Buffet bet $1M that S&P 500 ETF (VOO) index fund would beat hedge fund portfolio selected by Ted Seides. Low cost index funds performing generally better is well documented. Buffet's bet is common sense.
Reasons why:
- lower cost is important over longer term.
- Well diversified index fund picks every success, unlike actively managed portfolio.
I’m not claiming he was wrong but I’m not sure one can really reduce it to those few points as if it makes it all obvious.
[0] https://en.wikipedia.org/wiki/A_Random_Walk_Down_Wall_Street
But there was! That bet started in 2007, and 2008-2009 saw the biggest percentage drop in the S&P 500 in decades with the GFC. We're talking down to levels last seen in 1996, at the worst of it in March 2009.
You can compare portfolio performance through drawdown periods with backtesting tools.
Macroeconomic drawdowns are good times to have cash for acquisitions; instead of free government cheese.
"Tear Sheets: Definition and Examples in Finance, Vs. Prospectus" https://www.investopedia.com/terms/t/tearsheets.asp :
> While tear sheets date back to the old days when stockbrokers would rip individual pages out of the S&P summary book and send them to current or potential clients, most information is extracted online today. Therefore, any concise representation of a company's business fundamentals could be considered a tear sheet.
From https://news.ycombinator.com/item?id=24428206#24429801 :
> pyfolio.tears.create_interesting_times_tear_sheet measures algorithmic trading algorithm performance during "stress events" https://github.com/quantopian/pyfolio/blob/4b901f6d73aa02ceb... :
>> Generate a number of returns plots around interesting points in time, like [...]
From https://news.ycombinator.com/item?id=19111911 :
> pyfolio/examples/zipline_algo_example.ipynb: https://nbviewer.org/github/quantopian/pyfolio/blob/master/p... > "Worst Drawdown Periods"
Drawdown > Trading definitions: https://en.wikipedia.org/wiki/Drawdown_(economics)#Trading_d...
awesome-quant > Python > Trading & Backtesting: https://github.com/wilsonfreitas/awesome-quant#trading--back...
It’s funny because that streak of luck just seems to keep happening for most 10 year periods.
There have been quite a few 10-year and longer spans where the S&P 500 doesn't beat inflation. Did you realize that if you had invested in 1965 it would have taken you until 1990 to beat inflation? And that if you had invested at the peak in 2000, it would have taken you until 2015?
Even apart from inflation, there's some recent research which suggests that historically the stock market as a whole just hasn't performed as well as most people think. This paper was submitted by the author a few days ago but got no discussion here: https://news.ycombinator.com/item?id=38835832.
I'm not saying you're wrong, and I too hope something has changed, but do realize you might be assuming without sufficient evidence that the recent past is normal behavior. By historical standards, 2008 to 2022 really was an anomalous bull run.
And interestingly, the rise of intangible assets over time: https://anderson-review.ucla.edu/boom-of-intangible-assets-f...
Why leave out 2023?
the academic research even back then was pretty evident that a market cap weighted index fund has been outperforming hedge funds (over long periods like 10 yrs).
It's just that index funds way back, prior to vanguard, was not as easily accessible as it is today.
Properly used, a hedge fund should just be a drag on your portfolio, but you have it because you’re hedging against risks that others don’t even bother with (like, say, total US collapse).
In 2007, one of Bogle's more approachable books, "The Little Book of Common Sense Investing" came out, as a reference for this kind of philosophy across other writers: https://en.wikipedia.org/wiki/The_Little_Book_of_Common_Sens...
His math always worked but over time the returns have become more and more impossible to ignore.
(Interesting for those who follow Bogle he later pointed out an issue with index funds eating the world - what he called manager’s capitalism.)
But in reality managed funds usually freeze or even buy "opportunities" on the falling phase and short on the bottom (e.g. 2009), which causes them serious loses. Also they tend to miss the start of the bull runs (e.g. being bearish until 2011/2012).
If you read Kostolany (a contrarian), he talks about how hard it is to short correctly or to buy in the bottom, because going against the grain is hard.
Also known as “the market can remain irrational longer than you can remain solvent”.
Of course there are, but for how long? Long enough to rule out chance?
