Why Warren Buffet won the bet

[MichaelB]

If there were previous versions of this, I've not seen them. This is a sort of rebuttal to Warren Buffet by Ted Seides, the hedge fund manager who made the famous 10 year wager. Here he lists 6 reasons why he lot the bet, even though it has a year to go.

Price matters, risk matters, the S&P index choice is active not passive, it's apples vs oranges, it could have ended differently, and "Long-term returns only matter if we invest for the long term".

The fact that he doesn't address the core issues, that hedge funds as a category have very high fees but can't outperform a broad market index, is telling. Why pension funds and other institutional investors continue to invest in these is a mystery.

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

 

[Koolau]

After reading the article, I'm tempted to say "Warren Buffet won the bet because he's Warren Buffet and Seides is not." All of Seides explanations and hand waving do not truly address the headwinds of high fees in a meaningful (to me) way.

I don't consider myself smart enough (okay, let's say educated enough) to address most of Seides arguments. One I would take on is the Chicago Bulls vs the Chicago Bears. I see what Seides is trying to say, but I look at the financial "game" making the comparison of a football team vs a basketball team rather laughable. The financial "game" has the same scoring system - who made their money grow more?

I'm already committed to index investing so this is just my take on something I'm not used to thinking much about so YMMV

 

[Cobra9777]

...The fact that he doesn't address the core issues, that hedge funds as a category have very high fees but can't outperform a broad market index, is telling...

No. 4 apples and oranges...

Hedge funds are not limited to investments in large U.S. stocks, and professional investors in hedge funds don’t use the S&P 500 as their benchmark. Warren’s description of active managers necessarily underperforming as a group by the amount of fees charged is precisely true when the active managers’ investment universe is identical to the passive alternative. In this bet, it wasn’t.

It was global diversification that hurt hedge fund returns more than fees. In fact, a low-cost index of large global companies, the MSCI All Country World Index, almost exactly matched hedge-fund returns during the same nine-year period of our bet...

[emphasis added] I didn't get the impression he shied away from the issue of fees. The word 'fees' appeared 6 times in a fairly short article.

But I agree, it sounded a bit like sour grapes from a guy defending his livelihood. Comparison of a decade-long investment horizon to a single Texas hold-em hand is a bit of a stretch.

 

[ERD50]

There was a similar article by him a year or two ago, and it was posted here. I think I made the same comment, this guy would be better to keep his mouth shut, his 'excuses' just make him look even weaker.

S&P isn't really a good benchmark (then why did you accept it in the bet?), and on and on. He is wrong about just about everything, yet his business depends on him being right. Now, being wrong about almost everything, this quote from him concerns me:

Although a market crash is highly unlikely in the near future, ...

Watch out - a likely market crash ahead!

But my index AA will do OK. I'd love to see Warren double down on the bet with him. One bet as an extension ( a 20 year bet), and one as a reset.

-ERD50

 

[ERD50]

If the guy takes the bet again, he might do well to invest his hedge funds in leveraged S&P funds!

-ERD50

 

[OldShooter]

Hilarious article. Seides makes maybe the most important point in investing and he doesn't even realize it.

Basically, he is saying this: "Hedge funds didn't have good luck for the past 9 years. Boo-hoo."

Study after study has shown that an infinitesimal number of active managers have enough good luck over nine years to overcome their costs and deliver alpha. Worse, there is no way to identify those lucky managers except in the rear view mirror.

QED, Buffet's bet was probably the safest one he has ever made. Seides, OTOH, was betting with his heart and not his brain. Or maybe he is just that stupid.

 

[6miths]

But of course other hedge fund managers and advisors in general would just say that Seides is just one of those advisors who doesn't know what they are doing. They personally on the other hand are gold. Pure gold Jerry.

 

[Texas Proud]

Just a bunch of mumbo jumbo IMO...


He KNEW what the bet was at the time it was made... all he is talking about was a possibility... now he wants to cry a river because he lost and wants to try an explain it away and that hedge funds are not 'bad', but was just a blip in the stats...

