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Buffett wins $1M decade-old bet that the S&P500 would outperform hedgefunds

786 points by yurisagalov 9y ago

mcintyre1994 9y ago
If anyone finds this surprising I'd highly recommend reading 'Smarter Investing' by Tim Hale, which does a great job of advocating for index-based positions. With the exception of C, those fund-of-funds have done incredibly badly. One of the interesting things Tim discusses is that this poor performance compared to market tends to make investors second-guess their investments (often for good reason looking at those returns), and buy into the fund that did well last year instead. So you're also getting into a sell-low-buy-high routine.
ModernMech 9y ago
Reminds me a little of traffic. Yesterday I was cruising down the highway in the leftmost lane, going about 80 with a line of other cars. The other two lanes were actually more clear, but cars were going much slower. I notice this one car, weaving in and out of traffic in these two lanes, trying desperately to get ahead, constantly cutting people off. They did this for 40 miles, weaving in and out, sometimes getting ahead of me by quite a bit, sometimes falling behind. If they had just stayed in the left lane and cruised, they would have arrived at their destination at exactly the same time. My point is, it seems to be human nature to be bad at estimating long term averages, whether it be stock picks or just driving down the road. Checkout lanes are another example that comes to mind.
- kinkrtyavimoodh 9y ago
  I think the weaving in and out behavior can be explained in some part by the boredom of just cruising in a single lane for miles and miles. That being said, downvoted because the traffic analogy was very tangential to the point at hand and would only serve to derail conversation.
- differentView 9y ago
  Unless you only noticed that one car that was terrible at getting ahead. Better drivers might have passed you only once and you didn't notice them because you never saw them again.
  - mstanown 9y ago
    As it happens when one doesn't acknowledge Survivorship Bias.
  - foobarian 9y ago
    I wish Waze had an "A/B test mode" where you can bookmark the current cohort of drivers around you, and then N minutes later see where they ended up. Whenever traffic apps claim my main route home is backed up and I end up taking some weird backroads, I wonder if I would have been better off sticking with the main route.
- ramblerman 9y ago
  This is a poor analogy, and will only serve to induce responses to the analogy rather than the topic at hand.
- mojoe 9y ago
  The analogy works even deeper -- I've seen articles talking about how large amounts of lane changing actually slows traffic overall.
- perl4ever 9y ago
  Some people think you should not be in the left lane unless you are passing at that moment. In some places, there are even signs saying "keep right except to pass". Perhaps this person was driving aggressively because they were enraged at the line of traffic on the left. Which is to say, they may not have been doing it for a quantitative benefit as you assume. This might strengthen rather than weaken the analogy to the stock market though...since it could be that people invest in hedge funds not to increase their average return but to reduce the regret of not owning "winners" and having something to talk about.
  - matthewmcg 9y ago
    It's not just some people. It is actually the law in most states (albeit a seldom-enforced one). Don't cruise in the left lane.
    - quuquuquu 9y ago
      Most people cruise at a speed that is faster than everyone else in the other (non-left) lanes. But, please don't be the car that is cruising at 60mph in the left lane. It is a leading cause of accidents.
      - e12e 9y ago
        Ie speeding?
        quuquuquu 9y ago
        Some states are 70mph, and most cops won't pull people over unless they're doing 10-15mph over. Unless you are just really unlucky XD
        soundwave106 9y ago
        Not sure why the downvotes. (Some states are 80mph actually!) Speeding enforcement in the United States is fairly loose, with usually roughly a 10mph buffer. (The exception being various "speed traps", atypically mostly rural towns that rely on ticket revenue for an outsized portion of their town budget.) I think this adds to the problem with left lane issues; even if the "true" speed limit is 80mph, if the "posted" speed limit is 70mph, some people will do no more than 70mph no matter where they are.
- alkonaut 9y ago
  This was tested in an experiment I can't find now. One group of drivers was asked to stick to one lane, the other group was told to switch lanes when possible to get ahead. The outcome: as expected switching lanes gained next to nothing. But importantly the reported experience was significantly worse for those that stayed in one lane. So switching lanes doesn't reduce commute time but the perceived commute time - and that is not insignificant! This however isn't a poor performance because of switching a lot - these funds make money but the managers keep too much of it. The bet was on whether someone who invested in these funds would do better than the S&P - not whether the stocks in those funds did.
  - goialoq 9y ago
    That's because changing lanes is excited and camping is boring. This can be easily fixed by playing a game on your phone while camping.
  - KC8ZKF 9y ago
    This was tested by the Mythbusters television show. https://www.youtube.com/watch?v=ZefgUVg3qx0 https://www.youtube.com/watch?v=ZefgUVg3qx0
- rhizome 9y ago
  As far as driving goes, you never know why someone else is in a hurry. Sometimes they're trying to get to an emergency. Hope you were comfortable with your band of other left-lane cruisers, though.
islayfan 9y ago
For context the losers argument is that Buffet picked a good team in a good period and he would have a good chance in a second cycle. https://www.bloomberg.com/view/articles/2017-05-03/why-i-lost-my-bet-with-warren-buffett https://www.bloomberg.com/view/articles/2017-05-03/why-i-los....
- TekMol 9y ago
  A weak attempt at damage control. He keeps reiterating his parole that experts who actively select assets know more then the average Joe. Even though the average Joe just completely blew them out of the water over a whole decade :)
  - perl4ever 9y ago
    I agree that said experts probably don't know enough to justify their cost. But if the conclusion one draws is that the US large cap stock market is the place to put your money for the next 100 years just because it was great the last 100 years, I think that's the wrong lesson. Of all the markets in all the countries in the world, and all the asset classes, the US stock market has been an outlier for a long time, and it can't continue forever. Like Moore's law, and declining interest rates, and population growth, every trend stops somewhere since it would otherwise eat the world. Generally right at the point almost nobody is left to bet against it. There is no such thing as completely passive management - someone at least selects components of an index, and you at least choose which index and that is always going to be pivotal with respect to investment success. I don't think there is logically any way around some degree of deliberate selection of assets. All people can do is pay less for the illusion of expertise.
    - mikeash 9y ago
      Isn't that last sentence the whole point, though? I thought that index funds didn't generally do better than actively managed funds in terms of raw returns, they just didn't do much worse, and the vastly lower fees mean that you come out ahead overall. The point of an index fund isn't to attain some sort of stock picking nirvana where nobody's really picking anything, it's just to get a fee of 0.04% instead of 2%, or whatever.
mojoe 9y ago
I feel like there's some cognitive dissonance surrounding hedge funds in popular culture -- on the one hand you have people saying that any outsized short-term gains seen by hedge funds are the result of some selection/survivorship bias, and on the other hand you have people saying that any outsized returns are the result of illegal privileged information (see the TV show 'Billions'). I realize that there are enough hedge funds out there that both things can be happening. It's too bad that there's so little visibility into the industry, it would be fascinating to see some kind of hedge fund taxonomy.
- jerf 9y ago
  There's a whole lot of "X is bad, therefore any argument that supports the claim that X is bad is true and valid" when it comes to these matters. It's technically "affirming the consequent", but I think that fallacy gets another very tempting facet to it when it's enters the moral or ideological dimensions.
- alexasmyths 9y ago
  It doesn't have to be illegal. Hedge Funds have access to CEO's, they'll go in and interview them. Ostensibly, the CEO cannot say anything that is not 'public information' - but if you think about it, then why would the Fund even talk to the CEO if 'all info is public'? Because a lot of nuance can be gained from in person interviews. Little tidbits of information gleaned can make a difference. I'm not hugely knowledgeable of that industry, so I can't speak of the 'for sure' bad things happening, but I know at least one manager who does this. Funny: he totally does not believe that they really gain an edge over the public. Then I ask him why he bothers with the interviews and he doesn't have a very good answer. It's almost funny. I suspect his fund partners have a better clue. So that's one thing. Another - is that simply by having fewer regulator requirements, hedge's can do all sorts of things that bigger funds cannot. As far as 'hedge funds not doing as well as the S&P' - well - the S&P changes, and it's made of pretty good companies. Also - a lot of funds come and go - it may not just be 'survivor bias' - some may very well just be dam better than others. Almost all of the gains in VC go to top funds, and there's tons of churn in the bottom 50%, but that is a different dynamic.
