Ted Seides Concedes Bet with Warren Buffett | Hacker News Reader

Ted Seides Concedes Bet with Warren Buffett

bloomberg.com

182 pointsgreenburger130 comments

> "Comparing hedge funds and the S&P 500 is a little bit like asking which team is better, the Chicago Bulls or the Chicago Bears. Like the Bulls and the Bears in the Windy City, hedge funds and the S&P 500 play different sports."

That, to me, is a CRAZY statement to make. Both ETFs and hedge fund are financial funds that a person considers putting their money in with the intention of maximizing their return. To say that they "play different sports" is at best stretching the truth, at worst a lie.

> "The unexpected strength of the S&P 500 was a key contributor to Warren’s victory. Despite trading for a high multiple of earnings and facing an elevated level of risk, the S&P 500 performed in-line with historical averages."

So the "unexpected strength" came from performing "in-line with historical averages"?

He's saying that since the S&P is at a higher multiple, you'd expect returns to diminish since presumably its too high to keep growing quickly (and, potentially, turn into a bear/down market). So by performing at average, its actually out-performing what you'd expect given the conditions.

(Of course that's the theory, clearly the market isn't solely governed by its multiple and risk level)

I mean, he's a hedge fund investor. This is as pure of an illustration of Sinclair's quote about the difficulty of getting someone to understand something when their salary depends on them not understanding it as you're likely to find. Ted Seides wouldn't make the crazy amounts of money he no doubt makes if most people didn't fall for the hedge fund scam.

I agree with your first comment, but for the second: I think that means that high earnings multiples and elevated risk would normally result in returns lower than, rather than in line with, the average. So he expected what he thought would be the consequence of overvalued markets, but got averages instead.

Outside the context of this bet, there's quite a lot out there on whether unusually high multiples (I think the really popular one for discussions is Shiller's CAPE) do or do not predict returns, or whether they predict anything at all. The opinions usually range from "the market says this is the right price for this risk, so it must be right" to "we're going to crash", but it's not all that clear who's right. (I think Shiller's right about overvaluation—I'm not sure what Buffett thinks.) But it's a pretty old topic, so that one is definitely not something he made up just as an excuse.

> Both ETFs and hedge fund are financial funds that a person considers putting their money in with the intention of maximizing their return.

Retired investors are often more concerned with preservation of capital than they are with maximizing return. If you have a couple million in the bank and are withdrawing 4% a year to live on, you're probably more concerned about the SP500 dropping 50% than you are with making an additional 1% on your money.

> If you have a couple million in the bank and are withdrawing 4% a year to live on, you're probably more concerned about the SP500 dropping 50%

And then you have illustrious hedge funds that go out of business when the SP500 suffers a small blip [1]. In any case, paying 2-5% to a hedge fund doesn't seem very good business when you're withdrawing 4% a year to live on.

[1] https://en.wikipedia.org/wiki/Long-Term_Capital_Management

LTCM was a special bunch though, especially because of the astounding amount of leverage at play.

There are certainly more modern examples like Pershing Square which bet big on Valeant, Chipotle and (short) Herbal-Life.

If you notice, the common trend seems to be lack of risk mitigation.

The economic models of risk that most hedge funds use are...odd.

The lack of risk mitigation is perfectly rational because of the lack downside. If a manager creates a hedge fund that has a 10% chance of making $1 billion and a 90% chance of losing $50 billion, he's got a 10% chance of making $200 million and a 90% chance of making $0. That means his expected return is $20 million for a fund whose expected return is -$44 billion.

I'd like to understand what you mean by those numbers. Why does the manager's numbers for gain/loss differ from the fund's?

Because the fund manager's downside is capped at 0. Bankruptcy heals many ills.

Also because of the survivor effect: if 3 hedge funds do poorly and one does incredibly well, guess which fund manager gets interviewed on the news. And don't be surprised if the analysts decide that half of the funds were incredibly successful (since 2 of the 4 were really in a different category and shouldn't count).

I'd put downside capped at 0 and bankruptcy in different groups. At the very least you lost time. You probably also had some investment in the business. Downside capped at 0 would be some opportunistic investment using spare cash with a gain or 100% return guarantee.

But, you get the carry of some percentage which should pay for your time.

2 and 20. His scenario is a little contrived though

also, LTCM managers were partners in the firm.

You're kidding me, right?

What do you think "hedge" fund means?

Good luck on the next job if you lose a firm $44B

To be fair,I would pretty pissed off if I invested with Bill Ackman and he followed standard risk mitigation and diversification strategies.

The idea is to get concentrated exposure to stuff that's not just equivalent to being long the whole market.

That's why nobody invests all if their money with Pershing Square. It's just not what the fund is designed to do.

The idea of "hedge" fund is also to hedge their bets and preserve capital in-case of downside. Ackman doubled down on his biggest losing bet (Valeant), actually more than quadrupled down by taking up exposure to options that were almost worthless when he unwound the position.

The "hedge" part of "hedge fund" is a misnomer. The defining feature is that they're lightly regulated.

