A recent Fortune magazine article provided an update on Warren Buffett’s $1 million bet with Protégé Partners, a fund of hedge funds money manager that over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on the basis net of fees, costs and expenses. Buffett is trailing at the end of two years as his pick, the Vanguard S&P 500 Index Fund (Admiral Shares), is down 20.2% compared to -11.8% for Protégé’s picks.

Buffett and Protégé made their bet on Long Bets (as an aside, the Long Bets website has all sorts of fascinating bets ranging from computers continuing to fail the Turing test to where extra-terrestrial life forms will be discovered), which offers an arena for making long-term bets as a way of fostering long-term thinking. The details of the bet are available here. Both bettors contributed $320,000, which was used to purchase a strip bond that will be worth $1 million at the conclusion of the bet. The winner’s charity will receive the entire proceeds of the bet.

Buffett may be trailing but he likes the low-cost index fund’s chances:

A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.

For their part, Protégé Partners are putting faith in their hedge fund picking capabilities even though they have a very high fee hurdle to overcome. For starters Protégé charges investors a 1% annual management fee and 5% of any gains made by its hedge fund picks. The hedge funds themselves charge another 1.5% annual fee and 20% of any profits. The Vanguard S&P 500 Index fund, on the other hand, charges just 0.07%.

This article has 7 comments

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  2. A very interesting bet, since Buffet well knows that the S&P500 can be beat on a long timescale since he himself has done it. However, his comment on the fees is highly relevant.

    There are some interesting bets there on that long bets site, including some where the “winner” will not be able to see their victory (e.g., betting against lengthened lifespans, betting for the destruction of the earth). I suppose you don’t mind losing those if the money goes to charity…

    • Canadian Capitalist

      @Potato: Buffett puts his odds at 60%, which sounds like a rather slim advantage, despite Protege’s rather large fee hurdle. I’d have guessed that Buffett’s odds are much better than 60%, since all it takes is one hedge fund blowup to put Protege in a large hole. However, Protege must be pleased with all the publicity, whether the bet works out for them or not.

  3. Geez, there are some really thought-inducing “long” bets on that website! Anyways, it’s hard not to agree with ol’ Buffet due to his timelined portfolio investments. And yes, it certainly would only take one major hedgefund to blowup to give him his win.

  4. It’s a great bet, and I think Buffett will be vindicated. It’s easier to outperform a declining market, since cash has a non-negative return. If that fund is 20% cash, its loss is down markets will be (roughly) 20% lower than if they were fully invested. In a rising market, that cash component will be a drag.

    It is indeed all about the fees. Even if the fund does add value, it won’t likely add enough to overcome the hefty fees. Jack Bogle must be happy this bet occurred.

  5. There was an IEEE Spectrum article 2 years ago on the topic of using markets to make predictions. The article discussed the concept of allowing employees to bet on software release dates (and other various things), and proved to be pretty accurate.

    http://spectrum.ieee.org/computing/software/bet-on-it

    I suspect that “Long Bets”, where real money is on the table, might be surprisingly accurate if there’s a sufficiently large sample size.

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