pcurve 9y ago
I don't have problem people investing their personal money in hedge funds, but as indicated by the article, large institutions also invest in hedge funds, which in many cases are just a collection of smaller hedge fund, each charging hefty fee.
dsr_ 9y ago
Has anyone done the analysis to see if the stock-picking by those managers was worth anything at all? Obviously it wasn't worth the fees they charged. But if all those fees had been flattened down to the same expense as the Vanguard fund, would their advice have been worth anything over the index? To a first approximation, it looks like the answer is no.
- TuringNYC 9y ago
  Investments can have a dual mandate - high returns BUT also low volatility. Many hedge funds will admit their returns may not beat the S&P500, but will counter that their returns have lower volatility -- achieving more consistent gains over time. To answer your question, sounds like the answer is still no, but it is worth noting that this whole conversation is ignoring the volatility side of the conversation.
  - watsocd 9y ago
    You are correct except that doing this over 10 years somewhat removes the 'ignoring the volatility' argument.
    - icelancer 9y ago
      >>You are correct except that doing this over 10 years somewhat removes the 'ignoring the volatility' argument. Only lessens it slightly. There are plenty of bad 10-year periods you wouldn't be happy with if you were 50-55 years old with all your money in stocks, not to mention an index fund tracking the S&P500 rather than the full index. Obviously holding index funds that are primarily stocks is the play when you are younger, but risk-adjusted returns matter a lot more for someone with big money as they approach retirement. It's worth exchanging returns for lower volatility down the line. Not that I think this bet could have turned out any other way, of course...
    - TuringNYC 9y ago
      Depends on whether there was a major market correction in those 10 years. A better betting period would be 20 years, which almost certainly guarantees 1 and possibly 2 or 3 market corrections. Hedge funds would argue that they perform better in downcycles, possibly even with negative correlation to the market.
drharby 9y ago
Eye catching headline, but the set of hedgefunds is diverse with a large range of performance. I imagine the upper tails do pretty well
- derenrich 9y ago
  by pure luck?
- Marazan 9y ago
  And how do you, ahead of time, select the upper tail.
- mikeash 9y ago
  I'm sure that's true, but it's also true of dice. Unless the same funds remain in the upper tails over long periods of time, it's pointless.
- icelancer 9y ago
  Can you guarantee me access to upper tail funds? I'm interested. I'd love to get my money into Medallion.
  - drharby 9y ago
    That was kind of my point. Funds like medallion exist and succeed pretty consistently, but they are the tail. Certainly others go above and below at various points in time
- compiler-guy 9y ago
  The argument isn't that "No hedge fund will ever beat the market." The argument is that, "You can't tell in advance which hedge fund will beat the market." The long tail exists, just not for you.
- guard0g 9y ago
  It's not about the tail, but that the mean (and median) is so much lower after HF fees and FoF fees (and the fact that there's just not that much talent out there).
osrec 9y ago
This does not surprise me. My personal experience with hedge fund managers is that they are good salesmen that peddle their financial expertise to clients, convincing them of their financial rock-star status (usually gained through a lucky investment or two). Paulson is a classic example. Wealthy individuals buy into it, especially those that are less educated (e.g. those that have inherited money), and happily allocate away their money to these guys. Once the funds grow to a certain size, then they might consider pitching their investments to pension funds, and their money pot grows, as does the nominal value of their fees. By the time they have pension funds on board, their investments get less and less risky, eventually looking more and more like a basket of standard commodities or a standard equity index! Thus, the value they add also becomes smaller and smaller. In my opinion, the hedge fund industry is a bit of a farce, but there are a small number of firms that do have a secret sauce that works sometimes (rarely forever though). In my experience, the firms that tend to make consistent money are the market makers, rather than the speculators.
- RandomInteger4 9y ago
  I've only dabbled a little in cryptocurrency exchanges, so the terms seem to refer to the same thing to me, but maybe it's contextual? Forgive my ignorance, but can you explain the difference between market makers and speculators?
  - cm2187 9y ago
    You have market makers where you don't have an exchange, or where there is very little liquidity. Usually a bank but not always. They are there to "make a market", i.e. to offer liquidity to clients. Speculators take a directional position. Market makers make money on the bid/offer.
    - ycombobreaker 9y ago
      The exchange is not a counterparty. You have market makers there as well. Even in very liquid markets, it may be common to trade against market makers, just at a tighter bid-ask spread.
baron816 9y ago
So clearly, for the individual, the optimal strategy is to simply invest in index funds and just wait. But a new question that is being raised is: "what happens if everyone only invests in index funds?"
- minsight 9y ago
  That never happens. There will always be people who want to be different from the herd. Any inefficiencies will take care of themselves.
  - droopyEyelids 9y ago
    >Any inefficiencies will take care of themselves. Thats a ridiculous thing to say when the inefficiency here would represent your investments getting wiped out
    - throwaway2048 9y ago
      making less money isnt the same thing as being whiped out.
- mrep 9y ago
  This has been answered a thousand times. Everyone will never invest in index funds. What will happen is more and more people will invest in index funds until there are so little people actively investing in the stock market that the ones that do are able to beat it. However, them beating it will only net (after their fees) the same returns as index funds thus striking a balance where index funds match the performance of active investors. If either index funds or active investors (after fees) make more money, capital will move to the one that pays more until they balance again. We have had way too many active investors for a long time which is why index funds have constantly outperformed active investors but eventually they will balance as more and more people move their money to index funds.
  - Jabbles 9y ago
    You can't assume that we'll reach equilibrium in a different future situation given that we're not in equilibrium at the moment.
codecamper 9y ago
What is increasing S&P value other than the crowd willing to walk a little further out on the gangplank? I'd say it's a little too early to call that bet. (people can vote this one down as much as they want. The reality is that is the only thing making the value go up now.. just more people crowding into the same trade. Watch out when the crowd changes its mind)
- icebraining 9y ago
  The bet was started right at the peak before the 2008 fall. It still own. One can of course win any bet by stopping it when it's convenient, but that doesn't make it a very good bet, which is why a fixed period is used.
lordnacho 9y ago
Hedge fund guy here. - You have to consider risk. Perhaps use volatility as a proxy. Were the funds more or less volatile than the S&P? There are funds that are more and funds that are less. The bet ought to be adjusted for that, ie some form of risk adjusted return. - It's a rigged bet. A fund of 5 funds of funds is going to be the market, minus fees. Yes there are funds that aren't just long the market but quite a lot will be. Many managers find it a sensible bet to add some beta, because the market often goes up and you will often be judged vs the market, not absolute returns. Throw them all together in a pot and all the spice is gone. Now take out fees. - Plenty of individual funds did beat the S&P (I'll toot my own horn here), but to beat the average someone's gotta be under average, typically other hedge funds. - You have to wonder how the bet would have fared had we not experienced the unprecedented reaction of central banks to the crisis. I don't know if Buffett had considered that, he's a smart guy, but it didn't seem like that was what the bet was about. If the market had been allowed to take a "more natural" course perhaps the funds would have looked better. - You can find long periods in the past where the S&P was sideways. The constant advice to index is simplistic. Think about your own situation before you do that, there's at least a lot of interesting things to learn before you give up. ------Edit------ Seems to be a lot of response to this. Now I'm not saying it was particularly smart to bet against the market. In fact if you read closely you can see why. Which side of the bet would I have taken? Well, if I wasn't running a fund, I'd have taken Warren's side, for the same reason. As it happens you have very little credibility as a fund manager if you're not invested in your own fund, so I ended up backing myself. (Which is not quite the same as the bet.) For your average guy, I don't think there's a smart way for you to pick a fund to beat the market. You have to spend time actually investigating each strategy. An example of a fund who I think will provide a risk-adjusted market beating return is a guy I met once. He knows a bunch of stuff in detail about the valuation of exchange traded funds, and has infrastructure (technical and legal) in place to exploit discrepancies. It's quite far away from what people normally talk about when they talk about "investment". Most managers do not do this; they will just give you a variant of "I'm good at guessing and I can handle risk". Regarding central bank intervention, of course it's a manager's job to think about what might happen. I'm merely saying that most of them probably didn't see it coming, and that that is the major component of the underperformance. Consider that the HF marketing is basically "we'll think about the future for you". Now if what ends up happening is basically that you should buy everything and hold it, then why would you expect a guy who can predict turns to do any better than the market? Keep in mind you're paying fees for him to sell and buy as things go up and down. Note that several managers did in fact close down, not because of catastrophic losses, but because they got fed up with the game.
