Introduction
On 1st January 2008, legendary investor Warren Buffett entered into a $1m bet with Protege Partners LLC. Buffett wagered that the S&P 500 index would outperform the average return of five hedge funds selected by Protege over the subsequent decade. Buffett went on to win the bet, and around $2.2m was donated to charity.
This bet became very popular with the press and investor community, with headlines such as:
"An index tracker beat the best hedge funds in the world"
being commonplace. Is the truth somewhat more complicated?
The chosen few - the best of the best?
Protege chose the five funds (the names were never divulged), which generated an average return of around 22% over the decade.
However, while some incredibly bright people undoubtedly worked at these hedge funds, one could question whether they were the best hedge funds operating at the time.
We believe that stock markets are incredibly difficult to beat, but some firms have outperformed the market over sustained periods. One of these is Renaissance Technologies. Their Medallion fund generated a return of 39% after fees over 30 years from 1988 to 2018.
During the period of the bet, the fund generated the following returns.
There are, of course, two issues here:
I am publishing Medallion's results with the benefit of hindsight.
The Medallion fund was unavailable for selection because it was (and still is) closed to external investors.
However, I would still argue that the hedge funds selected were not among the best operating at the time.
A favourable starting point for the S&P 500?
The S&P 500 had a tough time in 2008 during the Global Financial Crisis but recovered to return more than 100% over the decade.
If the bet had instead started at the turn of the century, things might have worked out very differently, with the S&P 500 enduring a lost decade from 2000-2010.
In contrast, according to the Barclays hedge fund index, the average hedge fund in their sample set returned around 8% annually from 2000 to 2010.
For the period of the Buffett-Protege bet (2008-2017), the return was around 4.5%.
Comparing apples to oranges?
It's worth questioning whether the S&P 500 was a valid benchmark for the five hedge funds selected by Protege.
The S&P 500 was far more volatile, returning -37% in 2008 vs the hedge fund average of -23.9%.
The hedge funds were likely to be holding equities (shares) across the globe, and therefore, a benchmark that covered more than just the largest 500 U.S. companies might have been more appropriate. The MSCI ACWI, a common global equity benchmark (along with the FTSE Global All Cap), returned around half that of the S&P 500 during the decade of the bet.
Taking the argument a step further, it's unlikely that the five hedge funds held only equities. Each hedge fund may have implemented several strategies, and the overall portfolio across each firm was likely to have consisted of several asset classes other than just equities, such as bonds, commodities, derivatives, currencies and real estate. Bonds, for example, had a very different return profile over the decade when compared to the S&P 500.
Ted Seides, a co-founder of Protege, made these points and more in a 2015 article.
A second time? Unfortunately not
Alas, there will not be a subsequent bet, with Buffett (understandably) citing age as the reason.
Conclusion
As with many things investing-related, once you dig a little beyond the sensationalist headlines, the argument becomes more nuanced. While we believe that investing is commoditised, and we adopt a low-cost, globally diversified approach with our clients, meaning the Protege approach is not one we would consider, the fact that the S&P 500 beat the selected hedge funds over the decade in question doesn't tell us much about whether the hedge fund approach is inferior. A different time period, a more appropriate benchmark, or access to closed hedge funds may have given a different outcome.
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About us
The team at Pyrford Financial Planning are highly qualified Independent Financial Advisers based in Weybridge, Surrey. We specialise in retirement planning and provide financial advice on pensions, investments, and inheritance tax.
Our office telephone number is 01932 645150.
Our office address is No 5, The Heights, Weybridge KT13 0NY.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Although best efforts are made to ensure all information is accurate, you should not rely on this blog for your personal situation or planning.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.