly understand it, you can probably
outperform the market significantly by investing in 3 to 5 technology stocks.
Is it riskier? Yes. Is it worth it? Some people will say yes, others say no.
And that is absolutely fine.

~~~
tanderson92
> Investing through index funds and ETFs will correlate with a certain alpha

Thank you for showing others that you do not know what you are talking about.

------
islayfan
For context the losers argument is that Buffet picked a good team in a good
period and he would have a good chance in a second cycle.
[https://www.bloomberg.com/view/articles/2017-05-03/why-i-
los...](https://www.bloomberg.com/view/articles/2017-05-03/why-i-lost-my-bet-
with-warren-buffett).

~~~
TekMol
A weak attempt at damage control.

He keeps reiterating his parole that experts who actively select assets know
more then the average Joe.

Even though the average Joe just completely blew them out of the water over a
whole decade :)

~~~
perl4ever
I agree that said experts probably don't know enough to justify their cost.

But if the conclusion one draws is that the US large cap stock market is the
place to put your money for the next 100 years just because it was great the
last 100 years, I think that's the wrong lesson. Of all the markets in all the
countries in the world, and all the asset classes, the US stock market has
been an outlier for a long time, and it can't continue forever. Like Moore's
law, and declining interest rates, and population growth, every trend stops
somewhere since it would otherwise eat the world. Generally right at the point
almost nobody is left to bet against it.

There is no such thing as completely passive management - someone at least
selects components of an index, and you at least choose which index and that
is always going to be pivotal with respect to investment success. I don't
think there is logically any way around some degree of deliberate selection of
assets. All people can do is pay less for the illusion of expertise.

~~~
mikeash
Isn't that last sentence the whole point, though? I thought that index funds
didn't generally do better than actively managed funds in terms of raw
returns, they just didn't do much _worse_ , and the vastly lower fees mean
that you come out ahead overall. The point of an index fund isn't to attain
some sort of stock picking nirvana where nobody's really picking anything,
it's just to get a fee of 0.04% instead of 2%, or whatever.

------
Asooka
Am I reading that right? S&P500 nets you on average a 10% annual return of
investment? Does that mean you can "just" invest ten times your yearly living
expenses and practically live off idle income? How does that not completely
destroy the economy and why isn't everyone doing it?

~~~
pg314
> S&P500 nets you on average a 10% annual return of investment?

In the last 10 years, yes. Historically, it's been closer to 7% in real terms
(adjusting for inflation). There are no guarantees that this will be the case
for the future.

> Does that mean you can "just" invest ten times your yearly living expenses
> and practically live off idle income?

You'll need more than that because there are multi-year periods where the s&p
500 declines. The number that has been bandied around for a 'safe' withdrawal
rate is 4% [1], so you'll need closer to 25 times your yearly living expenses.

> How does that not completely destroy the economy and

Because not everybody is doing it. If they were you wouldn't be getting those
returns, obviously.

> why isn't everyone doing it?

Most Americans have less than $1000 in savings, let alone 10x their yearly
living expenses.

[1] [http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-
need...](http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-
retirement/)

------
lordnacho
Hedge fund guy here.

\- You have to consider risk. Perhaps use volatility as a proxy. Were the
funds more or less volatile than the S&P? There are funds that are more and
funds that are less. The bet ought to be adjusted for that, ie some form of
risk adjusted return.

\- It's a rigged bet. A fund of 5 funds of funds is going to be the market,
minus fees. Yes there are funds that aren't just long the market but quite a
lot will be. Many managers find it a sensible bet to add some beta, because
the market often goes up and you will often be judged vs the market, not
absolute returns. Throw them all together in a pot and all the spice is gone.
Now take out fees.

\- Plenty of individual funds did beat the S&P (I'll toot my own horn here),
but to beat the average someone's gotta be under average, typically other
hedge funds.

\- You have to wonder how the bet would have fared had we not experienced the
unprecedented reaction of central banks to the crisis. I don't know if Buffett
had considered that, he's a smart guy, but it didn't seem like that was what
the bet was about. If the market had been allowed to take a "more natural"
course perhaps the funds would have looked better.

\- You can find long periods in the past where the S&P was sideways. The
constant advice to index is simplistic. Think about your own situation before
you do that, there's at least a lot of interesting things to learn before you
give up.

\------Edit------

Seems to be a lot of response to this. Now I'm not saying it was particularly
smart to bet against the market. In fact if you read closely you can see why.
Which side of the bet would I have taken? Well, if I wasn't running a fund,
I'd have taken Warren's side, for the same reason. As it happens you have very
little credibility as a fund manager if you're not invested in your own fund,
so I ended up backing myself. (Which is not quite the same as the bet.)

For your average guy, I don't think there's a smart way for you to pick a fund
to beat the market. You have to spend time actually investigating each
strategy. An example of a fund who I think will provide a risk-adjusted market
beating return is a guy I met once. He knows a bunch of stuff in detail about
the valuation of exchange traded funds, and has infrastructure (technical and
legal) in place to exploit discrepancies. It's quite far away from what people
normally talk about when they talk about "investment". Most managers do not do
this; they will just give you a variant of "I'm good at guessing and I can
handle risk".

Regarding central bank intervention, of course it's a manager's job to think
about what might happen. I'm merely saying that most of them probably didn't
see it coming, and that that is the major component of the underperformance.
Consider that the HF marketing is basically "we'll think about the future for
you". Now if what ends up happening is basically that you should buy
everything and hold it, then why would you expect a guy who can predict turns
to do any better than the market? Keep in mind you're paying fees for him to
sell and buy as things go up and down. Note that several managers did in fact
close down, not because of catastrophic losses, but because they got fed up
with the game.