Eucatastrophe 9y ago
If the majority invested in only indexes, wouldn't that start to create inefficiencies where re-balancing affects the price of stocks more than its underlying value?
Ice_Walker 9y ago
I was under the impression the goal of Hedge Funds are not to "beat the market" but instead, to preserve capital during uncertain times.
cuteaussie 9y ago
Not surprising at all. It's easily the most popular investment tool of the last 20 years, and for good reason.
wpietri 9y ago
And I'm just going to self-promote a bit and say that the bet was registered via a project I worked on, the Long Now Foundation's project Long Bets: http://longbets.org/ http://longbets.org/ We've been going since 2002: https://www.wired.com/2002/05/longbets/ https://www.wired.com/2002/05/longbets/ We are happy to host bets of long-term significance, and the minimum bet is only $200/side. I am glad to personally help shepherd people who are serious about bets to make sure you get through the process. I would especially like to see HNers making bets about the things we argue a lot about. Bitcoin! VR! Uber! If you're tired of people posting waffle on some topic where you have a strong opinion, then challenge them to put money down.
- igravious 9y ago
  Cool. Put your money where your mouth is.
  - wpietri 9y ago
    I'm not sure why this is getting downvoted; that's exactly the point. We get people to stake money and reputation, which makes them very careful about making clear, specific claims. There is a whole lot of mouth around the future, but very few testable predictions. We could have tried creating an apparatus for rigorous predictions, but everybody understands a bet.
- the_cat_kittles 9y ago
  this utterly rules. like, i want to fly to your current location to give you a fist bump. in my utopian dream world, every political pundit has to put their thoughts on here.
  - vowelless 9y ago
    Even if they get funded by special interest groups to spew the group's narrative, at least this will be a quantization of how correct or incorrect the pundits are.
    - 9y ago
ourmandave 9y ago
So how is Mortimer paying him the bet? Is it a suitcase full of $1 bills?
- icebraining 9y ago
  The money is going to Girls Incorporated of Omaha, the charity chosen by Buffett.
ringaroundthetx 9y ago
Okay so any leveraged real estate fund would have outperformed the S&P500, without the possibility of a sudden margin call Any leveraged bond fund should have been able to as well, a carry trade from 2012 in European government bonds should have made many hundreds of percent A futures fund should have been able to A commodity options should have made monumental gains over the 85% that the S&P500 gave in 10 years, honestly should have made that in a month A fund that did what Warren Buffet got rich doing, by buying up bad companies and improving, should still have gotten high returns And finally, there were simply no cryptocurrency funds around! The problem, I say smugly, is that these fund of funds were probably all macro funds with too many assets under management, making them hard to manage in the niche markets I proclaimed. A fund with 1 billion AUM cannot manage that much real estate without eating into the management fees. There is not enough liquidity in the options market, and definitely not enough liquidity in cryptocurrencies. But this unfortunately influences perception that "NOBODY" is able to make / promise more than 5% a year over several years. This is false but I'm not going to try to change your mind. Consolidating capital with someone managing <500k to around 25 million should be able to consistently take advantage of these less scalable opportunities for great profits. After all, it is how Warren Buffett himself got 100s of thousands of percentage gains in his hedge fund of $105,000.
- icelancer 9y ago
  >>But this unfortunately influences perception that "NOBODY" is able to make / promise more than 5% a year over several years. This is not what people think. What people think is that you have cherry picked a bunch of asset classes above and neglected others that would beat the US Large Cap index over that time frame, but you cannot guarantee that those same asset classes would handily beat the same index over the next decade. If you can (Medallion fund type legends), then you aren't seeking my money, typically.
- compiler-guy 9y ago
  The problem for the every-person is finding the one that succeeds rather than fails. Given that in the aggregate these investments so severely underperformed, we can conclude that on an weighted average basis, you were more likely to lose money than gain money. No one disputes that some funds will over perform. The question is, which one? If you can predict that reliably, you will be rich. Most people can't.
brianliou91 9y ago
Although there is still tons of money going to actively managed funds it seems to be more and more common knowledge that index fund investing is ultimately the smartest thing to do for personal finance. Does anyone know what the risk factors are (if any) to this type of passive investing if EVERYONE begins to do the same thing?
- charlesdm 9y ago
  I had an interesting conversation with a very smart investor last year, and basically his idea was that while active managers will sell certain specific stocks (less volatile stocks) to fulfill redemptions in the event of a decline and/or crash, ETFs will generally just hit an (automated) sell on everything across the board. So proportionally they will sell off significantly more volatile small and midcaps vs large caps. Every since I have had that conversation, I no longer invest in passive index funds or ETFs.
  - jacalata 9y ago
    Why is that a problem? Because it gets less diversified?
  - fspeech 9y ago
    ETF funds themselves do not buy or sell anything. They exchange their own units for the indexed basket of shares.
  - tanderson92 9y ago
    This is incorrect, especially with ETFs. With an ETF, the seller/buyer (the individual, not the fund) pays all of the transaction costs. So buying and holding an ETF doesn't expose you to the problems which the behavior of panicking investors^. The same is not always true for mutual funds. caveat: Vanguard index funds may be special and this doesn't apply to the same extent because the ETFs are a dual share class of the larger mutual fund.
    - charlesdm 9y ago
deleted 9y ago
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bincyber 9y ago
Index funds will almost always outperform actively managed funds. They are the best choice for the layman investor. An excellent book on this topic is The Little Book of Common Sense Investing by John Bogle. https://www.amazon.com/Little-Book-Common-Sense-Investing/dp/0470102101 https://www.amazon.com/Little-Book-Common-Sense-Investing/dp...
- mooreds 9y ago
  I liked "A Random Walk Down Wall Street". That was the one that convinced me: https://www.amazon.com/Random-Walk-Down-Wall-Street/dp/0393330338 https://www.amazon.com/Random-Walk-Down-Wall-Street/dp/03933...
- jk2323 9y ago
  "Rest Estate always goes up!" "Index funds will almost always outperform actively managed funds." Convenient investment vehicles should not stop you thinking. Index ETF were a great idea. But now everybody is pouring tons of money into them. Not sure this is a good idea, at least not on the scale how it is currently done. A stock is priced by supply and demand. There are stocks where there is basically very little real trading. Only ETF and some HFT funds. Yet, the stock is rising with the index. What happens in a downturn? What happens if this stock drops significantly more? Every ETF has to re-balance to reflect this fact, easily leading to a feed-back effect. Some people betting on it: http://www.zerohedge.com/news/2017-04-09/horseman-global-unveils-new-shorting-philosophy-using-etf-flows-catalyst http://www.zerohedge.com/news/2017-04-09/horseman-global-unv...
  - misnamed 9y ago
    Index funds have to outperform active funds and traders in aggregate by definition. It's not a claim or debate, it's simple math. After savings on taxes and expenses, indexes represent the average + a fair bit more than other options. There is no feedback effect, except that more people indexing will lead to more trading arbitrage opportunities, which people will take and which doesn't hurt indexers, who will continue to take the market average return plus what they save in expenses and taxes. As an aside: the last place to get financial advice is Zero Hedge. Try this instead: http://www.etf.com/sections/index-investor-corner/swedroe-why-index-investing-wins?nopaging=1 http://www.etf.com/sections/index-investor-corner/swedroe-wh...
rwmj 9y ago
