Index Fund vs. Top Hedge Funds: Buffett Bet Halfway Update

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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 (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.

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  1. Tom Rasmussen says

    It’s sickening how hedge funds make people believe they can beat the market because they’re “smarter” than you. It’s even more troubling that people believe them. There’s some innate flaw in human psychology that makes us want to ascribe every good thing to skill rather than chance.

    I hope Buffett wins big. I hope it’s not even close. After all, I doubt Protege actually beat the market over the past six years — my guess is they just invested in something riskier than the S&P 500. Emerging markets have zoomed up 300% in the last five years, and mid-caps, European equities and tech stocks have beaten Protege’s number. Luckily for Buffett, in a downturn, these riskier categories will do a multiple worse than the S&P.

    Hedge fund guys are a crock. They pretend to be smart but they’re just smooth talkers with nice suits who can do Powerpoint animations and spout a few buzz words. Sure, a few of them will beat the market over time — if 100,000 people flip 100 coins, a few of them will get 70 heads. Then they claim they’re smarter than the rest of us and start up the Medallion Fund or Magellan Fund. But lo and behold, 20 years later the Magellan fund turned out not to be so good at flipping coins after all and now they need your money again.

  2. I heard about this! This is actually a tough one. The fees will put the hedge funds at a huge disadvantage, but the lack of diversification for the index will hurt it if the US market stagnates and foreign markets continue to outperform. I think a better bet would have been to put one of Vanguard’s globally-diversified target retirement funds against the hedge funds instead.

  3. This seems like a silly bet for Buffett to make. What does it accomplish if he wins, that hedge funds are bad investments? And even if he does win why wouldn’t someone invest in an index fund versus Berkshire Hathaway? And if he loses, then it will seem like some kind of validation of hedge funds which of course it wouldn’t be. This just seems like a publicity scheme to me.

  4. Agree 100% with Kyle. Why’d he chose S&P 500 index? Even if he were to stay with just domestic equities, the Total Stock Market Index would at least have been a more comprehensive choice which also has admiral shares at the low 0.07% ER.

    But, who am I to question Buffett?

  5. Tom, I think the part you’re missing is that “hedge fund guys” are working to make dollars for themselves.. and they do that very well.

    This bet is obviously a marketing ploy. It has made the rounds from Forbes to personal finance blogs. Congrats to Buffet and Protege for excellent results!

  6. I’ve followed your blog for a while. Since you are anonymous, and you share everything else (maybe you’ve already discussed this) can you tell us what your current annual salary is, both pre and post tax? If you prefer, your salary history and your wife’s as well?

    Obviously this isn’t something I would just ask anyone on the street, but I think it bears knowing on a site where you list all that you have saved. I want to know if it is even a reality for me to do the same.

    Thank you

  7. My favorite part of this is when they quote Buffet as saying he only has about a 60% chance of winning, those odds not being as favorable as he usually prefers.

  8. Justjoeguy says

    Buffet also said just recently that the recession will be long and deep. That was after the Federal government said the economy was growing just under 1 percent for the first quarter 2008. So maybe he doesn’t read the papers? Or maybe he doesn’t have a computer?

  9. This is an interesting bet. For me it doesn’t matter who wins and who loses. This is marketing genius however. For $1 million dollars, these hedge funds are getting their name out there.

    At the end of the day, Buffet does not make his money by making predictions. His predictions on how the stock market would be gaining less than the 10% average from the 1960’s to most currently have been pretty terrible. However, he’s been good at buying companeis at bargain prices.

    By itself, Berkshire Hathaway is a hedge fund. It buys and sells stocks, businesses, derivatives etc. The publicized thing is that Buffet makes $100,000/year. But how much do the rest of the executives make?

  10. Big deal “Buffet makes $100,000” a year, he makes a ton on stock gains. You appear to be an educated person so I am sure you knew that. Buffet does make predictions albiet much less risky ones than a hedge fund would be inclined to make. This is evidenced by his recent push of alternatives to petroleum. Correct bet? Probably. Bet? Yes.

  11. So, over the ten years of this example Buffett will probably be proven right, or not. Take another ten year period, and he would be proven wrong, or not. All it proves is that investing in any market is a gamble, and that some forms of gambling are riskier than others. I think we already knew this.

  12. I think the point of the experiment is to demonstrate how much fees eat into the potential returns. Studies have shown that there is actually negative correlation between total fund return and fee… and really, past performance do not indicate future performance, so paying high fee for past performance doesn’t make sense.

    Either way some charity is gonna get the money and both sides will get publicity. Everyone gets something to talk about. This is a win-win-win-win…

  13. I think the vitriol toward hedge fund managers is unwarranted… While yes, there are many unsuccessful strategies, and they do charge high fees, the fact remains that many of these people are smart, hardworking individuals who ARE able to find inefficiencies in the market. (Now if those inefficiencies can be exploited enough to cover their fees and then some is the question…)

    Don’t tell the Yale Endowment that hedge funds can’t add value. They continue to beat their peers and indexes year after year by finding talented managers.

  14. I don’t think all hedge funds are crooks and useless. There are definitely talented managers out there who will make smart decisions and beat the market and make their clients (and themselves) insanely rich. The problem is there are so many and unless you have tons of money and access to the big names, it’s really difficult to pick the right funds or funds of funds. I know of people who lost money big time investing in second/third tier hedge funds.

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