Historically, "hedge fund" was named after a private fund that did pairs trade by shorting one security as they long other to hedge their losses in a downturn or broader market decline.

Modern hedge funds use futures, swaps and derivatives to the same effect, hedge in "hedge fund" is in no way a misnomer and being lightly regulated is a direct consequence of them being limited partnerships which are not open to public or non accredited investors and not the other way round.

>Retired investors are often more concerned with preservation of capital

Retired investors should have a few years of draw-down available in low-risk investments to mitigate market risks. In retirement there should be very little dependency on market forces.

If you have a couple million in the bank that you're drawing down at 4% then why do you care what the S&P is doing even if you have another couple million there?

Depends entirely on when they plan to retire and life expectancy.

Yields went negative during the crisis and with 10 years since, have only returned to 75 to 100 bps while real interest rates still lie below 0%. 4% withdrawal rate with zero earnings/dividend/asset appreciation isn't very sustainable even with "a couple million" depending upon where they live and how big of a cushion they want.

Also - let's not forget that during a crisis, there can be a run on the bank which could lead to liquidity crisis where a bank might have it's position unwound in unfavorable terms where not everyone gets back what they put in. Even FDIC only insures 250k per account per bank, AFAIK.

You can in theory be retired for a very long time 115 - 55 = 60 years. IMO, you should at least target a 5% survival chance which likely puts you out 30+ years if you retire mid 60's.

>Both ETFs and hedge fund are financial funds that a person considers putting their money in with the intention of maximizing their return. To say that they "play different sports" is at best stretching the truth, at worst a lie.

They're playing different strategies. If you're a defense-driven team you play to win primarily be keeping the other team (call them the black swans) from scoring. To bring it out of metaphor, it's about risk-adjusted maximum return.

If you're an offense-driven team you're trying to put more points on the board. The S&P 500 is a decidedly long bet on 100%, large cap, primarily western corporate equities.

>So the "unexpected strength" came from performing "in-line with historical averages"?

Hedge fund guys are usually bears and as such they've successfully predicted 9 of the last 5 recessions. They're perpetually prepared for or waiting for history to be proven wrong. It is within that context that they are seeking a maximum return (and justification for high fees).

Just to be clear, you are agreeing with the post you responded to, right? That is, they are both playing the same game, but hedge funds use a different strategy.

Which is the point here. Their strategy is evidently a losing strategy. (Or, rather, suboptimal.)

* Their strategy is evidently a losing strategy. (Or, rather, suboptimal.)*

It was not their strategy that competed and lost. It was the strategy of paying them to play the game for you. Their strategy of running a hedge fund instead of an S&P 500 index fund could be working out very well for them.

Touché.

Hedge funds run that gamut from "bears" to "bulls", from value to speculation, from public equities to private equity and bonds and commodities. Renaissance is a market maker.

The only thing that "Hedge Funds" have in common is that they are private investment partnerships, and typically charge a percentage of assets plus a percentage of profits for their services. Based on their charters they can invest in many different ways.

Historically the term "hedge fund" arose because there was a popular class of private investment partnerships that sought to provide good risk adjusted returns by remaining hedged against possible market collapses. But those types of hedge funds are a small minority, and the label has lost all value.

Ted Siedes knows all of this, because he runs a fund of funds where he adds his own layer of fees to "hedge fund" fees in order to get his clients into the "best" funds. He's been selling the myth of "hedge fund" outperformance for a long time, which is why he made this bet. He's drinking his own koolaid, and it turned out to be made in Jonestown.

>They're playing different strategies. If you're a defense-driven team you play to win primarily be keeping the other team (call them the black swans) from scoring. To bring it out of metaphor, it's about risk-adjusted maximum return.

Yes, but that still reduces to a metric applicable to both investments; it just means you can't compare on return alone.

If hedge funds produce a slight higher return by but by taking significantly greater risk, that would be a legit strike against them.

  > they've successfully predicted 9 of the last 5 recessions

Have you transposed the numbers or is this an amusing reference to something?

It's probably saying that they invest as though recessions that didn't happen were going to happen.

That. It's an old joke about bear investors.

But as an investor, I'm not playing different sports. I'm looking to maximize returns while minimizing losses. A defensive team and an offensive team may have different strategies but their goal is the same: win the game.

Are you saying that "risk-adjusted maximum return" is essentially (rate of return, std. deviation), and that hedge funds are offering a lower rate of return in exchange for a lower std. deviation? Like how Treasury bonds offer (1%, 0)? I'm no hedge fund expert, but I've always assumed hedge fund claim to get higher rate of return than the S&P 500 through the brilliance of their active management (for which you pay them gobs of money). And in this experiment, over 10 years, the deviation of the S&P 500 compared to its expected average was about 0, and their returns (net fees) was about 25% the S&P 500. So even if the S&P 500 had less than average returns it would have still trounced the hedge funds.

Maximizing returns while minimizing losses is, ultimately, a meaningess phrase.