Question for financial types: For a few years I've owned a small selection of shares in FTSE companies (15 of them at the moment). I don't really do this scientifically, I just look for large, well-established companies where their shares look cheaper than long run, and buy those. (Partly I do this so I can see everyday companies that I own a tiny bit of). Is this practically equivalent to owning index-linked funds? Am I missing out? I plan to hold them for many years, and it's mostly "play money".
- desas 9y ago
  No it's precisely the opposite. You're gambling that you can beat the market for those 15 funds, index linked funds are gambling that the value of the market (index) as a whole will increase and will try to perform to the market. To do that they buy shares in all of the companies that are in the linked index (in proportion).
- Lon7 9y ago
  There's two parts to this answer. First, the numbers thrown around are that once you own 15 diversified stocks you have reduced your portfolio risk by 70 percent. That's not bad. At this point your volatility may not be that different than a market index. Of course it's different for every set of stocks, but I think this is a safe-ish guideline. So in that sense you are not missing out a whole lot. Second, and more importantly, it is very simple to put together 15 stocks with a low volatility, but also with very low returns. This is because the vast majority of the returns of an index come from a very small number of outperforming stocks. It's like the 90-10 rule. 90 percent of an index's performance comes from 10% of the stocks. Those aren't the exact numbers, but when you only pick 15 stocks, it is very likely that you will totally miss out on all outperforming stocks. Here's an article that talks about this in more depth and uses real numbers: http://www.efficientfrontier.com/ef/900/15st.htm http://www.efficientfrontier.com/ef/900/15st.htm
  - icelancer 9y ago
    >>This is because the vast majority of the returns of an index come from a very small number of outperforming stocks. This is the only thing the parent commenter needs to read to understand why indexing is not equivalent to owning 15 stocks that theoretically reduce portfolio risk (my guess is that the stocks are highly correlated and have too high of weight towards IT and not enough towards boring fields like industrials).
lpolovets 9y ago
For anyone interested in this bet, Ted Seides (the losing party) did a good podcast on the topic: http://capitalallocatorspodcast.com/BetwithBuffett/ http://capitalallocatorspodcast.com/BetwithBuffett/ My layman's understanding of hedge funds is they are better at hedging losses than increasing gains. So in good years they might underperform the broader market (e.g. gain 9% instead of 12%), but in bad years they should lose much less (e.g. lose 5% instead of 15%). I think this bet was largely a bet on the broader market dropping after a long run-up (which would theoretically favor hedge funds), but instead the market kept rising more and more.
- goialoq 9y ago
  Yes, this was the origin of the term "hedge" fund, but in recent ~decade has come to mean "actively managed investments" because the name sounded cool to people who don't know that the word "hedge" means something intentionally conservative and boring.
  - Iv 9y ago
    Yeah, it's hedgy.
- Iv 9y ago
  > I think this bet was largely a bet on the broader market dropping after a long run-up Well the bet included the 2008 crisis. That looks like even this theory is contradicted.
- valuearb 9y ago
  Hedge funds aren't about hedging anymore. Ted got the biggest market crash in last hundred years and still got trounced. He can't admit the truth because it's destructive to his very business model. Hedge funds as a group over time always trail the market because of their high fees. Funds of Funds layer yet another layer of fees, making this bet suicidal. Ted Seides is a Wall Street con man grafting fees off poorly informed investors. He was delusional to make this unwinnable bet.
kpommerenke 9y ago
It is not really surprising that a large group of hedge funds underperformed the S&P500. In fact, William Sharpe made the argument a long time ago: in aggregate, active investors hold the passive portfolio and earn the same return as passive investors before fees, but lower returns after fees. In aggregate, this is always and necessarily true: https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm
- misnamed 9y ago
  It's so simple and obviously true yet a shocking number of people think it could be otherwise (e.g. if too many people index).
yuhong 9y ago
The problem IMO is that stocks outperform bonds in the first place because of the debt-based economy. I suspect it is part of why Glass-Steagell was repealed in the first place.
- misnamed 9y ago
  Stocks should outperform bonds because they are riskier than bonds. Why would you expect or want it to be otherwise?
  - yuhong 9y ago
    But the more stocks outperform bonds, the more things like the repeal of Glass-Steagell are encouraged.
guard0g 9y ago
Best $1m in marketing that Ted Seides ever spent for 10 years of profile.
crystalmeph 9y ago
It's interesting that while the S&P did beat these hedge funds, Buffet's own Berkshire Hathaway (BRK.B) seems to have beat the S&P handily[0], with an increase of ~130% from $77.93 in 2007 to $179.89 today. I know Berkshire isn't actually a hedge fund, but is very analogous to a giant mutual fund, albeit one that takes a very active ownership role in the companies whose shares it owns. 0:http://quotes.morningstar.com/chart/stock/chart.action?t=BRK.B&region=USA&culture=en_US http://quotes.morningstar.com/chart/stock/chart.action?t=BRK..., look at the 10-year chart.
- tardo99 9y ago
  Yup this is the optimal strategy. I figure that one out a couple decades ago.
mycentstoo 9y ago
So, for the non financially savy, how can I set up my portfolio to bet on index funds?
- frankc 9y ago
  Just buy shares of SPY. It tracks the S&P 500. Keep in mind, returns aren't everything. They have to be considered along with risk. The S&P 500 also has big downturns of 20% or more. A good measure of return to risk is the sharpe ratio. The S&P's isn't all that good. This is why people invest in hedge funds.
diedyesterday 9y ago
Even though Efficient Market Hypothesis doesn't take into account some short-term subtleties and inconsistencies of human behavior, the insights it provides tend to dominate in the long term, which seems to be the case here with Mr Buffet's winning bet.
- tpallarino 9y ago
  So then how did Buffet make his money?
  - Marazan 9y ago
    Fundamental analysis, arbitrage plays and, starting out, investing other people's money with hugely favorable commission structure for himself.
hliyan 9y ago
> The five he selected had invested their money in more than 100 hedge funds, Wouldn't the average performance of that large a set anyway approach that of the S&P?
Asooka 9y ago
Am I reading that right? S&P500 nets you on average a 10% annual return of investment? Does that mean you can "just" invest ten times your yearly living expenses and practically live off idle income? How does that not completely destroy the economy and why isn't everyone doing it?
- nabla9 9y ago
  Pension funds are large investors, so part of peoples savings are there. In general people don't save that much. Not even enough to retire comfortably. Many people prefer own houses instead. Total market cap of SP500 is ~$20 trillion. Divided between US adults that is something like $80 thousand per adult.
- pg314 9y ago
  > S&P500 nets you on average a 10% annual return of investment? In the last 10 years, yes. Historically, it's been closer to 7% in real terms (adjusting for inflation). There are no guarantees that this will be the case for the future. > Does that mean you can "just" invest ten times your yearly living expenses and practically live off idle income? You'll need more than that because there are multi-year periods where the s&p 500 declines. The number that has been bandied around for a 'safe' withdrawal rate is 4% [1], so you'll need closer to 25 times your yearly living expenses. > How does that not completely destroy the economy and Because not everybody is doing it. If they were you wouldn't be getting those returns, obviously. > why isn't everyone doing it? Most Americans have less than $1000 in savings, let alone 10x their yearly living expenses. [1] http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/ http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need...
- ng12 9y ago
  Because 70% Americans have less than $1,000 in their savings account, let alone taxable brokerage accounts [1]. Living off cap gains is not even on most people's radar. If you're really interested there's a pretty interesting Reddit community based around saving for that goal [2]. 1. https://www.cnbc.com/2017/06/13/heres-how-many-americans-have-nothing-at-all-saved-for-retirement.html https://www.cnbc.com/2017/06/13/heres-how-many-americans-hav... 2. https://www.reddit.com/r/financialindependence https://www.reddit.com/r/financialindependence
ghostbrainalpha 9y ago
So obviously the Hedgefund didn't beat the market enough to have a better return for the investors.... But is there anyway to compare the (Returns + Extracted Money Through Fees) vs S&P500 to see the potential return of the Hedgefund before the fees were extracted?
- gmiller123456 9y ago
  Not likely. They were a "fund of funds", and hedge funds rarely actually disclose their investments even to investors, let alone the general public. You'd be lucky to even get a list from one fund, let alone all of them.
telltruth 9y ago
Key here is long term. If you are investing for long term and choose hedge fund then you are a sucker. Smart investors choose hedge fund only for short term investments and only because they know the fund is trying to exploit some information asymmetry. Such funds are usually ultra secretive and you would get to invest in it only because you knew someone running it.
atrex 9y ago
Did anyone calculate how would be the perfomance if there was no fee for the hedgefund?

