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Warren Buffett’s “Bet” – Vanguard S&P Fund vs. Active Managers

  • Warren Buffett publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds that would over an extended period match the performance of an unmanaged S&P 500 index fund charging only token fees (December 19, 2007)
  • Buffett suggested a ten-year bet and named a low-cost Vanguard S&P fund as his contender
  • Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their stock-selecting prowess, only one man – Ted Seides – stepped up to the challenge
    • Ted was a co-manager of Protégé Partners, an asset manager that had raised money from limited partners to form a fund-of-funds
  • Ted picked five fund-of-funds whose results were to be averaged and compared against Vanguard S&P index fund. The five he selected had invested their money in more than 100 hedge funds, which meant that the overall performance of the funds-of-funds would not be distorted by the good or poor results of a single manager

 

  • Warren Buffett made the bet for two reasons: 1) to leverage his outlay of $318,250 into a disproportionately larger sum that would be distributed in early 2018 to Girls Inc. of Omaha and 2) to publicize his conviction that his pick would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those “helpers” may be
  • Every actor on Protégé’s side was highly incentivized: both the fund-of-funds managers and the hedge fund managers they selected significantly shared in gains, even those achieved simply because the market generally moves upwards
  • Those performance incentives, it should be emphasized, were frosting on a huge and tasty cake: even if the funds lost money for their investors during the decade, their managers could grow very rich. That would occur because fixed fees averaging a staggering 2.5% of assets or so were paid every year by the fund-of-funds’ investors, with part of these fees going to the managers at the five funds-of-funds and the balance going to the 200-plus managers of the underlying hedge funds

Final Scorecard for the bet:

warren buffett bet scorecard

  • The five fund-of-funds got off to a fast start, each beating the index fund in 2008. Then the roof fell in. In every one of the nine years that followed, the funds-of-funds as a whole trailed the index fund
  • If a poll of investment “experts” had been asked late in 2017 for a forecast of long-term common-stock returns, their guesses would have likely averaged close to the 8.5% actually delivered by the S&P 500
    • Making money in that environment should have been easy
    • Wall Street “helpers” earned staggering sums
    • While this group prospered, however, many of their investors experienced a lost decade
  • Girls Inc. of Omaha found itself receiving $2,222,279
  • Performance comes, performance goes. Fees never falter

Bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.

Warren Buffett’s 2016 Annual Letter

Warren Buffett’s 2017 Annual Letter

Image Source: Bloomberg

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