What you mean is maximizing returns under some specific risk acceptance. That risk acceptance is different between hedge funds and other funds. You choose the fund that matches the game YOU are playing.

They're two tools in the same toolbox. Yes, it might be weird to answer a question like, "Is it better to spend more money on a cordless drill or on a circular saw?", but people actually - and I think legitimately - ask questions like this all the time.

I'm trying to balance a group of concerns against a limited set of resources. How do I make intelligent compromises to get most of what I want and hopefully all of what I need?

All this answer tells me is that Ted is out of touch with the practical concerns of people of limited means.

They are playing different sports. Hedge funds aren't really about maximizing your return, they are about maximizing the profit of the firm that manages it. That could mean making customers happy by maximizing their revenue, but if they can just do a good enough job and convince their customers that they are doing an excellent job by taking advantage of imperfect market information (the market in this case being money managing), then they can extract the most amount of money sustainably from their clients.

Alternatively they could just use an index fund, and their customers would be better off, but then they would have to convince those customers they were providing enough value to equal their fees, which would be hard, and would likely result in many lost customers.

modern reading of entrails.

In that sense, airplanes and bicycles are all vehicles.

I think in the context of the article, that hedge funds over ten years would outperform the index, it is more appropriate to say that hedge funds are bicycles that look like aeroplanes

> "My guess is that doubling down on a bet with Warren Buffett for the next 10 years would hold greater-than-even odds of victory."

Great Ted, so instead of complaining about why you lost, just make the same bet again at even higher stakes.

a martingale betting system is spotted in the wild!

as long as he can persist to infinity, he will make money.

i don't know if ted can, but i suspect warren is an immortal lizard person of celestial intellect (and wealth).

Personally, I really hope so.

Maybe I'm too biased (in Buffett's favor) but this reads like Seides saying: Sure I lost but Buffett only won because he was lucky.

>> "My guess is that doubling down on a bet with Warren Buffett for the next 10 years would hold greater-than-even odds of victory." <--- Reeks of the Gambler's fallacy.

Gambler's fallacy has to do with independent uncorrelated events. The stock market is no such beast. I have no love for seides, but this is atrocious timing for him. To a certain degree your yield on the s&p depends on timing. I know many people who were hired when the s&p is high and fired when it crashed. For the hoi polloi, i.e. "not Warren Buffett", the s&p is often life-procyclical and they get screwed.

Atrocious timing? It seems to me that he got supremely lucky. Within the first 14 months of the bet he had the largest bear market in nearly a century. Isn't this where the "risk management" advantage of hedge funds comes in? And he still lost.

Oh, and his piece is littered with false comparisons (picking benchmarks post facto despite knowing he'd be compared to the S&P500 index total return) and falsehoods (international stocks, see VTIAX, have provided a positive return over the period he describes); hard to take him seriously at all.

Exactly this. Seides and Buffet are saying Buffet will win "unless they get a market crash" (the second in the 10-year period).

Yes, hedge funds seek to hedge their bets against bear markets, but if you require two major crashes in 10 years to break even with passive investing, the smart money should go elsewhere.

The average time between stock market crashes is roughly 8 years... so 2 in 10 isn't outrageous.

Yeah but not a sensible bet to take even odds on. It would be about a 20% chance assuming a Poisson distribution (probably entirely false, but you get the point).

Yea, he got the greatest gift he could ever hope for at the beginning of the bet, and couldn't remotely come close to holding that lead. How often in 10 years do you expect a market correction of that size?

He's spewing nonsense now because he got caught with his pants down. His livelihood depends on convincing people that "hedge funds" outperform, no facts to the contrary will ever be accepted by him. He will always mark it up to being unlucky.

It really was a terrible bet for Ted, because it has heavily publicized his fund of funds incompetence to his customers and potential customers.

"How often in 10 years do you expect a market correction of that size?"

These days it feels like the answer to you question is "one, on average"

Moreover, each peak will tend to exceed the previous, so it's unsurprising that Buffet's side is going smoothly. I believe in a universe run on the principle of maximal irony, so I foresee Seidel losing the bet, but by about 3-4 months.

2008 was arguably the biggest market crash since 1929, it was nearly a 50% drop in less than a year. 1973-74 and 2000-2003 were nearly as bad over longer periods, but nothing else comes close.

Seidel literally got a market crash that occurs maybe once every 25 to 50 years and still couldn't win this bet. If he got two crashes he'd still lose because his hedge funds are rowing backwards 4% a year due to high fees.

I think you also missed a part of my point, which is that if you're not warren buffet or a programmer that has a steady six figure job, employment can be procyclical. You can more easily get jobs and pay hikes when the market is up, so your ability to invest peaks during the tops of the cycle, and you are at risk of things like unemployment at the bottom of the cycle.

Yeah hedge funds suck because they have high fees, but there's this Buffet-worshipping 'common man' implication that 'common man' should not be jealous of the rich man that has access to hedge funds because the S&P is just as good.

> Gambler's fallacy has to do with independent uncorrelated events. The stock market is no such beast.