786 points by yurisagalov 9y ago

mcintyre1994 9y ago

If anyone finds this surprising I'd highly recommend reading 'Smarter Investing' by Tim Hale, which does a great job of advocating for index-based positions. With the exception of C, those fund-of-funds have done incredibly badly. One of the interesting things Tim discusses is that this poor performance compared to market tends to make investors second-guess their investments (often for good reason looking at those returns), and buy into the fund that did well last year instead. So you're also getting into a sell-low-buy-high routine.

ModernMech 9y ago

Reminds me a little of traffic. Yesterday I was cruising down the highway in the leftmost lane, going about 80 with a line of other cars. The other two lanes were actually more clear, but cars were going much slower. I notice this one car, weaving in and out of traffic in these two lanes, trying desperately to get ahead, constantly cutting people off. They did this for 40 miles, weaving in and out, sometimes getting ahead of me by quite a bit, sometimes falling behind. If they had just stayed in the left lane and cruised, they would have arrived at their destination at exactly the same time. My point is, it seems to be human nature to be bad at estimating long term averages, whether it be stock picks or just driving down the road. Checkout lanes are another example that comes to mind.

kinkrtyavimoodh 9y ago
I think the weaving in and out behavior can be explained in some part by the boredom of just cruising in a single lane for miles and miles. That being said, downvoted because the traffic analogy was very tangential to the point at hand and would only serve to derail conversation.
differentView 9y ago
Unless you only noticed that one car that was terrible at getting ahead. Better drivers might have passed you only once and you didn't notice them because you never saw them again.
- mstanown 9y ago
  As it happens when one doesn't acknowledge Survivorship Bias.
- foobarian 9y ago
  I wish Waze had an "A/B test mode" where you can bookmark the current cohort of drivers around you, and then N minutes later see where they ended up. Whenever traffic apps claim my main route home is backed up and I end up taking some weird backroads, I wonder if I would have been better off sticking with the main route.
ramblerman 9y ago
This is a poor analogy, and will only serve to induce responses to the analogy rather than the topic at hand.
mojoe 9y ago
The analogy works even deeper -- I've seen articles talking about how large amounts of lane changing actually slows traffic overall.
perl4ever 9y ago
Some people think you should not be in the left lane unless you are passing at that moment. In some places, there are even signs saying "keep right except to pass". Perhaps this person was driving aggressively because they were enraged at the line of traffic on the left. Which is to say, they may not have been doing it for a quantitative benefit as you assume. This might strengthen rather than weaken the analogy to the stock market though...since it could be that people invest in hedge funds not to increase their average return but to reduce the regret of not owning "winners" and having something to talk about.
- matthewmcg 9y ago
  It's not just some people. It is actually the law in most states (albeit a seldom-enforced one). Don't cruise in the left lane.
  - quuquuquu 9y ago
    Most people cruise at a speed that is faster than everyone else in the other (non-left) lanes. But, please don't be the car that is cruising at 60mph in the left lane. It is a leading cause of accidents.
    - e12e 9y ago
      Ie speeding?
      - quuquuquu 9y ago
        Some states are 70mph, and most cops won't pull people over unless they're doing 10-15mph over. Unless you are just really unlucky XD
        soundwave106 9y ago
        Not sure why the downvotes. (Some states are 80mph actually!) Speeding enforcement in the United States is fairly loose, with usually roughly a 10mph buffer. (The exception being various "speed traps", atypically mostly rural towns that rely on ticket revenue for an outsized portion of their town budget.) I think this adds to the problem with left lane issues; even if the "true" speed limit is 80mph, if the "posted" speed limit is 70mph, some people will do no more than 70mph no matter where they are.
alkonaut 9y ago
This was tested in an experiment I can't find now. One group of drivers was asked to stick to one lane, the other group was told to switch lanes when possible to get ahead. The outcome: as expected switching lanes gained next to nothing. But importantly the reported experience was significantly worse for those that stayed in one lane. So switching lanes doesn't reduce commute time but the perceived commute time - and that is not insignificant! This however isn't a poor performance because of switching a lot - these funds make money but the managers keep too much of it. The bet was on whether someone who invested in these funds would do better than the S&P - not whether the stocks in those funds did.
- goialoq 9y ago
  That's because changing lanes is excited and camping is boring. This can be easily fixed by playing a game on your phone while camping.
- KC8ZKF 9y ago
  This was tested by the Mythbusters television show. https://www.youtube.com/watch?v=ZefgUVg3qx0 https://www.youtube.com/watch?v=ZefgUVg3qx0
rhizome 9y ago
As far as driving goes, you never know why someone else is in a hurry. Sometimes they're trying to get to an emergency. Hope you were comfortable with your band of other left-lane cruisers, though.

islayfan 9y ago

For context the losers argument is that Buffet picked a good team in a good period and he would have a good chance in a second cycle. https://www.bloomberg.com/view/articles/2017-05-03/why-i-lost-my-bet-with-warren-buffett https://www.bloomberg.com/view/articles/2017-05-03/why-i-los....

TekMol 9y ago
A weak attempt at damage control. He keeps reiterating his parole that experts who actively select assets know more then the average Joe. Even though the average Joe just completely blew them out of the water over a whole decade :)
- perl4ever 9y ago
  I agree that said experts probably don't know enough to justify their cost. But if the conclusion one draws is that the US large cap stock market is the place to put your money for the next 100 years just because it was great the last 100 years, I think that's the wrong lesson. Of all the markets in all the countries in the world, and all the asset classes, the US stock market has been an outlier for a long time, and it can't continue forever. Like Moore's law, and declining interest rates, and population growth, every trend stops somewhere since it would otherwise eat the world. Generally right at the point almost nobody is left to bet against it. There is no such thing as completely passive management - someone at least selects components of an index, and you at least choose which index and that is always going to be pivotal with respect to investment success. I don't think there is logically any way around some degree of deliberate selection of assets. All people can do is pay less for the illusion of expertise.
  - mikeash 9y ago
    Isn't that last sentence the whole point, though? I thought that index funds didn't generally do better than actively managed funds in terms of raw returns, they just didn't do much worse, and the vastly lower fees mean that you come out ahead overall. The point of an index fund isn't to attain some sort of stock picking nirvana where nobody's really picking anything, it's just to get a fee of 0.04% instead of 2%, or whatever.

mojoe 9y ago

I feel like there's some cognitive dissonance surrounding hedge funds in popular culture -- on the one hand you have people saying that any outsized short-term gains seen by hedge funds are the result of some selection/survivorship bias, and on the other hand you have people saying that any outsized returns are the result of illegal privileged information (see the TV show 'Billions'). I realize that there are enough hedge funds out there that both things can be happening. It's too bad that there's so little visibility into the industry, it would be fascinating to see some kind of hedge fund taxonomy.

jerf 9y ago
There's a whole lot of "X is bad, therefore any argument that supports the claim that X is bad is true and valid" when it comes to these matters. It's technically "affirming the consequent", but I think that fallacy gets another very tempting facet to it when it's enters the moral or ideological dimensions.
alexasmyths 9y ago
It doesn't have to be illegal. Hedge Funds have access to CEO's, they'll go in and interview them. Ostensibly, the CEO cannot say anything that is not 'public information' - but if you think about it, then why would the Fund even talk to the CEO if 'all info is public'? Because a lot of nuance can be gained from in person interviews. Little tidbits of information gleaned can make a difference. I'm not hugely knowledgeable of that industry, so I can't speak of the 'for sure' bad things happening, but I know at least one manager who does this. Funny: he totally does not believe that they really gain an edge over the public. Then I ask him why he bothers with the interviews and he doesn't have a very good answer. It's almost funny. I suspect his fund partners have a better clue. So that's one thing. Another - is that simply by having fewer regulator requirements, hedge's can do all sorts of things that bigger funds cannot. As far as 'hedge funds not doing as well as the S&P' - well - the S&P changes, and it's made of pretty good companies. Also - a lot of funds come and go - it may not just be 'survivor bias' - some may very well just be dam better than others. Almost all of the gains in VC go to top funds, and there's tons of churn in the bottom 50%, but that is a different dynamic.

pcurve 9y ago

I don't have problem people investing their personal money in hedge funds, but as indicated by the article, large institutions also invest in hedge funds, which in many cases are just a collection of smaller hedge fund, each charging hefty fee.

dsr_ 9y ago

Has anyone done the analysis to see if the stock-picking by those managers was worth anything at all? Obviously it wasn't worth the fees they charged. But if all those fees had been flattened down to the same expense as the Vanguard fund, would their advice have been worth anything over the index? To a first approximation, it looks like the answer is no.