~~~
misnamed
> You have to consider risk.

The question is: OK, you account for risk, now what? You can manage risk by
tempering an all-stock portfolio with bonds, lowering volatility. Why pick
high-cost hedge funds over that option?

> Throw them all together in a pot and all the spice is gone.

Except if you look at the breakdown, any one of those sub-funds did poorly.
None beat the S&P.

> Plenty of individual funds did beat the S&P

But how is an investor to know in advance? Also: winning funds tend to rotate
around - can't use past performance as a reasonable guide to pick a fund going
forward.

> You have to wonder how the bet would have fared had we not experienced the
> unprecedented reaction of central banks to the crisis.

You can always argue this time was different, but the reality is we had
roughly 7% average returns on the S&P over the course of the bet, which is
pretty typical. It wasn't just some short period, either - for nine out of the
ten years the S&P won the bet against the group.

> You can find long periods in the past where the S&P was sideways.

Which is why a smart portfolio is three-fund, covering global stocks and
bonds. A portfolio of that makeup does not tend to travel sideways for long
periods like the US market can alone. Take for instance 2000 to 2010, in which
US stocks did go sideways - bonds and international stocks compensated for
that.

At the end of the day, instead of excuses/explanations (no offense intended)
I'd like to see you make a case for who should be using hedge funds and why.

~~~
Veratyr
> The question is: OK, you account for risk, now what? You can manage risk by
> tempering an all-stock portfolio with bonds, lowering volatility. Why pick
> high-cost hedge funds over that option?

I think his point is that hedge funds may have higher risk-adjusted returns
than the S&P 500, despite lower absolute returns. For (ridiculously
unrealistic) example, say you have an average 7%/yr return on the S&P 500 with
volatility of ~14% and a hedge fund with a 5%/yr return but volatility of ~1%.
At the end of the time period, a fixed $1M investment is clearly going to come
ahead on the S&P 500 but the hedge fund is clearly the better fund, as matched
for volatility (through leverage) with the S&P 500, the returns would be
70%/yr.

You'd pick the hedge fund because matched for volatility (through leverage or
bonds or what have you), the hedge fund performs better.

~~~
misnamed
It's theoretically possible but I'll believe it's actually possible when I see
it. I don't see volatility data in the linked article, but if they released it
somewhere we could perhaps model a stock/bond portfolio of comparable
volatility and see how they did. I would be willing to bet the stock/bond
approach would win on a risk-adjusted basis, but can't say without data.

Meanwhile, though, a generic vanilla Total Bond market index fund over the
past 10 years returned 4.3% annually. A $100,000 investment would have turned
into over $150,000 over the course of the bet, higher than the hedge fund
collection. So the hedge funds would have to have less volatility than a very
steady intermediate-duration bond fund, which, incidentally, had far lower
draw-downs in its worst years. So at the very least, in plain language, if
'big drops' are a measure of risk, then the hedge fund set was riskier than
bonds and still lost to bonds.

------
telltruth
Key here is long term. If you are investing for long term and choose hedge
fund then you are a sucker. Smart investors choose hedge fund only for short
term investments and only because they know the fund is trying to exploit some
information asymmetry. Such funds are usually ultra secretive and you would
get to invest in it only because you knew someone running it.

------
diedyesterday
Even though Efficient Market Hypothesis doesn't take into account some short-
term subtleties and inconsistencies of human behavior, the insights it
provides tend to dominate in the long term, which seems to be the case here
with Mr Buffet's winning bet.

~~~
tpallarino
So then how did Buffet make his money?

~~~
Marazan
Fundamental analysis, arbitrage plays and, starting out, investing other
people's money with hugely favorable commission structure for himself.