I get this because he said that any one time the lower possible outcome can win... which means he thinks that the hedge fund should have won but did not...

 

[Chuckanut]

The reasons for his losing the bet reminds me of certain sports teams when they lose a big game:

1. If the ball had bounced left instead of righ on the last punt we would have won.

2. If the refs had caught that foul we would have won.

3. If we were playing on the home court we would have won.

4. If that freak rain storm had not wet down the field in the last quarter we would have won.

5. If Joe Shlabotnik had been healthy we would have won.

Blah, blah, blah......

Maybe some hedge fund managers feel a kinship with Mr. Shlabotnik.

Shlabotnik was demoted to the minor leagues after hitting .004 over an entire season; his one hit was a bloop single with his team comfortably ahead. One time he promised to hit a home run in the bottom of the ninth; he popped out instead, but circled the bases anyway. His greatest achievements included making spectacular plays on routine fly balls and throwing out a runner who had fallen down between first and second.

Note: Before some people waste their precious time looking up who this guy was, let me say that Joe Shlabotnik was Charlie Brown's favorite baseball player.

 

[Hermit]

I do agree with him that diversification is important. I have 17% of my funds in international indexes. They have been dogs for quite a while and I have under performed a lot of folks on this board. For that reason I have not kept up with Buffet's bet either. I think I will continue with my allocation. If I don't, I will be chasing performance.

 

[easysurfer]

He already lost when he considered betting against The Warren .

 

[Hermit]

He already lost when he considered betting against The Warren .

Well, I guess Warren really does have a crystal ball!

My take: I think Warren was just trying to prove that high fees were a drag on performance. I doubt if he expected the S&P to be as high as it is now. Maybe a bit of luck involved?

 

[OldShooter]

I do agree with him that diversification is important. ...

Yes, as I have said in other posts here it is a mystery to me why Buffett continues to recommend the S&P 500 instead of a total International or at least a total US market index fund. The large caps in the S&P comprise only a about 1/3 of the investable stocks worldwide and it underweights small caps and probably underweights value stocks as well. Personally I see no reason to use it.

... I have 17% of my funds in international indexes. They have been dogs for quite a while ...

Well, ... you may well be saying "good dog" when the dollar weakens. In local currency terms the internationals have not done all that badly. 4Q16, though, the dollar rose as much as 8% vs local currencies, wiping out most gains in local currencies. That doesn't bother me a bit; I look at it as simply some saved-up money that I'll get when the dollar weakens again.

Well, I guess Warren really does have a crystal ball! ...

I don't think it took any crystal ball gazing at all. Ref my post #6. Statistically it was a slam dunk. I would have taken the bet, too, although I don't have a million bucks that I can afford to give away.

 

[Texas Proud]

Well, I guess Warren really does have a crystal ball!

My take: I think Warren was just trying to prove that high fees were a drag on performance. I doubt if he expected the S&P to be as high as it is now. Maybe a bit of luck involved?

I agree that he probably did not expect the return, but the S&P 500 is a major index that anybody can agree to on a bet... making it a basket of different funds or including international would have made it more complicated and would not have changed the point he was trying to make...

 

[photoguy]

The reason the hedge fund manager lost is because he is statistically illiterate. From what I read, he bet on an average of hundred of funds (each of which might hold a huge number of stocks). No surprise then that he gets basically average performance but with the anchor of huge expense ratios dragging it down to terrible results.

Here's a description of the hedge fund approach from http://fortune.com/2016/05/11/warren-buffett-hedge-fund-bet/

Start with the fact that it’s harder to pick five stellar funds than one. And each fund of funds is invested in many underlying hedge funds. Most likely, the Protégé group is invested in well over 100 individual hedge funds. The chance of identifying 100 truly stellar funds is close to zero.
Each of the individual hedge funds is itself diversified, owning 30 to 50 or even more securities. Allowing for overlap, the Protégé Group probably owns more than 1,000 different securities in all. That would make it pretty close to an index fund--only with super-high fees.