TuringNYC 9y ago
Investments can have a dual mandate - high returns BUT also low volatility. Many hedge funds will admit their returns may not beat the S&P500, but will counter that their returns have lower volatility -- achieving more consistent gains over time. To answer your question, sounds like the answer is still no, but it is worth noting that this whole conversation is ignoring the volatility side of the conversation.
- watsocd 9y ago
  You are correct except that doing this over 10 years somewhat removes the 'ignoring the volatility' argument.
  - icelancer 9y ago
    >>You are correct except that doing this over 10 years somewhat removes the 'ignoring the volatility' argument. Only lessens it slightly. There are plenty of bad 10-year periods you wouldn't be happy with if you were 50-55 years old with all your money in stocks, not to mention an index fund tracking the S&P500 rather than the full index. Obviously holding index funds that are primarily stocks is the play when you are younger, but risk-adjusted returns matter a lot more for someone with big money as they approach retirement. It's worth exchanging returns for lower volatility down the line. Not that I think this bet could have turned out any other way, of course...
  - TuringNYC 9y ago
    Depends on whether there was a major market correction in those 10 years. A better betting period would be 20 years, which almost certainly guarantees 1 and possibly 2 or 3 market corrections. Hedge funds would argue that they perform better in downcycles, possibly even with negative correlation to the market.

drharby 9y ago

Eye catching headline, but the set of hedgefunds is diverse with a large range of performance. I imagine the upper tails do pretty well

derenrich 9y ago
by pure luck?
Marazan 9y ago
And how do you, ahead of time, select the upper tail.
mikeash 9y ago
I'm sure that's true, but it's also true of dice. Unless the same funds remain in the upper tails over long periods of time, it's pointless.
icelancer 9y ago
Can you guarantee me access to upper tail funds? I'm interested. I'd love to get my money into Medallion.
- drharby 9y ago
  That was kind of my point. Funds like medallion exist and succeed pretty consistently, but they are the tail. Certainly others go above and below at various points in time
compiler-guy 9y ago
The argument isn't that "No hedge fund will ever beat the market." The argument is that, "You can't tell in advance which hedge fund will beat the market." The long tail exists, just not for you.
guard0g 9y ago
It's not about the tail, but that the mean (and median) is so much lower after HF fees and FoF fees (and the fact that there's just not that much talent out there).

osrec 9y ago

This does not surprise me. My personal experience with hedge fund managers is that they are good salesmen that peddle their financial expertise to clients, convincing them of their financial rock-star status (usually gained through a lucky investment or two). Paulson is a classic example. Wealthy individuals buy into it, especially those that are less educated (e.g. those that have inherited money), and happily allocate away their money to these guys. Once the funds grow to a certain size, then they might consider pitching their investments to pension funds, and their money pot grows, as does the nominal value of their fees. By the time they have pension funds on board, their investments get less and less risky, eventually looking more and more like a basket of standard commodities or a standard equity index! Thus, the value they add also becomes smaller and smaller. In my opinion, the hedge fund industry is a bit of a farce, but there are a small number of firms that do have a secret sauce that works sometimes (rarely forever though). In my experience, the firms that tend to make consistent money are the market makers, rather than the speculators.

RandomInteger4 9y ago
I've only dabbled a little in cryptocurrency exchanges, so the terms seem to refer to the same thing to me, but maybe it's contextual? Forgive my ignorance, but can you explain the difference between market makers and speculators?
- cm2187 9y ago
  You have market makers where you don't have an exchange, or where there is very little liquidity. Usually a bank but not always. They are there to "make a market", i.e. to offer liquidity to clients. Speculators take a directional position. Market makers make money on the bid/offer.
  - ycombobreaker 9y ago
    The exchange is not a counterparty. You have market makers there as well. Even in very liquid markets, it may be common to trade against market makers, just at a tighter bid-ask spread.

baron816 9y ago

So clearly, for the individual, the optimal strategy is to simply invest in index funds and just wait. But a new question that is being raised is: "what happens if everyone only invests in index funds?"

minsight 9y ago
That never happens. There will always be people who want to be different from the herd. Any inefficiencies will take care of themselves.
- droopyEyelids 9y ago
  >Any inefficiencies will take care of themselves. Thats a ridiculous thing to say when the inefficiency here would represent your investments getting wiped out
  - throwaway2048 9y ago
    making less money isnt the same thing as being whiped out.
mrep 9y ago
This has been answered a thousand times. Everyone will never invest in index funds. What will happen is more and more people will invest in index funds until there are so little people actively investing in the stock market that the ones that do are able to beat it. However, them beating it will only net (after their fees) the same returns as index funds thus striking a balance where index funds match the performance of active investors. If either index funds or active investors (after fees) make more money, capital will move to the one that pays more until they balance again. We have had way too many active investors for a long time which is why index funds have constantly outperformed active investors but eventually they will balance as more and more people move their money to index funds.
- Jabbles 9y ago
  You can't assume that we'll reach equilibrium in a different future situation given that we're not in equilibrium at the moment.

codecamper 9y ago

What is increasing S&P value other than the crowd willing to walk a little further out on the gangplank? I'd say it's a little too early to call that bet. (people can vote this one down as much as they want. The reality is that is the only thing making the value go up now.. just more people crowding into the same trade. Watch out when the crowd changes its mind)

icebraining 9y ago
The bet was started right at the peak before the 2008 fall. It still own. One can of course win any bet by stopping it when it's convenient, but that doesn't make it a very good bet, which is why a fixed period is used.

lordnacho 9y ago

Hedge fund guy here. - You have to consider risk. Perhaps use volatility as a proxy. Were the funds more or less volatile than the S&P? There are funds that are more and funds that are less. The bet ought to be adjusted for that, ie some form of risk adjusted return. - It's a rigged bet. A fund of 5 funds of funds is going to be the market, minus fees. Yes there are funds that aren't just long the market but quite a lot will be. Many managers find it a sensible bet to add some beta, because the market often goes up and you will often be judged vs the market, not absolute returns. Throw them all together in a pot and all the spice is gone. Now take out fees. - Plenty of individual funds did beat the S&P (I'll toot my own horn here), but to beat the average someone's gotta be under average, typically other hedge funds. - You have to wonder how the bet would have fared had we not experienced the unprecedented reaction of central banks to the crisis. I don't know if Buffett had considered that, he's a smart guy, but it didn't seem like that was what the bet was about. If the market had been allowed to take a "more natural" course perhaps the funds would have looked better. - You can find long periods in the past where the S&P was sideways. The constant advice to index is simplistic. Think about your own situation before you do that, there's at least a lot of interesting things to learn before you give up. ------Edit------ Seems to be a lot of response to this. Now I'm not saying it was particularly smart to bet against the market. In fact if you read closely you can see why. Which side of the bet would I have taken? Well, if I wasn't running a fund, I'd have taken Warren's side, for the same reason. As it happens you have very little credibility as a fund manager if you're not invested in your own fund, so I ended up backing myself. (Which is not quite the same as the bet.) For your average guy, I don't think there's a smart way for you to pick a fund to beat the market. You have to spend time actually investigating each strategy. An example of a fund who I think will provide a risk-adjusted market beating return is a guy I met once. He knows a bunch of stuff in detail about the valuation of exchange traded funds, and has infrastructure (technical and legal) in place to exploit discrepancies. It's quite far away from what people normally talk about when they talk about "investment". Most managers do not do this; they will just give you a variant of "I'm good at guessing and I can handle risk". Regarding central bank intervention, of course it's a manager's job to think about what might happen. I'm merely saying that most of them probably didn't see it coming, and that that is the major component of the underperformance. Consider that the HF marketing is basically "we'll think about the future for you". Now if what ends up happening is basically that you should buy everything and hold it, then why would you expect a guy who can predict turns to do any better than the market? Keep in mind you're paying fees for him to sell and buy as things go up and down. Note that several managers did in fact close down, not because of catastrophic losses, but because they got fed up with the game.

