So far, it's working out.
The Bus vs. the Private Jet
Yesterday, The Wall Street Journal’s Spencer Jakab reminded me of a wager that I had forgotten: the performance of the S&P 500 against that of five hedge funds of funds, or HFOFs. The bet occurred in late 2007, with hedge fund manager Protege Partners selecting five HFOFs to compete against Warren Buffett's selection of Vanguard 500 Index VFIAX portfolio. On Dec. 31, 2018, the 10-year results will be tallied. The loser must pay $1 million to charity.
At the time, Buffett's decision appeared odd. Hedge funds were regarded as one of the ways that the rich became richer. Index funds, in contrast, were a sound way of investing in mutual funds--but they were only mutual funds. How good could they be if anybody could own them?
Indeed, hedge funds had thrashed the stock market over the previous 10 years. Hedge funds had profited nicely during the decade's seven feast years and had also finished in the black during the famine of 2000-02, when stocks were thrashed. Over that period, HFOFs had trailed hedge funds themselves because of the cost of their extra layer of fees, but they were still well ahead of the S&P 500. From 1998 through 2007, HFOFs had gained an average of 9% per year*, with the S&P 500 at 6%.
*Stating the "average" hedge fund performance is always a tricky business, as hedge funds self-report their returns. As a result, one hedge fund database differs from another. The 9% figure is taken from Morningstar's database and includes funds that no longer report their returns as well as those that remain live.
The timing was not good for the stock portfolio, either. The wager was made after five straight years of stock market gains, when stock multiples were high and housing prices were already on their way down.
One year into the bet, Buffett's selection was far behind. Stocks plunged, and Vanguard 500 Index plummeted along with them. Although HFOFs did not dodge the 2008 downturn as successfully as they had dodged the technology-stock sell-off a few years previously, their 18% calendar-year loss was less than half that of the Vanguard 500 Index portfolio. HFOFs were off to a large early lead.
That bulge has now disappeared, and then some. The size of Vanguard 500 Index's lead is unknown because Protege has not released the names of the five HFOFs. However, the parties did state at the end of last year, when the bet was five years old and thus at the halfway point, that Protege's HFOFs had been virtually flat for the period. The S&P 500, in contrast, was up 8% cumulatively. With the S&P 500 rising another 29% this year, and most HFOFs treading water once again, the index fund's margin has become quite large. It's likely that Buffett's portfolio is now 30 percentage points ahead of the competition.
There are three reasons for Buffett's relative success.