Maybe I'm not remembering correctly, but wasn't there a bit of research a few years ago that showed that most investors performed worse than throwing darts randomly at a dart board (of stocks)?

EDIT: Obviously, I know next-to-nothing about the stock market (etc.).

There's the case about the active investors vs a cat (and the cat won). https://www.fool.com/investing/2016/08/01/a-cat-outperformed...

Are you suggesting I should have a (fat)cat as an investment manager?

Fallacy could confuse either side of that bet: the gambler's fallacy if he lost, the hot hand fallacy if he won.

It seems like he had a reasonable justification for expecting a reversal of fortune in this case-- the US bull market cannot continue forever, and hedge funds traditionally outperform in bear markets and beat the S&P when global markets are stronger than the US.

If he thought he needed the market to produce returns in the bottom 10-20% of it's average decade returns, it was a terrible one, he's a 4-1 or 9-1 dog. Or maybe he thought the market was overvalued and that it was closer to 50-50 that it would have a bad decade. But that's still a 50-50 bet, no big edge for him.

And in both cases the reality is that he's giving up 3-4% a year in fees to the index. That's a huge edge for the index, he'd need the worst decade in history to beat that.

Anyone who has every analyzed long term hedge fund returns comes away convinced they are terrible. Those fees are just far too high to overcome for 95% of the funds.

Strange that he doesn't even mention let alone discuss that the primary reason he lost may just be the reason Buffett originally cited which was the high fees of hedge funds/active management. That in most if not all market conditions, high fees preclude a better average return than index funds.

The only reason Seides provided which I found somewhat persuasive was that hedge funds tend to do better in downturns -- this is probably a traditional hedge fund that's actually hedged. I wonder if adding such hedging to an index fund in an automated way would improve performance or not?! Not sure if it's been tested.

Yea, it's actually likely that many investment managers have skills that can beat the market. But it's been proven that the vast majority cannot, after fees. Those that have "skill" have an edge that is so thin that 2% a year evaporates it (mutual funds). With Hedge Funds charging 2% + profit share, it's an even heavier burden.

Guys like Buffett that beat the market by 7-10% a year over decades are nearly unicorns in rareness.

The secret is that Buffett isn't beating the market by 7-10% a year over decades. He's not a hedge fund prodigy, he's a management prodigy.

His companies beat the market because he is the antithesis of the quarterly-numbers-driven model of Wall Street. He focuses on fundamentals, long-term value, and having leadership that's on the same page. He makes sure his businesses aren't underspending on fundamentals or overspending on inessentials, and then he gets out of the way.

Saying that Buffett "beats the market" is like saying that a sports coach is really good at picking winning teams. His companies outperform the market because Buffett enables them to outperform the market.

(on top of that, yes, he's a savvy investor and he's made some ballsy calls - but absent his management I doubt you would see him doing better than the 2% that other actively-managed funds can earn above the market return)

Your information is incorrect.

As an investor - not as a manager - Buffett stomped the market for decades prior to the modern concept of Berkshire Hathaway becoming the business model.

Numerous other Graham disciples likewise stomped the market over long periods of time.

https://www8.gsb.columbia.edu/articles/columbia-business/sup...

Going further, other well-known value investors applying similar approaches (by their own admission), stomped the market as well. Those include the likes of Phil Fisher and Seth Klarman. The out-performance isn't subtle, it's dramatic, and it takes place over long periods of time.

How many Graham-trained "superinvestors" never beat the markets, though?

What "superinvestors" are you alluding to here? Are you suggesting that getting investment advice from Graham is sufficient to reproduce the kinds of returns he and Buffett have had? Because that seems like an unrealistic expectation, and a totally orthogonal argument to whether or not investors can "beat the market". It's like talking about Google and then asking how many other Stanford CS grads never went on to start successful tech companies.

Learning from somebody good doesn't automatically guarantee you'll end up being as good as them afterwards, for a variety of factors.

The point was about selection bias: just because you can observe n successful Graham investors in the wild does not tell you how many Graham investors there were to begin with. Nor does it tell you whether the proportion of successful Graham investors is greater than the proportion of successful investors from other schools.

> Learning from somebody good doesn't automatically guarantee you'll end up being as good as them afterwards, for a variety of factors.

Exactly the point. How many students did Graham have over the years who flunked out, or went on to underperform the market?

How many articles got written about those guys?

I think beating the market was way easier in earlier times because the markets were less efficient. These days everyone have data and watch metrics.

Metrics are useless without philosophical and psychological commitment to the process. Many mediocre value investors can do valuations all day, understand moats, and then allow tons of biases to cloud their thinking and panic at the worst times. Then there's the guys who do valuations, then look at the charts to pick entry/exit point s, as if they can predict price action. With so many people doing it wrong, is there any reason to doubt the market is still inefficient?

Buffett has never used computers. He reads financial reports. He doesn't want to know the market price until he's estimated a valuation, so he doesn't bias his decision. He's not staring at the tape or CNN so he doesn't get wound up to make knee jerk decisions. He sits around and reads and learns.

