Only a highly confident investor would bet against Warren Buffett. But Ted Seides had the humility to admit that his loss of a $1 million wager is all but certain. Unlike what most believe, though, he said the high fees charged by his hedge funds were not to blame.
When Seides was introduced as the only man “brave enough” to answer Buffett’s call to place a bet against anyone where hedge funds would be pitted against low-cost passive investments, he was quick to clarify that he would be better characterized as ”stupid enough” to take on Buffett.
The bet, which was made almost 10 years ago, will be settled at the end of this year. The $1 million wager put the 10-year performance of the S&P 500 against a selection of five hedge fund-of-funds from 2008-2017. With hedge fund performance lagging throughout the last decade, Seides has conceded to losing the wager with Buffett.
The bet was prefunded 10 years ago, when Buffett and Seides’ former firm anted approximately $320,000 each. That amount has grown to nearly $2 million, which will go to the winner's charity.
Seides is the managing partner of Hidden Brook Investments, LLC, an advisory and private investment firm. He was a founder of Protégé Partners LLC, a multi-billion dollar alternative investment firm in the hedge fund space. Previously, he worked at the Yale University Investments Office.
Seides spoke at the University of Virginia Investing Conference on November 10. He talked about why he wouldn’t make the bet again, citing recent changes in the hedge fund industry as a concern.
I’ll come back to Seides’ thoughts on the decline of the hedge fund industry, but first let’s look at how he ended up on the losing side of a bet with Buffett.
Why Seides thought Buffett was the patsy at the poker table
Seides opened, tongue-in-cheek, by saying, “I really never get a chance to talk about it.”
Seides walked through how he first got involved in a wager that would lead to him being forever known as “the hedge fund guy.”
“I was sitting around my office in the summer of 2007, and at the time our fund was short subprime and long risk assets. I never slept better in my life,” Seides said.
“And the markets have a tendency to make it so if you’re doing well, you think you’re much smarter than you are,” Seides said candidly.
After a successful start with his newly founded firm, Protégé Partners, Seides decided to challenge Buffett’s claims calling into question the value of the hedge fund industry.
“I had heard that Warren made a statement about hedge funds to the market and he wrote something in an annual letter about fees,” Seides said.
“Then I saw a transcript of a Q&A [from an event Buffett attended] where a student had said to him, ‘Well, if you think the market could beat hedge funds, why didn’t anyone take you up on the bet?’,” Seides said.
“And his response was, ‘Well no one did, I must be right.’,” according to Seides.
“So I wrote him a letter,” Seides explained. “I tried to make it ‘cute’ enough that he would respond, and he did.”
“That started a series of letters that was very comical, a very ‘cat and mouse’ game, and that crystalized into the bet,” Seides said.
Seides looked back on his decision to take on Buffett. “I really only took the bet because I thought I would win,” Seides said, “and I actually still think there were very good odds of winning that bet, at the time. I still believe that.”
He explained that the S&P was trading at near historical highs at the inception of the wager. With a belief that subsequent returns wouldn’t be very good – which would in turn create market conditions that favor hedge funds – Seides felt he chad a strong chance of beating Buffett.
Seides reflected on his confidence that he would win the bet by referencing Buffet’s famous words: “If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy.”
“I thought he was the patsy at the poker table,” Seides said.
Why Seides wouldn’t bet Buffett again
Seides acknowledged that he lost the bet. Looking back on the performance of hedge funds throughout the last decade, Seides explained why – and he blamed the Fed.
According to Seides, the biggest headwinds that affected hedge funds in the last decade were caused by the Fed’s zero-interest rate policy (ZIRP). This hurt hedge funds more than other investment vehicles, he said.
According to Seides, “What was interesting with the bet was that we knew what the fees would be ahead of time, so you knew what your headwind was.”
“The rest of the bet was ‘can you overcome the fees?’,” he said.
“Fees played a meaningful role,” Seides acknowledged. “But in this particular period of time, there were a lot of other factors that played into the bet and favored the S&P,” he said, urging investors to consider the role of fees relative to market conditions.
“I think the biggest driver was that post-crisis, the S&P has returned 18 or 19% annually for eight years, which is far above what everyone would expect,” Seides said. “That more than made up for the big hit in 2008,” he explained, “that led the S&P, despite starting with a very high valuation, to have a historically normal return stream.”
“If you told me the S&P was going to have a historically normal return stream 10 years ago, I might still have made the bet, but I wouldn’t have thought the odds would have been as high as I did,” Seides said.
Seides won’t make another bet with Buffett because, he claimed, the hedge fund world has changed.
“Hedge funds have been hurt by low rates and competition, there’s more sophistication [in the market],” he said. “There’s also the rise of ETFs, which didn’t exist 10 years ago,” he said. “So now you can create factors at lower costs.”
“There are a lot of things that you couldn’t have anticipated that made it hard for hedge funds, but the biggest is just what happened with the Fed,” he concluded.
“If you properly risk-adjusted the bet and normalized the risk you were taking, I would be more likely to want to make the bet,” he added. “I tried to encourage Marc Yusco [of Morgan Creek] to make that wager with Warren,” Seides said. “Warren backed away from it, citing age, which was reasonable.”
“[Buffett] was happy to say ‘I would make that bet against anyone again’,” Seides said, “but it’s easier to say that publicly than to actually do it again.” “I think he had more to risk and very little to gain by doing it again,” Seides added.
It will be Yusco’s turn to see who the patsy is. On October 3, he accepted Buffett’s wager for a second 10 years.
Marianne Brunet is a financial market analysis with Advisor Perspectives.
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