Warren Buffett’s Index Bet: Year 6

Before the great recession, the Oracle of Omaha made a $1 million charity wager that an unassuming Vanguard S&P 500 index fund would outperform a portfolio of handpicked hedge funds over a ten-year timeframe. Six years in, who’s leading and who’s leaking oil?

Without knowing it, Warren Buffett and the leaders of hedge firm Protégé Partners picked a great time to make this bet. Since 2008 we’ve experienced a little bit of everything – a gruesome recession, the financial system teetering on the brink, drastic government bailouts, big fears about Europe, and a slow but steady recovery. So who’s fared better through all the thick and thin?

So far, Mr. Buffett’s S&P 500 pick has a big lead. For the six-year period, the index fund is up 43.8 percent while the unnamed funds that Protégé picked are up 12.5 percent. In 2013 alone, the Vanguard fund beat the hedgies 32 percent to 11.

A familiar pattern

We’ve said it before: we’re not surprised by how this bet is shaping up. With a big advantage on management expenses and no temptation to chase hot stocks or time the market based on predictions, the index fund has prospered by staying invested and holding tight. The hedge funds, with far more choices and tools at their disposal have apparently guessed wrong about what the markets would do.

What now?

Those choices explain the 31 percentage point deficit Protégé needs to make up just to get even in the bet.  31% difference!  That gap would easily get you fired in the money management business.  And it would leave a big hole in your portfolio if you owned the Protégé hedge funds.  The pressure is now on Protégé to turn in truly extraordinary performance in the remaining four years just to catch up.  That sounds like a recipe for a lot more risk for Protégé.

As we described last week, index funds seem like they would deliver just average performance, but they have consistently outperformed the majority of actively managed funds for decades.

Stay tuned for another update in early 2015. We’re expecting more of the same.

Our prior year posts: Year 5.  Year 4.  Year 3.

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