Replace the word value investor with lottery winner and perhaps the logical error you're making will become more obvious; one can name lottery winners all day long, it doesn't validate their strategy, it's simply survivorship bias. I'm not saying value investing doesn't work, just that your argument for it is ill formed, pointing out successes is not a rational argument for something. You have to know how many failures there are as well and need the same information for other strategies you're saying are less effective.

Ex fund manager here. Some things about this bet that need to be mentioned:

- It should be risk adjusted. No idea how the numbers come out, but what's the sense in comparing the return without the accompanying variance? For example if the S&P has 15% vol over the period but the hedge fund 30%, that factor of two needs to be taken into account somehow.

- Management fees of 2% are clearly too high for this day and age. They came about historically when hedge funds were collections of small amounts of money, happy to take large risks. If you're willing to have volatility of 36%, paying 2% a year is going to be different from paying 2% for 12% vol. Part of the reason vol is lower is institutional investors are not HNWs. I used to run a fund that ran 36% vol as a target, and the IIs came to us and said they couldn't present it to their superiors. The explanation that you could just put less capital in didn't seem to resonate with the box checkers. Must be something that Kahnemann and Tversky could illuminate.

- I'm not sure the thing about the S&P being unnaturally strong is a valid excuse. If you're a hedge fund, you are free to just do a leveraged play on the S&P, thus beating it if you think it's going up. Same goes for what will inevitably come up, the extraordinarily loose monetary policy following the crisis. Whatever caused the S&P to go up, you could have bet on it.

- The bets are against funds-of-funds, which compound fees. You might be paying 2/20 to the underlying funds and 1/10 to the manager of this portfolio. That's a pretty big chunk. Normally what the FoF says to its customers is they have access to funds that others don't, through good relationships gained over years. Though looking at the summary in Buffett's letter it looks like even if you added ~30% for the 10 years of fees to each group, you still wouldn't beat the S&P. But that's just my late night eyeballing, perhaps with the performance fee it would be in the ballpark.

- Buffett stipulated it had to be multiple funds-of-funds, probably because this would mean you'd get S&P with costs. What else are a bunch of mainly American hedge funds going to invest in, given you have hundreds of underlying funds? You might get the odd emerging markets fund, but they'll be swamped out by the hundreds of generic funds that just punt some US stocks. Restricting it to funds-of-funds is actually pretty smart, because FoFs are going to tend to be conservative and take a selection from the buffet (yeah I said that). Allowing individual hedge funds might have given a very different result.

Yeah this bet was not a smart one for Ted given the terms. I'd gladly take it with a few slight revisions though:

1) The hedge funds don't have to be "funds-of-funds", and

2) I can choose the hedge funds.

But I suspect Buffett wouldn't take that bet. He strikes me as someone who doesn't take bets without knowing pretty well in advance that he'll win.

It also sort of alters the claim from "hedge funds as an industry will beat the S&P 500 overall" to "elite hedge funds can consistently beat the S&P 500." But given that he is a fund manager, I have no idea what Seides was thinking trying to claim the former.

Yeah, its not like he gets paid to make smart bets or anything... oh wait!

Well it's good no one paid him for this bet because it was a shitty one. He could have chosen sensible options like Rentec or Baupost. Clear failure there...

It was Seides's idea to make it funds of funds and he could choose them -

http://archive.fortune.com/2008/06/04/news/newsmakers/buffet...

5 hedge funds I'm not sure would make a lot of sense, too small a number to diversify, funds wind down.

The hedge funds were winning for the first few years with the crisis. A straight up stock market is not great for the hedge fund side.

Also worth noting that Buffett is an active manager and claims he could beat the S&P by a large margin if he was managing a smaller portfolio. And he's said the efficient market theory is dumb and makes his job easier. He tells people to put their money into index funds and then does the opposite. From his perspective he's talking his own book, if there is another Warren Buffett level talent out there, no need to tell everyone to find the best competition and back him, might as well tell people they're wasting their time, just buy the index.

There are comparable talents to Warren Buffett, and Seides could have chosen them. If Jim Simons wasn't retired, I'd happily give up the legal right to invest in the S&P 500 ever again just to invest with him if that was somehow a requirement.

Instead, Seides did...whatever this silly attempt was. I get that the "fund of hedge funds" clause was his idea, but it was stupid.

I use the word "stupid" unironically, fully self-aware of potential Dunning-Kruger, and I reiterate - there was nothing sensible about his taking the bet at those terms. It was never a defensible position that hedge funds as an aggregate industry outperform the market - maybe before the turn of the century, but not after the market became saturated with every Tom Dick and Larry with a shingle outside their doors.

Even if it fundamentally changes the goal of the bet, Seides should have had different terms if he really wanted to win.

I'm interested: with Jim Simons, is it some acumen you believe in, some method he employs, or some connections/stature that leads good deals to his door?

For instance, with Buffett, it seemed his stature, historical perspective, and means allowed him to invest $5B in Goldman Sachs at the near height of panic, under terms that very few were able to get.