 

[Sunset]

.....
Well, ... you may well be saying "good dog" when the dollar weakens. In local currency terms the internationals have not done all that badly. 4Q16, though, the dollar rose as much as 8% vs local currencies, wiping out most gains in local currencies. That doesn't bother me a bit; I look at it as simply some saved-up money that I'll get when the dollar weakens again.

......

I'm hoping and playing the same bet, not really by choice
It's a pretty big slice about $300K , so I'm hoping the strong US currency does not hold strong, but it is possible it stays strong for decades

 

[ERD50]

The reason the hedge fund manager lost is because he is statistically illiterate. From what I read, he bet on an average of hundred of funds (each of which might hold a huge number of stocks). No surprise then that he gets basically average performance but with the anchor of huge expense ratios dragging it down to terrible results.

Here's a description of the hedge fund approach from Why Warren Buffett Is Winning His $1 Million Bet Against Hedge Funds | Fortune.com

Yea, but (from an earlier thread):

http://www.early-retirement.org/forums/f44/name-an-arcane-industry-85582.html#post1843454

Originally Posted by Boho View Post
His bet is against a fund of hedge funds. That's how most of these studies were conducted - an index against the average whoever/whatever. The best few of the bunch will beat the index. In the case of funds, for example, about 8% beat the index. I'd like to see him challenge a single fund with a good track record.

An update just came out, and this time they break out the best and worst funds within those funds (and it ain't pretty, if you are a hedge fund manager!):

And the envelope, please? After nine years, the index fund has registered a compounded annual increase of 7.1%. And the average for the five funds (whose names have never been made public) is 2.2%. In total gains, the index fund is up 85.4%. The average gain of the five funds is 22%. (The best performer of the five is up 62.8%. The worst performer—over nine years, remember—has been mind-bendingly bad: up only 2.9%.)

Warren Buffett Says He's Winning Hedge Fund Bet | Fortune.com

Yeah, he should have just picked one fund, that's the ticket!

-ERD50

So even the best hedge fund of five did much worse than the S&P 500. Buffet could have also put together 5 index fund portfolios, with different (but reasonable) weightings of small cap, international, etc - and likely all 5 would have outperformed the best of those 5 hedge funds.

-ERD50

 

[Texas Proud]

The reason the hedge fund manager lost is because he is statistically illiterate. From what I read, he bet on an average of hundred of funds (each of which might hold a huge number of stocks). No surprise then that he gets basically average performance but with the anchor of huge expense ratios dragging it down to terrible results.

Here's a description of the hedge fund approach from Why Warren Buffett Is Winning His $1 Million Bet Against Hedge Funds | Fortune.com

He did have a choice... but choose badly...

But the performance bar for Protégé was even higher, because it chose funds of funds



​

 

[jollystomper]

Hindsight is always 20/20.

What was that saying about "ifs" and "buts" being candy and nuts?

 

[OldShooter]

... It's a pretty big slice about $300K , so I'm hoping the strong US currency does not hold strong, but it is possible it stays strong for decades

Yeah. I've got even more, but I think the Force is with us. Consider:

The dollar is strong because it is the world's reserve currency. Many people around the world hate that, because it allows the US to play politics (i.e., sanctions) with access to the US banking system. Further, the many poor countries that have been forced to borrow in dollars are badly hurt by the dollar's strength. Finally the US debt exceeds GDP, hardly a trait of a reliable currency.

But we are currently the tallest midget. Nobody trusted the Russians even before Crimea. Now they are out of the running. Nobody really trusts the Chinese, either. The Euro may be dying of self-inflicted wounds. Other currencies (real, rupee) are not real contenders and the highest quality currency (Swiss francs) does not have a big enough economy behind it to be a reserve currency.

Eventually, though, the dollar will weaken -- maybe by a lot. In 5 years the yuan and the Euro may be contenders, at least for oil sales using a basket of currencies. It is in US industries' and workers' interest for the dollar to weaken, making them more competitive in world markets. A weaker dollar is also advantageous to us if we ever actually start paying down the debt. The flip side, of course, is domestic inflation (beyond the fed's control) as imports rise in dollar cost.

