Posted by Jay Livingston
“A bet is a tax on bullshit,” says Alex Tabarrok. Most of the time though, even when the losers are paying up, they still reject the notion that their position was bullshit.
Heather MacDonald (see the previous post) didn’t put actual money on her prediction that the court-ordered curtailing of the NYPD stop-and-frisk policy would increase crime, but if she had, even while she was handing over the cash-filled envelope, she would be insisting that her views about policing are correct. It’s easier to give up your money than to give up your ideas.*
That’s true even when the money in question is a million dollars.
In 2007, Ted Seides, a hedge fund manager at Protégé Partners, and Warren Buffet made a million-dollar bet.** Buffet was a hedge-fund skeptic despite all the tales of hedge funds elevating their investors from merely wealthy to filthy rich. Basically the bet was whether the hedge funders would outperform the market over the next decade. Seides selected a pool of five hedge funds; Buffet took the market – the S&P 500.
It’s 2018, and time’s almost up. Let’s turn up the cards over and see who won. The hedge funds showed an average yearly gain of 2.1%; the S&P, 7.1%.
In Bloomberg piece yesterday (here), Seides conceded: “With eight months remaining, for all intents and purposes, the bet is over. I lost.”
The title of the article is “Why I Lost My Bet With Warren Buffet.” The more accurate title would have been “I Lost But That Doesn’t Mean I Was Wrong.” Seides argument is basically that this was an unusual event. “S&P 500 defied the odds” with its “anomalously strong relative performance.” He makes the analogy to a single showdown hand of hold ’em. You expect that the pocket aces to stand up against the 7♣ 4♦. But every so often, the next five cards will include a couple of sevens.
But when you use five hedge funds, not one, and 500 stocks; when you use a ten-year period rather than a day or month or even year; then you greatly reduce the chances that the outcome is a freakish event.
The trouble, Seides says, is that over the past decade the market has gone up, not down. Alas. Hedge funds do much better when the market tanks. Thus he persuades himself that his ideas are still right. In fact, he’s ready to go double or nothing.
| 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. The S&P 500 looks overpriced and has a reasonable chance of disappointing passive investors. Hedge funds mitigate risk in bear markets, while seeking to participate in some of a bull market. Investing in hedge funds is a bet against continuing bull markets; investing in the S&P 500 is a bet on a continuing bull market. [emphasis added] |
Buffet’s principle reason for avoiding hedge funds is the high fees they charge their investors. Those high fees pay the salaries and bonuses of people like Ted Seides. No wonder he defends hedge funds despite his having just lost a million-dollar bet. As Mark Twain said, “It is very difficult to get a man to understand something, especially if his income depends on not understanding it”
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* The subject line of this post is a reference to an old Jack Benny joke. (Benny, for you youngsters out there in the under-70 crowd, was a comedian whose persona included being a tightwad.) A robber points a gun at him and utters the cliche robber line, “Your money or your life.” Benny hesitates. The robber repeats, “Come on buddy, your money or your life?” “I know,” says Benny, “I’m just trying to decide.”
** The actual amount they put on the tables was $320,000, a sum that after ten years would probably be worth $1M. It turned out to be a bit more. See this Business Insider article for details.
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