(Caveat: I don't know anything about Simons, but I'm very curious about the basis for your claim/offer, knowing that in the HN crowd, you have a lot of industry experience.)

Buffett will tell you value investing isn't just being good at valuing investments, its practicing dozens of little techniques to eliminate outside influences from your thought process, so you can make rational decisions in every market. Some smart investor fail because they can't control their own psychology.

Read the Mr Market parable for an overview.

I'm aware of what you're saying about Buffett (he is essentially an excellent and influential business magnate, not just an excellent investor), but it doesn't apply to Simons. He's a mathematician (Chern-Simons theorem), and his investing methodology is utterly different from Buffett's.

Simons' firm, Renaissance Technologies, doesn't do value investing. They were one of the first hedge funds to do quantitative financial modeling. I suspect a lot of what they do is market making instead of purely directional trading, but it's hard to know since the fund is incredibly secretive. Simons' business connections or acumen in the traditional sense have nothing to do with the fund's success; it's entirely about the strategy they employ.

Thanks for the clarification and explanation.

> Also worth noting that Buffett is an active manager and claims he could beat the S&P by a large margin if he was managing a smaller portfolio. And he's said the efficient market theory is dumb and makes his job easier. He tells people to put their money into index funds and then does the opposite. From his perspective he's talking his own book, if there is another Warren Buffett level talent out there, no need to tell everyone to find the best competition and back him, might as well tell people they're wasting their time, just buy the index.

Buffett already can't exploit his ideas and opportunities he sees because his scale is simply too large. So he doesn't even need to con investors into buying the S&P500. Your two points are in direct contradiction.

It is possible that he realizes 99.9999% (read the Superinvestors of Graham and Doddsville) of investors are far better off with S&P500 index investing than actively picking stocks, and that he doesn't need to tell the 0.0001% anything because their skill will manifest itself.

Volatility isn't risk.

If I own a machine that legally prints a new hundred dollar bill for me every day, I might be able to sell it for a half million dollars most days.

If one day I check the market and find that it's p crashed and magic hundred dollar bill printing machines are now selling for only $10,000, I haven't lost a penny. In fact I'm about to become much wealthier because I'm not selling, I'm just going to keep printing hundred dollar bills and buy more machines.

Risk is when you overpay for an investment, or don't know how to value it, or are merely speculating. If you can't predict reasonably accurately the future cash flows of your investments, you are taking a lot of risk. Volatility is opportunity.

> Warren and I have written during the past two years that he will win the bet absent a market crash. Hedge funds tend to significantly outperform in bear markets, as demonstrated in 2008 and 2000-2002.

This bet started in January 1st, 2008 shortly before the market crash of 2008. What could Ted Seides mean by bringing this up? It seems to just reinforce Buffet's win.

I think he is pointing out that if you look at the 2008-2009 timeframe, the hedge funds had a loss of roughly 5-15%, while the S&P500 had a loss of roughly 20%. The hedge funds did better in bear markets... they just don't do well enough in bull markets to make up the difference over a 10 year period with only a single crash.

In a theoretical world where modern hedge funds were in business between 2000 and 2009, we might have come to a different conclusion: there were a number of down markets during that time and hedge funds might have been able to do much better.

He meant that with a second market crash he might have won.

Well, this almost 10 year period didn't teach anything to this guy, or, more probable, he's just trying to defend a rigged industry.

Basically, he's saying that Warren won by luck, while in truth it wasn't even close. It's worth to state this clearly - the passive index did a 85.4% return up to date, while the five funds did 2.9%, 7.5%, 8.7%, 28.3%, 62.8%. You do the math.

If there is one guy in this world that understand how economy and markets work, it's Warren. And he has a ~60 years track record to back this up.

His point about the biases of the S&P 500 are valid but his conclusions are not. There's a point where even he acknowledges that hedge funds saw comparable performance to a separate passive fund (MSCI All World I think?).

Even if his thesis around the S&P 500's value is correct (which I agree with) it doesn't mean that passive investments as a whole will be outperformed by equivalent hedge funds. I'd be curious to see what the performance of hedge funds that were effectively "US-only" was, my suspicion is that they weren't in line with the S&P further invalidating his conclusions.

Comparing to an incorrect benchmark (MSCI All-World) post-facto isn't exactly a get out of jail free card for trailing the benchmark that was known at the time of the bet. It just shows you're pretty desparate for excuses.

I clicked on the link expecting to read an elaborate version of "I lost the bet because I was wrong," perhaps followed by a detailed inquiry into the facts and reasons that motivated Buffett -- a man with a long history of NOT losing bets -- to take the other side of the bet. That's what one is supposed to do when things go wrong, right?

Instead, Mr. Seides lays out in this article six reasons why, despite losing the bet, he's still right.

Which begs the question:

Why did he agree to the bet in the first place?

I love this part: >"But the S&P 500 defied the odds and rewarded investors with a historically normal 7.1 percent nine-year annualized return."