So, IMO there are many potential long-range forces to push the dollar down and few forces other than our reserve currency status to push it up. So I'm not worrying. YMMV, of course.

 

[Skyward1]

Beware, when a man who is considered by many to be the best ever in a certain field and who has been doing it longer than you have been on this planet posits a little wager to compare results, hubris may not your friend.

 

[clifp]

After reading the article, I'm tempted to say "Warren Buffet won the bet because he's Warren Buffet and Seides is not." All of Seides explanations and hand waving do not truly address the headwinds of high fees in a meaningful (to me) way.

I don't consider myself smart enough (okay, let's say educated enough) to address most of Seides arguments. One I would take on is the Chicago Bulls vs the Chicago Bears. I see what Seides is trying to say, but I look at the financial "game" making the comparison of a football team vs a basketball team rather laughable. The financial "game" has the same scoring system - who made their money grow more?

I'm already committed to index investing so this is just my take on something I'm not used to thinking much about so YMMV

I think if Seides was smart, he would have stopped with. "I made a bet with Warren Buffett, like most people over the last 60 years who took the opposite side of a trade with Warren, he made the better bet."

I know it is obvious to all of us but really is the fees and not which index/investment class he used.

I've talked about the Morningstar Dividend Newsletter many times. Over the last 12 years the newsletter has beat the S&P 500 by 1.3%/year. My portfolio has followed the newsletter very closely over the years. Over 15 years (ending in Dec 31, 2016), my portfolio has beat the S&P 500 by 1.3% also. My AA has varied but my Schwab portfolio in recent years has been ~85%/10%/5%

Interestingly enough, it is isn't the Dividend stocks that have particularly outperforming (although I think their lower volatility has resulted in some Alpha). But what has really made the difference is his investments, in Master Limited Partnerships which for tax reasons aren't included in index funds.
A couple of these like Magellan Midstream Partners (MMP) had 10 year CAGRs of 15%. So just as foreign stocks were supposedly the reason hedge funds lost, Master Limit Partnerships are the reason Morningstar Dividend Newsletter won.

Still, the 2% fees alone would have killed any performance advantage.

Just FYI, the newsletter editor Josh Peters, got recruited to manage a mutual fund, the new guy doesn't impress me, so I'll be canceling my subscription and moving more of my portfolio to index funds and Wellesley over the coming years.

 

[urn2bfree]

Actually Seides shows how truly dumb he must be when he claims that the S & P is the wrong benchmark. (I can't seem to copy and paste from the article but basically as quoted in post # 3 above) He says that his funds returns were the SAME as a low cost index of International Funds. So he concedes again that there is NO ADVANTAGE TO HEDGE FUNDS AND THEIR FEES since you can duplicate their returns with a low cost index.

On this topic I have some personal experience and concern with regard to my parents' (now just my mother's) investments. My father ran things until he died and so I had no knowledge of exactly what he was doing. My mother has no interest in any of it. He has long had a big position in a Hedge Fund. (Not naming it because I don't want to advertise or give the impression I am shilling for it).
Being a devoted indexer, I am skeptical of Hedge Funds and would be inclined to tell mom to cash out and come over to the low cost index way of life. But the results for this fund over 40 years cannot be ignored. This fund may be the Warren Buffet of Hedge Funds. It has only had 2 down years in the last 40. Annualized returns of around 14% as far as I can tell. I can't bring myself to suggest changing that position.

 

[Koolau]

<SNIP>

It has only had 2 down years in the last 40. Annualized returns of around 14% as far as I can tell. I can't bring myself to suggest changing that position.

Would your mom entertain the idea of diversifying some of her winnings in this fund? Maybe she would think putting 1/3 or 1/2 into "something else" (say, an index fund) would be a good idea if her son suggested it. Just a thought.

 

[OldShooter]

Would your mom entertain the idea of diversifying some of her winnings in this fund? ...

+1

The "prudent man" rule for fiduciaries limits a single holding to 15% of a portfolio. Some limit to 10%.

FWIW, 14% CAGR is better than Bernie Madoff paid. Falls into the too good to be true category for me. YMMV, however.