Halfway Update – 5 Years Later! Carol Loomis has posted the 5-year update in Fortune of the $1,000,000 index fund vs. hedge fund bet. Halfway through the 10-year bet (1/1/08 to 12/31/17), the Vanguard S&P 500 index fund backed by Buffett is up by 8.69%. The group of hedge funds hand-picked by Protégé Partners are up by 0.13%. Note that the index fund had been lagging just about ever year since this one, but that’s why we are looking at a longer period. Consider this halftime.
It will be very interesting to see how this turns out. Hedge funds charge fees of roughly 2% of assets annually + 20% of any gains. You may notice that five years of 2% fees would be 10% (ignoring the compounding effect for simplicity), and the hedge funds are lagging by about 9%. Costs matter!
You can read the terms of the bet and each side’s arguments at LongBets.org (also see original Fortune article below for backstory). This carefully-tracked bet was part of the inspiration for my transparent Beat the Market experiment. Too often, people are not honestly and accurately tracking the total performance of their portfolios. These ongoing updates help illustrate how hard it is to consistently beat a low-cost, diversified portfolio over the long run, and how it’s incorrect to declare yourself a winner even after several good years. Who knows, the hedge funds may still win.
Original blog post from 2008:
In the Fortune article “Buffett’s Big Bet”, we see how it came to be that Buffett bet a million dollars that a simple S&P 500 index fund would beat a group of 5 top hedge funds over 10 years. The bet will run from 1/1/2008 to 12/31/2017.
In one corner, you have the Vanguard’s 500 Index fund, ticker VFIAX (admiral shares), which tracks the S&P 500 Index with a lean 0.07% annual expense ratio. (The regular investor shares are VFINX.) It passively invests in small pieces of huge publicly-traded US companies.
In the other corner, you have a group of five hedge funds hand-picked by a big name Wall Street money management firm called Protege (funds of funds, actually). They have worked with folks like David Swensen, and George Soros. Hedge funds are usually only available to individuals with more than $1 million net worth or $200,000 annual income, and they can invest in just about anything. Tiny companies, entire companies, foreign companies, pork belly futures, whatever. However, in exchange you pay big fees: 1% annually for the fund of funds layer, 1.5% annually for the hedge funds themselves, and then 20% of any gains each year on top of that.
Past performance stats: From its inception in July 2002 through the end of 2007, the Protégé fund gained 95% (after all fees), soundly beating the Vanguard S&P 500 index fund’s 64%.
Warren Buffett bet on the index fund, believing that those fees are simply too high to overcome, even with their perfect alignment of interest, some of the smartest minds in the world, and the ability to invest in just about anything. But more important of course are either the shame or bragging rights to those hedge fund managers!
Buffett himself assesses his chances of winning at only 60%, which he grants is less of an edge than he usually likes to have. Protégé figures its own probabilities of winning at a heady 85%. Some people will say, of course, that just by making this bet, Protégé has acquired some priceless publicity.
The last part is probably true. No matter what, Protege will make a ton of money in fees at the end of 10 years. If they win the bet, they’ll be on magazine covers and end up even more insanely rich. If they lose, they simply change their hedge fund name and try again.
By Jonathan Ping | Investing | 1/28/13, 9:48pm