It should be easy to make a hedge fund that outperforms the market, as long as you make two more hedge funds which over the same period, don't.
The economic game theory around hedge funds is not pretty. By the very nature of the markets, if one really could consistently beat the market, it would be extremely rare and valuable skill, so you could charge fees for that service that would cover nearly all of the difference between your performance and market performance. Similarly, if you could identify funds that consistently would beat the market, you'd effectively be one of the people who could consistently beat the market. This means that pretty much all investors putting money in hedge funds can't really distinguish between the funds that consistently outperform the market and those that don't. They consequently have to rely on proxy signals. For the above reasons, one of those signals is... the fees. So, if you are running a hedge fund and you wish to convince investors that you can consistently beat the market, you should charge fees exactly as if you do consistently beat the market. If you don't, that raises a question in investors' minds as to why you don't charge fees commensurate with the service you are providing.
The end result is that a potential investor in hedge funds is faced with a bevy of difficult to distinguish choices, a small number of which might actually be able to consistently beat the market, but charge fees that eat up almost all of the difference in performance. The rest charge fees that would eat up almost all of the difference in performance if they did perform that well, but instead will perform worse overall, and consequently lose the investor far more money than if they just put their money into an index fund.
Over 20-30 years.
Private equity in the US averages 15% annual return, including funds that close/died with a total loss of capital.
Citadel hedge fund was 20% annual return to the investor after fees (individual years range from -10% to 50%). Before fees (that is; their stock picking ability) returns about 40-50%.
Not to mention quant/HFT firms that consistently do 40-80% annual returns over 15-20 years. No wonder quant TC is 2-5x the TC of FAANG AI SWEs.
All the above is closed to “retail” investors, though. It’s not fair, but that’s life.
For most people (less than $10M net worth), VTI/VTSAX/VOO is the best you can do.
The strategies that quant funds run are often capacity-constrained, so if they do 20-40% a year, it is non-compounding. That matters.
It wasn't popular common sense until buffet and Bogle proved it.
We are actually in that situation now where the gains of S&P 500 relies completely on the top handful of companies and as much as (IIRC) 70% of the companies in S&P 500 are lagging the market.
[1] This is not an endorsement; my personal experience with their pool was mediocre at best.
Reminds me of the gamblers ruin paradox. In some games even if the expected payout from each round is positive, it can be shown that the gamblers wealth goes to 0 over suffiently large time scales with probability 1.
In real life, the time scales are not long enough and the number of N samples in one’s life is too small.
This is why retirees over age 60 are concerned with “sequence risk”. That is, you get unlucky VTI/VOO/S&P returns for 5 years, but you don’t live long enough for the average to come back to 8-10%.
Downside risk becomes more important than average return.
I doubt that qualitative assessment holds up when you add some numbers.
As a thought experiment, imagine a portfolio that generally replicates the S&P500, but also sells covered out-of-the-money calls on all the stocks. (Whenever a call triggers, you re-balance your portfolio. Let's ignore transaction costs for now.)
According to the efficient market hypothesis, the portfolio sketched above will have roughly the same average returns as the S&P500. Especially if the calls sold are far-out-of-the-money.
It may well be outstanding and still not make up for it all.
> This is not an endorsement; my personal experience with their pool was mediocre at best.
That's the opposite of an endorsement!
That sounds like, at best, pretty great.
I believe I saw data that showed this has always been the case, but I can’t quickly find it.
Yes, but picking losers is a lot easier and winners a lot harder:
> We study long-run shareholder outcomes for over 64,000 global common stocks during the January 1990 to December 2020 period. We document that the majority, 55.2% of U.S. stocks and 57.4% of non-U.S. stocks, underperform one-month U.S. Treasury bills in terms of compound returns over the full sample. Focusing on aggregate shareholder outcomes, we find that the top-performing 2.4% of firms account for all of the $US 75.7 trillion in net global stock market wealth creation from 1990 to December 2020. Outside the US, 1.41% of firms account for the $US 30.7 trillion in net wealth creation.
