Value Investing

The Deeper Lesson Of Losing The “Buffett Bet”

Endowments and foundations routinely allocate capital to a diverse portfolio of alternative investments, including hedge funds, private equity and venture capital. But most struggle to beat a passive index. That reality – the futility of the strategy pursued by many supposedly sophisticated investors – was painfully illustrated by the “Buffett bet.”

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See 2017 Hedge Fund Letters.

Charles Munger

The bet was a $1 million wager made almost 10 years ago, and put the 10-year performance of the S&P 500 against a selection of five hedge fund-of-funds from 2008-2017. You can read more about how Protégé ended up on the losing side of the bet with Buffett in my recent article featuring an interview with Seides.

Jeff Tarrant delivered a keynote speech at the MIT Sloan 2018 Investment Conference on March 16, where he discussed why Protégé lost the bet but still considers it a win. Our readers can judge whether Tarrant is justified in his rationalizing of losing the bet, but everyone should question whether a diversified fund of hedge funds, with its high fees, can beat a low-cost index over a 10-year time horizon.

He is the founder and chairman of Protégé Partners LLC, a fund of hedge funds, and of MOV37, which specializes in machine-learning investment strategies. Tarrant’s reputation as an investor came into the limelight when he worked with John Paulson to use credit-default swaps to successfully bet that the housing bubble would collapse during the financial crisis.

I’ll explain why Tarrant claimed that losing to Buffett was a win for him, but first let’s look at how the wager was set up.

How the bet played out

“I actually didn’t make the bet with Buffett,” Tarrant said, “it was my partner, Ted Seides, who took Buffett up on it when he was at Protégé.”

“Buffett was saying ‘I want to bet hedge funds against the S&P 500,’ so we took him up on it,” Tarrant recalled, explaining how the pair’s newly founded firm, Protégé, ended up backing the wager.

“Originally, the bet was supposed to be 10 hedge funds, but then Buffett found out we were a fund of funds,” Tarrant said.

“So [Buffett] said we should pick five funds of funds, which was actually a really smart thing for Warren Buffett to do,” according to Tarrant. “Because that means you end up with five funds of funds, each having 25 managers – so you end up with something like an index of hedge funds,” he said.

Presumably – and logically – Buffett reasoned that the more diversified were Protégé’s investments, the less likely it would be that one or two strong performers could deliver the returns that would beat an index. That is essentially the same logic followed by endowments and foundations in their pursuit of alpha.

Tarrant explained that the bet was prefunded 10 years ago, when Buffett and Protégé anted approximately $320,000 each. That amount grew to $2.2 million, which went to Girls Inc. of Omaha, Buffett’s charity of choice, when he won.

“But I like to look at the positive things in life, and I feel like we kind of won,” Tarrant said.

Read the full article here by Marianne Brunet, Advisor Perspectives