In Covid-19’s ‘Kangaroo Market’, passive investments (example of a passive approach is to buy an index fund that follows one of the major indices like the NIFTY50) outperformed actively managed funds (has a team of managers all making investment decisions for the fund), leading many to question whether the added costs of active management are worth it. While financial markets have shocked everyone during this chaotic period, many consider that the current market figures do not reflect the true perception of the economy. To examine this situation further, we look at a historic bet which took place in 2005 and withstood the brunt of the 2008 financial crisis.
(Credits: u/theahsbdjdbfn on Reddit)
On February 24th, 2018, Berkshire Hathaway Inc. CEO and Chairman Warren Buffet published his annual letter to shareholders as a part of the annual report (2017) of Berkshire. Financial media companies such as Bloomberg, Wall Street Journal and FT cover these annual letters akin to the launch of the iPhone for the tech industry, that is, it is safe to say that the documents are widely read. After 4 days of studying through the entire report, financial analysts all over the world released their takeaways. Whether it was the announcement that the firm had US$ 116 billion in cash and holdings, the US$ 29 billion Berkshire Hathaway made because of the 2017 US tax reforms or the US$ 3 billion hit the company’s insurance/underwriting business took (due to the recent tragic hurricanes which took place in the North American Region), it is safe to say that the report didn’t disappoint and lived up to the expectation of its equivalence earlier mentioned.
Perhaps, the most interesting thing that Mr Buffet mentioned in his annual letter was the US$ 500,000 bet he had publicly wagered against hedge fund managers in 2005. He believed that “active investment management by professionals – in aggregate – would over a period of years underperform the returns achieved by rank amateurs who simply sat still.”
He had explained that the massive fees levied by a variety of “helpers” would leave their clients – again in aggregate – worse off than if the amateurs simply invested in an unmanaged low-cost index fund. He had further argued that no investment pro could select a set of at least five hedge funds that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees.
Here is an excerpt from the letter:
“What followed was the sound of silence. Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their stock-selecting prowess, only one man – Ted Seides – stepped up to my challenge. Ted was a co-manager of Protégé Partners, an asset manager that had raised money from limited partners to form a fund-of-funds – in other words, a fund that invests in multiple hedge funds.”
The name of the hedge funds selected by Mr Seides for his side of the bet were not disclosed. The basic terms of the bet are public. By the end of the bet on 31st December 2017, $1 million invested in the funds chosen by Mr Seides would have gained $220,000 in the same period that Mr Buffett's investment would have earned $854,000. Mr Seides surrendered the wager in May 2017 as Mr Buffet’s investment bet was so far ahead.
"For all intents and purposes, the game is over. I lost," Mr Seides wrote in a Bloomberg post where he gave a multitude of reasons for why he lost, including that "passive investing is all the rage today and the S&P 500 is the most popular index." Mr Seides also said that it is unlikely that “history will repeat itself.” The money won by Mr Buffet now supports Girl's Inc. in its efforts to inspire young girls to be "strong, smart, and bold" through direct service and advocacy.
Every trading guru on earth has an opinion about low-fee, passive index investing versus actively managed investments. The Buffett-Seides contest provides fodder for arguments on both sides. While Buffett won according to the terms of the bet, the hedge fund side showed the merits of a bit of extra tweaking and pruning following the 2008 crash, which put them ahead of Buffett's Vanguard fund until 2012. But in the long-run, Mr Buffet won the war.
But in the long-run,
“we are all dead.”
Gautam Marwah is the founder of Indianaut, a platform showcasing and strengthening India's next best analytical and creative minds.