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3710251
> Four out of every seven common stocks that have appeared in the CRSP database since 1926 have lifetime buy-and-hold returns less than one-month Treasuries. When stated in terms of lifetime dollar wealth creation, the best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926, as other stocks collectively matched Treasury bills. These results highlight the important role of positive skewness in the distribution of individual stock returns, attributable both to skewness in monthly returns and to the effects of compounding. The results help to explain why poorly-diversified active strategies most often underperform market averages.
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447
Over ten years, most individual stocks under perform a market index (even more so if stock was initially a top performer):
> […] Since 1926, the median ten-year return on individual U.S. stocks relative to the broad equity market is –7.9%, underperforming by 0.82% per year. For stocks that have been among the top 20% performers over the previous five years, the median ten-year market-adjusted return falls to –17.8%, underperforming by 1.94 per year. Since the end of World War II, the median ten-year market-adjusted return of recent winners has been negative for 93% of the time. The case for diversifying concentrated positions in individual stocks, particularly in recent market winners, is even stronger than most investors realize.
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4541122
Most stocks suck, and chances are generally low that you'll pick the non-sucky ones. Further, you have to buy when a non-sucky stock is or becomes not-sucky and then know when it does become sucky and sell before it drags down your returns.
And not only do you have to be "good", you really should be better than just going for market returns (via a low-cost index fund).
> But, what about stock picking? How long would it take to determine if someone is a good stock picker?
> An hour? A week? A year?
> Try multiple years, and even then you still may not know for sure. The issue is that causality is harder to determine with stock picking than with other domains. When you shoot a basketball or write a computer program, the result comes immediately after the action. The ball goes in the hoop or it doesn’t. The program runs correctly or it doesn’t. But, with stock picking, you make a decision now and have to wait for it to pay off. The feedback loop can take years.
[…]
> This is the existential crisis that I am talking about. Why would you want to play a game (or make a career) out of something that you can’t prove that you are good at? If you are doing it for fun, that’s fine. Take a small portion of your money and have at it. But, for those that aren’t doing it for fun, why spend so much time on something where your skill is so hard to measure?
* https://ofdollarsanddata.com/why-you-shouldnt-pick-individua...
Instead of saying 'most stocks suck', you should probably say that probability distribution of future prices of stocks is highly skewed, but current prices reflect the expected future price. Logically, the median stock (and thus most stocks) will trade above its future potential.
Suppose you had a lottery where 90% of tickets pay one hundred dollar next week. You wouldn't say those tickets suck. You'd be happy to own lots of them.
Now suppose I tell you that the other 10% of tickets pay one million dollars next week. That makes the tickets even more desirable.
But in an efficient market, all tickets will trade at approximately 100,000 dollars today. That will make it look like 90% of tickets suck. But both in lottery tickets and in stocks, suck-age is relative to prices paid.
If 60% of tickets paid X, and 40% paid 0, then tickets would trade for about 0.6 * X, and most tickets will look like they don't suck: most tickets almost double in value.
"Lose" also includes stalling such that as the rest of the market goes up, your portfolio does not do anything. It can even mean when the market goes up 5% your portfolio only goes up 3%.
Now compound this lack of performance over a few decades, both pre-retirement when accumulating, and post-retirement during decumulation.
Buy the index fund to get the market return, then pick out and short the 'losers' that either don't grow or grow slower than the index. Either way, you will have increased your returns.
This doesnt make sense. The "losers" in this case don't necessarily go down in price, they just go up in price less than the overall market. Shorting these losers would still lose you money.
Its easy to pick a stock that goes up less than the market, its hard to pick a stock that goes down (at least one that goes down by more than the cost to borrow and short it).
Not really. Standard and Poors evaluates the top 500 on a quarterly basis. The losing stocks are naturally purged from such index funds on a regular basis.
In any case, broader index funds / indices that don't eliminate users as quickly (basically, only when they stop trading on public markets), don't do worse. So the mechanism you describe is pretty much irrelevant to the success of index funds.
And so is the implied mechanism of 'picking all the winners'.
That caps your upside from infinite to finite. But you collect a steady stream of option premiums. The result doesn't look all that different on average from just investing in the plain index fund. You just get a different risk distribution.
(Similarly, you can invest in an index fund that tracks (junk) bonds. Upside is finite there as well.)