Buffett way ahead in $1 mn wager against hedge funds

Billionaire investor Warren Buffett speaks at an event on September 18, 2014, in Detroit, Michigan (AFP Photo/Bill Pugliano) (Getty/AFP/File)

Washington (AFP) - On the eve of the 2008 financial crisis, a US hedge fund chief bet $1 million that his complex, high-cost strategies could beat the plodding approach of investment guru Warren Buffett.

Seven years into the 10-year wager, Buffett -- already the world's second-richest man -- is winning hands-down, the hedge fund head grudgingly admitted Thursday.

"We sure look wrong," wrote Ted Seides, president of Protege Partners, who made the personal bet with Buffett, founder of the wildly successful Berkshire Hathaway investment house.

The two bet over whose investment approach would come out ahead in the 10 years from January 1, 2008. Buffet selected Vanguard's conservative, S&P 500-based Admiral shares, and Seides assembled a group of five funds that invest exclusively in other hedge funds.

Buffett's argument was that the high management and performance fees charged by hedge funds -- and especially hedge funds of funds -- wipes out the advantage they gain over more pedestrian investing styles from their complicated hedging strategies.

The result so far: Admiral shares are up 63.5 percent since 2008, while after the management and performance fees are stripped out, the Seides hedge fund of funds return to investors was just 19.6 percent.

Indeed, before the fees are netted out, the Seides funds only brought back 44 percent.

Seides though argued in a CFA Institute blog post that the unanticipated conditions of the post-crisis period -- particularly the Federal Reserve's still-in-place zero interest rate policy -- have been exceptional, and so not a reasonable gauge.

That, combined with investment managers' focus on the S&P 500, have tilted the gambling table in Buffett's favor, he said.

"These factors wreaked havoc on a bet, the prospects of which we initially felt quite confident about," he argued.

Moreover, he argued, it was not the fees that accounted for the poorer performance of the hedge fund of funds, so Buffett's thesis has not been proven.

"These seven lean years for hedge funds may go down in the annals of market history as a period driven singularly by central bank stimulus. Using that lens, it becomes less clear that the bet, if lost, proves that hedge funds are not worth an investment across a cycle."

Yet both approaches have proven inferior to how the money put up for the bet was handled. Together Buffett and Seides put $640,000 into a zero-coupon bond that would be mature at a value of $1 million after 10 years, to pay off the wager.

That turned out to be one of the best investments in the financial crisis. By 2012, said Seides, it was already worth $950,000, up 50 percent. The bond was sold and the money put in Berkshire Hathaway stock, and is now worth $1.7 million.

The real winner, then, will be the charity that gets that money when the bet concludes in 2018.