Warren Buffett, one of the most renowned investors in the world, made headlines in 2008 with a $1 million bet that an S&P 500 index fund would outperform a selection of any five hedge funds over a decade. This bet, which started on January 1, 2008, has been widely discussed in the financial community and has provided valuable insights into the effectiveness of passive versus active investment strategies.
1. The Bet and Its Background
Buffett's wager was placed through a platform called Long Bets, a non-profit organization seeded by Amazon's Jeff Bezos. The bet aimed to demonstrate the power of passive investing, specifically using a simple S&P 500 index fund, against the best and brightest minds in the hedge fund industry.
Ted Seides, a co-founder of Protege Partners LLC, accepted the challenge and selected five hedge funds to compete against the S&P 500 index fund. The Protege funds generated an average return of around 22% over the decade, while the S&P 500 index fund returned more than 100%.
2. The Initial Setback and Recovery
The bet started poorly for Buffett as the S&P 500 index fund lost 37% of its value in 2008 due to the Global Financial Crisis. However, the hedge funds managed to reduce their losses to an average of 23.9%.
Despite this initial setback, the S&P 500 index fund recovered strongly in subsequent years. By 2014, it had outperformed the hedge funds significantly, leading Ted Seides to concede defeat two years before the official end of the bet.
3. The Final Outcome and Lessons Learned
By the end of 2017, the S&P 500 index fund had achieved a total gain of 125.8%, significantly outperforming the hedge funds, which showed gains ranging from 2.8% to 87.7%.
The victory of the S&P 500 index fund underscores the power of passive investing and the pitfalls of active management. The high costs associated with active management, coupled with the unpredictability of stock prices, severely diminish the net returns available to investors.
Burton Malkiels seminal work, A Random Walk Down Wall Street, provides empirical evidence supporting the inefficiency of active management and the effectiveness of passive investing strategies.
4. The Role of Fees and Diversification
Ted Seides argued that fees were not the primary factor in the S&P 500 index fund's victory. Instead, he suggested that global diversification and market risk played a more significant role in the hedge funds' underperformance.
The MSCI All Country World Index, which is a global equity benchmark, performed almost exactly in line with the hedge funds during the bet period, further highlighting the importance of diversification in investment strategies.
5. Conclusion and Future Implications
Warren Buffett's bet serves as a powerful endorsement of passive investing, a strategy that is both simple and effective. His victory underscores the importance of low-cost index funds and a disciplined rebalancing approach for steady growth.
As some experts suggest, it may be time to diversify investment strategies, especially given the recent performance of certain Warren Buffett-backed ETFs.
