Buffett's million-dollar bet: an index fund crushed hedge funds

Transcript

Transcribed by machine (Whisper) from the episode’s audio, so a word may be off here and there.

1. 2:30:43

   So what's the impact of this? Well, just to put an even finer point on this, St. Warren over in Omaha comes back into the story here. In 2007, fortuitously, right before the crash, he had issued a public challenge Warren Buffett had. He said that he would bet $1 million of his own money against any and all takers from the hedge fund industry that over a 10-year period starting on January 1st, 2008, the Vanguard 500 Index Fund would outperform after fees the same dollar amount invested in any portfolio of at least five hedge funds.

2. 2:31:30

   And then the winner of the bet would get to select a charity that the funds would be donated to. It's kind of crazy, right? You get to pick any five hedge funds you want. Yep. And you can go pick the five best. You can pick the five Tiger Cubs, you know, whatever you want. And they just have to outperform the S&P over a 10-year period. Not just the S&P, specifically the Vanguard 500 Index Fund. I know, it's cool he named it.

3. 2:31:54

   It's really cool that he named it. It's good for Vanguard. So this also just tells you kind of everything you need to know. old Only one person took him up on the bet. You do know who this is. Of course I know who this is. Of course you know who it was. Our friend. Ted, I'm sure you are listening. Friend of Acquired, Ted Saides, host today of the Capital Allocators podcast. The only hedge fund industry manager that took Warren up on his bet and accepted the challenge.

4. 2:32:22

   And as Ted would be the first to tell you, he got whooped. It didn't look that way at first. The hedge funds were off to a good start, but in the fullness of the decade, I don't have the numbers in front of me, but it was something like the S&P performed like 130 something percent and the hedge funds in aggregate were like 30 to 40 percent. I've got the numbers right here. Yeah, it is not even close.

5. 2:32:45

   So the Vanguard 500 Index Fund over the 10 year period blows away Ted's selected hedge fund portfolio so much so that Ted ends up conceding early to Warren. Wow. Yeah, like a year or two before it's over, Ted's like, Warren, you won. What charity am I making the checkout to? So when all is said and done, the Vanguard 500 returns a total of 126% net after fees for the 10-year period, while the hedge fund portfolio returns just 36%.

6. 2:33:20

   So, yeah, what's that? Over 10 years. Over 10 years. Yeah. And yes, Ben, the charity that the check is made out to is Warren Selects Girls Inc. of Omaha as the recipient of the money. I wonder, we got to ask Ted if it was an option to pick the Rentech Medallion Fund. Oh, that's a good question. So Ted, it'd be fun to ask him. He actually chose five hedge fund of funds to get a total basket of about 100 different hedge funds in the portfolio.

7. 2:33:51

   And Warren said like, yeah, sure, that's fine. Because then you're just buying the average. And the extra fee layer on top of the fund of funds, too. Yeah, what? Yeah, I'm not sure why he made that choice. But either way, Warren wins. But truly, the more diversification you get, the more you're just buying the market. And the more you're buying the market, the less interested you should be in paying fees.

8. 2:34:12

   You should pay fees when it's more concentrated and thus uncorrelated with the market. Right, right. Well, either way, Warren writes in Berkshire's 2016 annual letter related to all this, quote,