------
ghostbrainalpha
So obviously the Hedgefund didn't beat the market enough to have a better
return for the investors....

But is there anyway to compare the (Returns + Extracted Money Through Fees) vs
S&P500 to see the potential return of the Hedgefund before the fees were
extracted?

~~~
gmiller123456
Not likely. They were a "fund of funds", and hedge funds rarely actually
disclose their investments even to investors, let alone the general public.
You'd be lucky to even get a list from one fund, let alone all of them.

------
pcurve
I don't have problem people investing their personal money in hedge funds, but
as indicated by the article, large institutions also invest in hedge funds,
which in many cases are just a collection of smaller hedge fund, each charging
hefty fee.

------
ourmandave
So how is Mortimer paying him the bet? Is it a suitcase full of $1 bills?

~~~
icebraining
The money is going to Girls Incorporated of Omaha, the charity chosen by
Buffett.

------
hliyan
> The five he selected had invested their money in more than 100 hedge funds,

Wouldn't the average performance of that large a set anyway approach that of
the S&P?

------
atrex
Did anyone calculate how would be the perfomance if there was no fee for the
hedgefund?

------
guard0g
Best $1m in marketing that Ted Seides ever spent for 10 years of profile.

------
mycentstoo
So, for the non financially savy, how can I set up my portfolio to bet on
index funds?

~~~
frankc
Just buy shares of SPY. It tracks the S&P 500. Keep in mind, returns aren't
everything. They have to be considered along with risk. The S&P 500 also has
big downturns of 20% or more. A good measure of return to risk is the sharpe
ratio. The S&P's isn't all that good. This is why people invest in hedge
funds.

------
ringaroundthetx
Okay so any leveraged real estate fund would have outperformed the S&P500,
without the possibility of a sudden margin call

Any leveraged bond fund should have been able to as well, a carry trade from
2012 in European government bonds should have made many hundreds of percent

A futures fund should have been able to

A commodity options should have made monumental gains over the 85% that the
S&P500 gave in 10 years, honestly should have made that in a month

A fund that did what Warren Buffet got rich doing, by buying up bad companies
and improving, should still have gotten high returns

And finally, there were simply no cryptocurrency funds around!

The problem, I say smugly, is that these fund of funds were probably all macro
funds with too many assets under management, making them hard to manage in the
niche markets I proclaimed.

A fund with 1 billion AUM cannot manage that much real estate without eating
into the management fees. There is not enough liquidity in the options market,
and definitely not enough liquidity in cryptocurrencies.

But this unfortunately influences perception that "NOBODY" is able to make /
promise more than 5% a year over several years. This is false but I'm not
going to try to change your mind. Consolidating capital with someone managing
<500k to around 25 million should be able to consistently take advantage of
these less scalable opportunities for great profits. After all, it is how
Warren Buffett himself got 100s of thousands of percentage gains in his hedge
fund of $105,000.

~~~
compiler-guy
The problem for the every-person is finding the one that succeeds rather than
fails. Given that in the aggregate these investments so severely
underperformed, we can conclude that on an weighted average basis, you were
more likely to lose money than gain money.

No one disputes that some funds will over perform. The question is, which one?
If you can predict that reliably, you will be rich.

Most people can't.

~~~
ufmace
Not just predict which ones, but get them to take your money too. AFAIK, many
of the ones that are performing really well don't want to expand their AUM
that much and so don't advertise and won't take just anyone's money.

------
yuhong
The problem IMO is that stocks outperform bonds in the first place because of
the debt-based economy. I suspect it is part of why Glass-Steagell was
repealed in the first place.

~~~
misnamed
Stocks should outperform bonds because they are riskier than bonds. Why would
you expect or want it to be otherwise?

~~~
yuhong
But the more stocks outperform bonds, the more things like the repeal of
Glass-Steagell are encouraged.

------
drharby
Eye catching headline, but the set of hedgefunds is diverse with a large range
of performance. I imagine the upper tails do pretty well

~~~
icelancer
Can you guarantee me access to upper tail funds? I'm interested. I'd love to
get my money into Medallion.

~~~
drharby
That was kind of my point. Funds like medallion exist and succeed pretty
consistently, but they are the tail. Certainly others go above and below at
various points in time

------
codecamper
What is increasing S&P value other than the crowd willing to walk a little
further out on the gangplank?

I'd say it's a little too early to call that bet.

(people can vote this one down as much as they want. The reality is that is
the only thing making the value go up now.. just more people crowding into the
same trade. Watch out when the crowd changes its mind)

~~~
icebraining
The bet was started right at the peak before the 2008 fall. It still own.

One can of course win any bet by stopping it when it's convenient, but that
doesn't make it a very good bet, which is why a fixed period is used.