Eucatastrophe 9y ago

If the majority invested in only indexes, wouldn't that start to create inefficiencies where re-balancing affects the price of stocks more than its underlying value?

Ice_Walker 9y ago

I was under the impression the goal of Hedge Funds are not to "beat the market" but instead, to preserve capital during uncertain times.

cuteaussie 9y ago

Not surprising at all. It's easily the most popular investment tool of the last 20 years, and for good reason.

wpietri 9y ago

And I'm just going to self-promote a bit and say that the bet was registered via a project I worked on, the Long Now Foundation's project Long Bets: http://longbets.org/ http://longbets.org/ We've been going since 2002: https://www.wired.com/2002/05/longbets/ https://www.wired.com/2002/05/longbets/ We are happy to host bets of long-term significance, and the minimum bet is only $200/side. I am glad to personally help shepherd people who are serious about bets to make sure you get through the process. I would especially like to see HNers making bets about the things we argue a lot about. Bitcoin! VR! Uber! If you're tired of people posting waffle on some topic where you have a strong opinion, then challenge them to put money down.

igravious 9y ago
Cool. Put your money where your mouth is.
- wpietri 9y ago
  I'm not sure why this is getting downvoted; that's exactly the point. We get people to stake money and reputation, which makes them very careful about making clear, specific claims. There is a whole lot of mouth around the future, but very few testable predictions. We could have tried creating an apparatus for rigorous predictions, but everybody understands a bet.
the_cat_kittles 9y ago
this utterly rules. like, i want to fly to your current location to give you a fist bump. in my utopian dream world, every political pundit has to put their thoughts on here.
- vowelless 9y ago
  Even if they get funded by special interest groups to spew the group's narrative, at least this will be a quantization of how correct or incorrect the pundits are.
  - 9y ago

ourmandave 9y ago

So how is Mortimer paying him the bet? Is it a suitcase full of $1 bills?

icebraining 9y ago
The money is going to Girls Incorporated of Omaha, the charity chosen by Buffett.

ringaroundthetx 9y ago

Okay so any leveraged real estate fund would have outperformed the S&P500, without the possibility of a sudden margin call Any leveraged bond fund should have been able to as well, a carry trade from 2012 in European government bonds should have made many hundreds of percent A futures fund should have been able to A commodity options should have made monumental gains over the 85% that the S&P500 gave in 10 years, honestly should have made that in a month A fund that did what Warren Buffet got rich doing, by buying up bad companies and improving, should still have gotten high returns And finally, there were simply no cryptocurrency funds around! The problem, I say smugly, is that these fund of funds were probably all macro funds with too many assets under management, making them hard to manage in the niche markets I proclaimed. A fund with 1 billion AUM cannot manage that much real estate without eating into the management fees. There is not enough liquidity in the options market, and definitely not enough liquidity in cryptocurrencies. But this unfortunately influences perception that "NOBODY" is able to make / promise more than 5% a year over several years. This is false but I'm not going to try to change your mind. Consolidating capital with someone managing <500k to around 25 million should be able to consistently take advantage of these less scalable opportunities for great profits. After all, it is how Warren Buffett himself got 100s of thousands of percentage gains in his hedge fund of $105,000.

icelancer 9y ago
>>But this unfortunately influences perception that "NOBODY" is able to make / promise more than 5% a year over several years. This is not what people think. What people think is that you have cherry picked a bunch of asset classes above and neglected others that would beat the US Large Cap index over that time frame, but you cannot guarantee that those same asset classes would handily beat the same index over the next decade. If you can (Medallion fund type legends), then you aren't seeking my money, typically.
compiler-guy 9y ago
The problem for the every-person is finding the one that succeeds rather than fails. Given that in the aggregate these investments so severely underperformed, we can conclude that on an weighted average basis, you were more likely to lose money than gain money. No one disputes that some funds will over perform. The question is, which one? If you can predict that reliably, you will be rich. Most people can't.

brianliou91 9y ago

Although there is still tons of money going to actively managed funds it seems to be more and more common knowledge that index fund investing is ultimately the smartest thing to do for personal finance. Does anyone know what the risk factors are (if any) to this type of passive investing if EVERYONE begins to do the same thing?

charlesdm 9y ago
I had an interesting conversation with a very smart investor last year, and basically his idea was that while active managers will sell certain specific stocks (less volatile stocks) to fulfill redemptions in the event of a decline and/or crash, ETFs will generally just hit an (automated) sell on everything across the board. So proportionally they will sell off significantly more volatile small and midcaps vs large caps. Every since I have had that conversation, I no longer invest in passive index funds or ETFs.
- jacalata 9y ago
  Why is that a problem? Because it gets less diversified?
- fspeech 9y ago
  ETF funds themselves do not buy or sell anything. They exchange their own units for the indexed basket of shares.
- tanderson92 9y ago
  This is incorrect, especially with ETFs. With an ETF, the seller/buyer (the individual, not the fund) pays all of the transaction costs. So buying and holding an ETF doesn't expose you to the problems which the behavior of panicking investors^. The same is not always true for mutual funds. caveat: Vanguard index funds may be special and this doesn't apply to the same extent because the ETFs are a dual share class of the larger mutual fund.
  - charlesdm 9y ago

deleted 9y ago

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bincyber 9y ago

Index funds will almost always outperform actively managed funds. They are the best choice for the layman investor. An excellent book on this topic is The Little Book of Common Sense Investing by John Bogle. https://www.amazon.com/Little-Book-Common-Sense-Investing/dp/0470102101 https://www.amazon.com/Little-Book-Common-Sense-Investing/dp...

mooreds 9y ago
I liked "A Random Walk Down Wall Street". That was the one that convinced me: https://www.amazon.com/Random-Walk-Down-Wall-Street/dp/0393330338 https://www.amazon.com/Random-Walk-Down-Wall-Street/dp/03933...
jk2323 9y ago
"Rest Estate always goes up!" "Index funds will almost always outperform actively managed funds." Convenient investment vehicles should not stop you thinking. Index ETF were a great idea. But now everybody is pouring tons of money into them. Not sure this is a good idea, at least not on the scale how it is currently done. A stock is priced by supply and demand. There are stocks where there is basically very little real trading. Only ETF and some HFT funds. Yet, the stock is rising with the index. What happens in a downturn? What happens if this stock drops significantly more? Every ETF has to re-balance to reflect this fact, easily leading to a feed-back effect. Some people betting on it: http://www.zerohedge.com/news/2017-04-09/horseman-global-unveils-new-shorting-philosophy-using-etf-flows-catalyst http://www.zerohedge.com/news/2017-04-09/horseman-global-unv...
- misnamed 9y ago
  Index funds have to outperform active funds and traders in aggregate by definition. It's not a claim or debate, it's simple math. After savings on taxes and expenses, indexes represent the average + a fair bit more than other options. There is no feedback effect, except that more people indexing will lead to more trading arbitrage opportunities, which people will take and which doesn't hurt indexers, who will continue to take the market average return plus what they save in expenses and taxes. As an aside: the last place to get financial advice is Zero Hedge. Try this instead: http://www.etf.com/sections/index-investor-corner/swedroe-why-index-investing-wins?nopaging=1 http://www.etf.com/sections/index-investor-corner/swedroe-wh...

rwmj 9y ago

Question for financial types: For a few years I've owned a small selection of shares in FTSE companies (15 of them at the moment). I don't really do this scientifically, I just look for large, well-established companies where their shares look cheaper than long run, and buy those. (Partly I do this so I can see everyday companies that I own a tiny bit of). Is this practically equivalent to owning index-linked funds? Am I missing out? I plan to hold them for many years, and it's mostly "play money".

