A Story About a $1 Million Bet
I was a little surprised when I checked the analytics to realise that the subscription list of this newsletter seems to have grown. There were names I do not recognise, people who have chosen – apparently willingly – to read this collection of financial musings. Either that or the previous readers – both of you – have elected to forward this newsletter on to poor unsuspecting people that you know. My heart goes out to them.
If you’re a glutton for punishment, all of the previous newsletters are listed on the blog section of the company website.
Anyway, enough nonsense. This month’s newsletter covers a long story about a longer wager, scam warnings, and the usual helping of good news. Enjoy.
The 10-Year Buffet Bet
Sorry to be a little cliché with the mention of Warren Buffet, but he is rather central to this story. You’ll see what I mean.
In 2008, the quintessential active investor and widely accepted – even at that point in time – best stock picker in the world offered up a sizeable bet to the rest of the financial industry. Warren Buffet staked $1m (today the equivalent value is $1,456,906.94 – source: U.S. Bureau of Labour Statistics) that the S&P 500 Index would beat any actively managed hedge fund over a ten-year period, net of costs.
“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.”
I’d best explain. ‘Actively managed’ means individuals or teams of people (sometimes quite large teams) trying to identify stocks that will consistently outperform the average performance of the broader stock market. In other words, active investors are people who believe that they can consistently “beat the market”. Hedge funds in particular will use a wide array of financial tools to try to do this.
You’ve heard of ‘shorting a stock’, which is making money when a stock decreases in value. Betting against something, in other words. That’s just one of the many ways in which a hedge fund may try to make money.
By comparison, an index is incredibly simple. There are no complex strategies, there is no shorting, there are no teams of individual stock researchers. An index is simply a way of measuring the collective performance of a group of assets. In the case of the S&P 500, it is the 500 largest companies in America. An index fund is simply a replication of the index itself. If the S&P 500 index was comprised of 500 companies, then an S&P 500 index fund will be comprised of the exact same underlying 500 companies, and it will measure the average performance of those companies, relative to their size and contribution to the index.
Sorry for the explainer, and back to the bet. Warren Buffet believed that, largely owing to the exorbitant costs that hedge fund managers charge and the minuscule fees that index funds charge, that any collection of hedge funds would not beat the S&P 500 over a ten-year period from 2008.
Ted Seides — then co-manager of Protégé Partners, an investment management firm in New York particularly fond of hedge funds – took the bet. He was confident that with the wide array of tools, the expertise of the stock-pickers and the expensive research teams, that his selected group of hedge funds would comfortably beat the “boring/average/unsophisticated” S&P 500 index fund.
Simplicity, as is often the case, was the ultimate form of sophistication. Results from 2008 to 2015 below:
Unsurprisingly, Buffet went on to win the bet comfortably. The winnings were donated to a female youth charity in Buffet’s hometown of Omaha, Nebraska.
At the end of 2016, Buffett's index fund bet had gained 7.1% per annum compared to 2.2% per annum for Protégé's picks. In cumulative terms, 85.4% to Protégé's 22%. Yikes.
Relevance to today
Whilst this might be an interesting story, you may be wondering what the relevance is today. A few things.
Number one, the marketing budgets of the hedge funds in question will be remarkably similar to most actively managed investment houses today - colossal.
What happened throughout the period of this bet – salespeople selling investors the concept of “beating the market” – goes on regularly today. You have only to click on any investment website, get on public transport, or show the slightest interest in an investment topic, and you will be bombarded with adverts from the actively managed investment industry. I won’t mention names, but you’ll see them.
For two recent examples of the active management industry going pear-shaped, you can Google either Neil Woodford (UK story) or Cathie Wood (US story). Both are similar tales. An active investor flushed with a superior performance history (which does happen from time-to-time, to give credit where it’s due) and a gargantuan marketing budget. The results are both predicable and depressing; money piles in, performance plummets, and people suffer. The Woodford episode in particular was a debacle.
Number two, as you have likely guessed from the tone of this email, I do not – and Purpose Financial Planning never will - advise clients to invest in expensive actively managed investment funds. The strategy that I use for my personal money is exactly the same strategy that I recommend to clients. I pay the same fees and invest in the same funds as the firm’s clients do – with the only difference being the risk profile/asset allocation of the portfolio. I think that’s important.
Scam warning
Never a bad time to remind ourselves of this, as the con artists seem to be ramping up their efforts recently. I receive at least one scam phone call per day, although my phone has developed this very useful habit of warning me when a number is a suspected spam caller. In that instance I am simply ignoring the call, which is working well so far. A lot of scammers use automated dialling systems calling every number they can, and only being passed through to a human when someone picks up.
Anyway, just a little reminder. Please be conscious of anyone calling you purporting to be from your bank, HMRC (they seem to love this one), Amazon, the post office, the list goes on. That’s not to say that every time someone from these companies calls you it is a scam, but it’s just a reminder to be vigilant. No-one will ever call you and ask you for your bank PIN, for example, and be very careful handing over card details.
HMRC - Bravo
HMRC have done a fine job with their app. In all honesty I’m not sure if it’s new or the result of a significant upgrade on what was there previously, but it is quite good. It’s easy to register, secured via PIN code thereafter, and will easily direct you to your state pension forecast, a tax calculator, your self-assessment details, the list goes on. Kudos to them, as anything that helps people avoid the long waiting times commonly associated with calling HMRC is a benefit to all.
The Optimism Prism
Your monthly dose of the good stuff:
New Prosthetic Hand Allows Man to Sense Temperature: ‘I could feel the warmth of another person’
Recommendations
A break from all things personal finance. I have just finished Shantaram, a 2003 novel by Gregory Roberts. Apparently, it’s very well-known and I am quite behind the times, but the latter part of that sentence is nothing new. It’s excellent, and if you’re looking for a new novel to absorb you, I thoroughly recommend it.
A bit of a random one – I’m a big fan of getting out and walking early in the morning. A very good way to clear the head and start the day. I tend to listen to audiobooks or podcasts, but when I don’t I notice that this is the time when my brain is throwing up all sorts of – sometimes good, sometimes not so good – ideas. It turns out I’m behind the times again - Nietzsche said that “All truly great thoughts are conceived while walking”.
The Six Nations. Going quite well this year.
The compliance bit:
This newsletter is for information purposes and does not constitute financial advice, which should be based on your individual circumstances.
The value of investments may go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
A pension is a long-term investment, and the value is not guaranteed. Any advice or considerations are again personal to each individual’s circumstances.