He must know that 7% is something of a magic number, it's what Jeremy Siegel argued is the steady, annual inflation-adjusted gains for equites for the past 200 years in his seminal book "Stocks for the Long Run," which was written in 1994 and is the foundational argument for passive equity investing ("Irrational Exuberance" and others argue directly against it).

The fact that the S&P 500 did 7.1% over 9 years is only "lucky" if you ignore the precise argument that Buffet, Siegel and many others make.

Not quite. Seides' claim is that, at the start of the period, the S&P 500 was valued at the high end of its historical range. It is somewhat reasonable to expect that it would come down from that high instead of going higher.

... and the S&P 500 did go down from that high. Within a year after the bet was made, the S&P 500 crashed, dropping 50% of its value. But the S&P 500 still more than made up the returns to beat the hedge fund.

Translation: Even experts can get fooled into thinking they can time the market...

He did time the market correctly, and still lost.

... and still claimed that most of the time, he would win.

Hedge funds tend to do well under volatility. The steadiness may have been what he was referring to by "lucky."

If anyone was curious about how Berkshire Hathaway did over a similar period:

3 May 2007-3 May 2017

S&P 500: +60% Berkshire Hathaway A (BRK.A): +129%

Dude is good.

Berkshire Hathaway didn't distribute any dividends during this period; many companies in the S&P 500 index did, so this is not a good comparison.

The S&P 500 index total return still lost to S&P500 but by a more modest ~29%.

While we're on the topic, can anyone explain to me the purpose of paying dividends? When I try to look this up, all I get is the definition of a dividend. Wouldn't that money be better going back into the company, increasing its value to the investors the same amount, but now with more capital for innovation/survival? Why do companies incentivize investors to hold their stock?

The whole point is to make money for the owners. For any individual investor, they can sell, but not the owners as a whole.

Buying the stock back when it's undervalued might be a better way to do it, though.

From what I've seen, buybacks are often more about preventing dilution due to share-based compensation; they're effectively a tax-advantaged dividend. However, they can also be a sign of a company that has no better idea for spending their capital, which can indicate a decline in the ROI of their R&D. Could HP and IBM have done better with their cash over the last 10-15 years than buying back stock? Share repurchases seem to obfuscate with plausible deniability whether the intent is to return capital in a tax-advantaged way, or whether there's just a basic lack of faith in investing in new innovations.

Id rather just have the cash in my hand rather than some hypothetical increase in the share price.

Then again all my shares are in an ISA so I don't pay tax on dividends

Some companies are good at one thing and don't want to expand. They think investors have better opportunities outside.

Elegantly stated.

dividends usually come from mature companies (think coca cola and chase bank). a dividend signals that they're likely not going anywhere.

some investors like the guaranteed income. dividends are attractive in this regard, especially in a bear market.

some companies–like apple–just have too much money on hand so a dividend makes sense.

if you've saturated the market, it's usually less efficient to spend your profits trying to expand your business somehow than to simply let your investors take that return and invest it as they see fit.

Without dividends, stocks wouldn't exist as a financial instrument, as there's otherwise no payout for the person stuck holding shares of the company at the end.

In a purely rational market, the value of a stock should be the present value of future dividends that share will pay out. Price fluctuations reflect investors' changing estimates of what that ultimate payout will be, based on how well the company is doing.

Dividends or the expectation of asset liquidation. A company can wind down and sell its patents, for example. I suppose you could say the sales proceeds are dividends as well, but they're not what one typically thinks of as dividends.

On the investor side at least, some investors actually want an ongoing income stream, especially retirees or someone wanting a passive income. Paper valuations don't pay for groceries & bills & travel.

When bank savings interest rates are low (1 - 2%), shares with dividend payouts of 7% and higher look attractive, especially from a stable company (like a national supermarket chain or a telecommunications near-monopoly). And some stocks have a progressive dividend, ie they pledge to increase their dividend payout per share each year. (So in my case, one of the shares I bought about 10 years ago now pays out the equivalent of an 18% return to me in dividends every year.) As the dividend payouts increase, people are prepared to pay more for the stock, so it pushes the share price. (So that 18% yield stock has since tripled in price, as many investors are happy to just take a 6% return instead.)

18% yield is awesome. Care to reveal the name of the company ? If I were to take a guess, it would have to be Costco or AT&T

Eeek, that should have been 14%, not 18% (sorry, my mistake!).

I'm in Australia, and the company is Wesfarmers (WES.AX), an Australian mining company that diversified into retail, bought the second-largest supermarket chain in Australia, and now 87% of their earnings comes from retail. I bought most of my shares at the very bottom when they did a capital raising at $13.50 (start of 2009). Today it pays $1.98 annual dividend per share. (Today's share price is $43.29).

I've obviously cherry-picked my best example ;) But I also got close with JB Hi-Fi (JBH.AX), bought them at $10.24 in 2012, today it pays $1.09 annual dividend per share (so yielding 10.6% on the price I bought at, and the share price today is $25.65).

I wrote more about my method in this HN comment a couple of years ago:

https://news.ycombinator.com/item?id=10904190

Basically I look for stocks that are yielding 6 - 8%, check for a pattern of steadily growing dividends, and make sure it isn't suddenly high-yield because it's about to go bankrupt or in a dying industry.