desas 9y ago
No it's precisely the opposite. You're gambling that you can beat the market for those 15 funds, index linked funds are gambling that the value of the market (index) as a whole will increase and will try to perform to the market. To do that they buy shares in all of the companies that are in the linked index (in proportion).
Lon7 9y ago
There's two parts to this answer. First, the numbers thrown around are that once you own 15 diversified stocks you have reduced your portfolio risk by 70 percent. That's not bad. At this point your volatility may not be that different than a market index. Of course it's different for every set of stocks, but I think this is a safe-ish guideline. So in that sense you are not missing out a whole lot. Second, and more importantly, it is very simple to put together 15 stocks with a low volatility, but also with very low returns. This is because the vast majority of the returns of an index come from a very small number of outperforming stocks. It's like the 90-10 rule. 90 percent of an index's performance comes from 10% of the stocks. Those aren't the exact numbers, but when you only pick 15 stocks, it is very likely that you will totally miss out on all outperforming stocks. Here's an article that talks about this in more depth and uses real numbers: http://www.efficientfrontier.com/ef/900/15st.htm http://www.efficientfrontier.com/ef/900/15st.htm
- icelancer 9y ago
  >>This is because the vast majority of the returns of an index come from a very small number of outperforming stocks. This is the only thing the parent commenter needs to read to understand why indexing is not equivalent to owning 15 stocks that theoretically reduce portfolio risk (my guess is that the stocks are highly correlated and have too high of weight towards IT and not enough towards boring fields like industrials).

lpolovets 9y ago

For anyone interested in this bet, Ted Seides (the losing party) did a good podcast on the topic: http://capitalallocatorspodcast.com/BetwithBuffett/ http://capitalallocatorspodcast.com/BetwithBuffett/ My layman's understanding of hedge funds is they are better at hedging losses than increasing gains. So in good years they might underperform the broader market (e.g. gain 9% instead of 12%), but in bad years they should lose much less (e.g. lose 5% instead of 15%). I think this bet was largely a bet on the broader market dropping after a long run-up (which would theoretically favor hedge funds), but instead the market kept rising more and more.

goialoq 9y ago
Yes, this was the origin of the term "hedge" fund, but in recent ~decade has come to mean "actively managed investments" because the name sounded cool to people who don't know that the word "hedge" means something intentionally conservative and boring.
- Iv 9y ago
  Yeah, it's hedgy.
Iv 9y ago
> I think this bet was largely a bet on the broader market dropping after a long run-up Well the bet included the 2008 crisis. That looks like even this theory is contradicted.
valuearb 9y ago
Hedge funds aren't about hedging anymore. Ted got the biggest market crash in last hundred years and still got trounced. He can't admit the truth because it's destructive to his very business model. Hedge funds as a group over time always trail the market because of their high fees. Funds of Funds layer yet another layer of fees, making this bet suicidal. Ted Seides is a Wall Street con man grafting fees off poorly informed investors. He was delusional to make this unwinnable bet.

kpommerenke 9y ago

It is not really surprising that a large group of hedge funds underperformed the S&P500. In fact, William Sharpe made the argument a long time ago: in aggregate, active investors hold the passive portfolio and earn the same return as passive investors before fees, but lower returns after fees. In aggregate, this is always and necessarily true: https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm

misnamed 9y ago
It's so simple and obviously true yet a shocking number of people think it could be otherwise (e.g. if too many people index).

yuhong 9y ago

The problem IMO is that stocks outperform bonds in the first place because of the debt-based economy. I suspect it is part of why Glass-Steagell was repealed in the first place.

misnamed 9y ago
Stocks should outperform bonds because they are riskier than bonds. Why would you expect or want it to be otherwise?
- yuhong 9y ago
  But the more stocks outperform bonds, the more things like the repeal of Glass-Steagell are encouraged.

guard0g 9y ago

Best $1m in marketing that Ted Seides ever spent for 10 years of profile.

crystalmeph 9y ago

It's interesting that while the S&P did beat these hedge funds, Buffet's own Berkshire Hathaway (BRK.B) seems to have beat the S&P handily[0], with an increase of ~130% from $77.93 in 2007 to $179.89 today. I know Berkshire isn't actually a hedge fund, but is very analogous to a giant mutual fund, albeit one that takes a very active ownership role in the companies whose shares it owns. 0:http://quotes.morningstar.com/chart/stock/chart.action?t=BRK.B&region=USA&culture=en_US http://quotes.morningstar.com/chart/stock/chart.action?t=BRK..., look at the 10-year chart.

tardo99 9y ago
Yup this is the optimal strategy. I figure that one out a couple decades ago.

mycentstoo 9y ago

So, for the non financially savy, how can I set up my portfolio to bet on index funds?

frankc 9y ago
Just buy shares of SPY. It tracks the S&P 500. Keep in mind, returns aren't everything. They have to be considered along with risk. The S&P 500 also has big downturns of 20% or more. A good measure of return to risk is the sharpe ratio. The S&P's isn't all that good. This is why people invest in hedge funds.

diedyesterday 9y ago

Even though Efficient Market Hypothesis doesn't take into account some short-term subtleties and inconsistencies of human behavior, the insights it provides tend to dominate in the long term, which seems to be the case here with Mr Buffet's winning bet.

tpallarino 9y ago
So then how did Buffet make his money?
- Marazan 9y ago
  Fundamental analysis, arbitrage plays and, starting out, investing other people's money with hugely favorable commission structure for himself.

hliyan 9y ago

> The five he selected had invested their money in more than 100 hedge funds, Wouldn't the average performance of that large a set anyway approach that of the S&P?

Asooka 9y ago

Am I reading that right? S&P500 nets you on average a 10% annual return of investment? Does that mean you can "just" invest ten times your yearly living expenses and practically live off idle income? How does that not completely destroy the economy and why isn't everyone doing it?

nabla9 9y ago
Pension funds are large investors, so part of peoples savings are there. In general people don't save that much. Not even enough to retire comfortably. Many people prefer own houses instead. Total market cap of SP500 is ~$20 trillion. Divided between US adults that is something like $80 thousand per adult.
pg314 9y ago
> S&P500 nets you on average a 10% annual return of investment? In the last 10 years, yes. Historically, it's been closer to 7% in real terms (adjusting for inflation). There are no guarantees that this will be the case for the future. > Does that mean you can "just" invest ten times your yearly living expenses and practically live off idle income? You'll need more than that because there are multi-year periods where the s&p 500 declines. The number that has been bandied around for a 'safe' withdrawal rate is 4% [1], so you'll need closer to 25 times your yearly living expenses. > How does that not completely destroy the economy and Because not everybody is doing it. If they were you wouldn't be getting those returns, obviously. > why isn't everyone doing it? Most Americans have less than $1000 in savings, let alone 10x their yearly living expenses. [1] http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/ http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need...
ng12 9y ago
Because 70% Americans have less than $1,000 in their savings account, let alone taxable brokerage accounts [1]. Living off cap gains is not even on most people's radar. If you're really interested there's a pretty interesting Reddit community based around saving for that goal [2]. 1. https://www.cnbc.com/2017/06/13/heres-how-many-americans-have-nothing-at-all-saved-for-retirement.html https://www.cnbc.com/2017/06/13/heres-how-many-americans-hav... 2. https://www.reddit.com/r/financialindependence https://www.reddit.com/r/financialindependence

ghostbrainalpha 9y ago

So obviously the Hedgefund didn't beat the market enough to have a better return for the investors.... But is there anyway to compare the (Returns + Extracted Money Through Fees) vs S&P500 to see the potential return of the Hedgefund before the fees were extracted?

gmiller123456 9y ago
Not likely. They were a "fund of funds", and hedge funds rarely actually disclose their investments even to investors, let alone the general public. You'd be lucky to even get a list from one fund, let alone all of them.

telltruth 9y ago

Key here is long term. If you are investing for long term and choose hedge fund then you are a sucker. Smart investors choose hedge fund only for short term investments and only because they know the fund is trying to exploit some information asymmetry. Such funds are usually ultra secretive and you would get to invest in it only because you knew someone running it.

atrex 9y ago

Did anyone calculate how would be the perfomance if there was no fee for the hedgefund?