Hope that helps!

I'm heading to Omaha tomorrow for my first $BRK shareholder meeting this weeekend. Super excited to hear Warren and Charlie speak and answer questions. Warren just has incredible discipline (way above most people). He does not let emotions get the best of him. All of his decisions and investments are calculated and thoroughly researched.

"People who mix their politics up with their investment activity.... I don't think that makes sense." -- Warren Buffett

The timing of conceding this bet is auspicious.

--Signed, another $BRK meeting attendee

For bet details: http://longbets.org/362/ [edit: grammar]

> STAKES $1,000,000 will go to Girls Incorporated of Omaha if Buffett wins, or Friends of Absolute Return for Kids, Inc if Protege Partners, LLC wins.

That's one hell of a charity name.

Edit: It seems it must be parsed as (Friends of (Absolute Return for Kids)), and good on them that they've renamed it since: https://en.wikipedia.org/wiki/Ark_(charity)

Also: We Think Girls Are The Greatest Thing Since Sliced Bread... we serve hundreds of girls every day.

"I have learned nothing." - Ted Seides

>"No. 2: Risk matters, eventually"

Isn't this exactly backwards??

>No. 6. Long-term returns only matter if we invest for the long term

>Studies of human behavior repeatedly point to the inability of investors to stay the course through tough times.

I'd like to see some studies of this with, for example, 401k accounts. Do people actually pull out of indices and into bonds when their the index is really far down?

I could see a marked difference in behavior between retirement accounts and taxable accounts; those with taxable accounts are probably going to feel much more like they need to do something, since they had to do something to make the buys in the first place.

To answer your question: Yes, investment flows tend to be trend following, people put money in when the market has been doing well and pull it out when it's been doing poorly. There are macroeconomic reasons for this, since people tend to be cash poor in downturns and cash rich in booms, but there also seems to be psychological 'returns chasing' behavior which hurts the median investor's returns. Here's a source using mutual fund flows, which shouldn't be fundamentally different than ETF fund flows:

http://www.businessinsider.com/blackrock-sp-500-vs-equity-fu...

I'm sure the claimed studies are out there, but there's a lot of evidence in the very circumstances of a market crash. Too much supply saturating demand, causing prices to tumble. The supply spikes because so many people start selling...

There are two main reasons why index funds outperform active funds.

1. Fees. Active funds start as underdogs because of their fees.

2. The distribution of returns in the stock market is very uneven. Just handful of well performing stocks at any moment account make significant gains in market. Index funds pick these winners every time. Active funds start as underdogs even in the stock picking game.

Why Indexing Works, Heaton , Polson and Witte, 2015. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2673262

> The risk of substantial index underperformance always dominates the chance of substantial index outperformance, with the difference being greater the smaller the size of the selected sub-portfolios. It is far more likely that a randomly selected (small) subset of the 500 stocks will underperform than overperform, because average index performance depends on the inclusion of the extreme winners that often are missed in sub-portfolios.

> defied the odds and rewarded investors with a historically normal 7.1 percent nine-year annualized return

I know, past performance is not an indicator of future outcomes, but when talking odds, surely decades worth of data showing historical returns in a similar range, the odds in this case would be skewed towards preferring a continuation of that trend.

What if (hypothetically) a large majority of investors started investing into index funds? For example, an enormous amount of retail investors are won over by this bet and believe passive investment in index funds will always lead to higher returns. Are there any ramifications of this situation that may cause inefficiencies where investing in hedge funds may lead to better returns over a period of decades? Should we all just dump our money into SPY and VTI now that Warren Buffett has won this bet? Or maybe Ted was just unlucky to take this bet during successive rounds of QE that pushed interest rates to historic lows and perhaps artificially turned more risky assets into the only vehicles for returns?

I have no strong evidence to back this up, but I believe that odds exactly why the price of the S&P500 in terms of price to earnings is so high right now.

If you look at where the money is moving, this is exactly right and it has already happened. Passive management is crushing the inflow numbers.

Perhaps this creates opportunities, but maybe not opportunities at scale.

OP made a sucker's bet for two reasons: 1. Fees, which he doesn't mention this write up 2. Hedging, which drags performance in up market years. Markets tend to move up over time, so the longer the outlook, the more likely he is to lose.

> "Although a market crash is highly unlikely in the near future..."

Statements like this are just harbingers of doom to me.

I think it's important to note that Ted's bet was in fund of funds, which require additional fees that would negatively effect his investment return regardless of its performance.

This bet remains the worst possible framing of a question "can hedge funds provide value?".

Some do, more don't. Active investing is negative sum so unless you've got some pretty good reasons to believe that the specific active manager [fund] has a market beating methodology then you should not be touching them.

Investing in a basically un-curated basket of hedge funds is a bad idea full stop and it was crazy to take the other side.

There are two separate issues.

1 The expected returns from the two investments. 2 The likley returns at the time the bet was made.

Someone is a sore loser.

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