Practical analysis for investment professionals
12 February 2015

Betting with Buffett: Seven Lean Years Later

Just as stock picks sometimes head in the wrong direction upon purchase and call into question whether a thesis is early or wrong, so too has hedge fund underperformance over the last seven years raised the question of whether hedge funds are bent or broken. Standing seven years into a 10-year wager with Warren Buffett, we sure look wrong.

What follows is an assessment of what happened, and an outlook on where to go from here. A number of cyclical headwinds have hindered hedge fund returns, particularly over the last six years. When put under a microscope, hedge funds look a little better than they appear on the surface.

The late Peter Bernstein liked to say that despite what we may think, we don’t know what will happen in the future. We believe that those extrapolating from the recent past to call for the demise of the hedge fund industry are probably a bit extreme. Our contention is that the last seven years may prove one of many periods when lean times are followed by fat ones.

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The Bet

Buffett’s Big Bet (“The Bet”) took the view that high fees would ultimately doom hedge funds to underperform the S&P 500 over long periods of time. As he described it at the Bet’s inception:

Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.

A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.

Buffett’s case implies that the market should win by approximately the amount of fees paid to the hedge fund and fund of funds managers. However, after seven years of live action, the lead taken by the S&P 500 is substantially more than the difference in fees would suggest.

Index versus Hedge Funds

“Fund of Funds” is the composite return of the five hedge fund of funds selected by Protégé Partners, LLC (“Protégé”) for the Bet. Returns reflect actual results of the fund of funds in the Bet from 2008–2013 and estimated results for 2014. Management fees are estimated as 1.5% of net assets per annum for hedge funds and 1.0% of net assets per annum for fund of funds. Incentive fees are estimated as 20% of gains per annum for hedge funds and 5% of gains per annum for fund of funds, both subject to a high-water mark.

Just over half (24.4% ÷ 43.9% = 55.6%) of the underperformance by hedge funds can be attributed to fees. A full 19.5% of cumulative underperformance, or approximately 2.6% per annum, must have been caused by something else.

Furthermore, the first year of the Bet, 2008, heavily favored hedge funds, so the “something else” was even more pronounced thereafter. Over the last six years, the S&P 500 returned 159%, in comparison to the 57% return of the fund of funds. Using our estimates, fees subtracted 22% cumulatively from returns over those six years, accounting for only 21% of the performance shortfall in this stretch.

Over the vast majority of the Bet’s duration, 79% of the outcome has been determined by something other than fees. So much for the 80/20 rule!

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Six Separate Years, One Distinct Environment

The “something else” can be discovered when breaking down the components of a hedge fund’s return. Stated simply, the return earned by a hedge fund is a function of the beta embedded in the strategy, the return on cash balances, the alpha from security selection, and the fees and expenses incurred along the way.

We believe the headwinds faced by hedge funds have resulted from a combination of the substantial outperformance of the S&P 500 over global equity markets and the adverse impact of the Fed’s Zero Interest Rate Policy (ZIRP) on hedge funds relative to other investment vehicles. Together, these factors wreaked havoc on a bet, the prospects of which we initially felt quite confident about. As we intend to show, the residual performance after adjusting for the impact of this investment environment manifests a return stream that could have been beneficial to a diversified portfolio of risk assets under different circumstances.

Mismatched Market Exposure

We believe the S&P 500 is not an appropriate benchmark for a portfolio of hedge funds. That said, it’s hard to fault Warren for choosing the S&P 500 as a proxy. Even if it is not intellectually pristine, the S&P 500 is used extensively by investment organizations, clients, and the press as a generic bogey for almost everything related to the asset management industry. I like to quip that the index is so pervasive that upon receiving a semi-annual report card from my children’s school, my son’s teacher said, “He is performing nicely in math and reading. You should be proud of his work, but he’s still not keeping up with the S&P 500.”

Hedge funds generally, and the fund of funds chosen for the Bet specifically, diversify geographically, have a small-cap bias, and take on much less market risk than a fully invested long-only portfolio. As such, the Bet represents an apples-to-oranges comparison when pitting hedge funds against the S&P 500. The S&P 500 was one of the best performing indexes in the world over the last seven years, providing a boost from market exposure relative to more diversified hedge fund portfolios.

Global Indices

Global Indices

Source: Bloomberg.

Global and Small-Cap Bias

The fund of funds in the Bet has essentially matched the performance of the globally diversified MSCI ACWI Index — what a difference the selection of an index makes! We approximate that the underperformance of global markets relative to the S&P 500 contributed 2.3% annually to the shortfall of hedge funds in the Bet.1 On the other hand, hedge funds benefited by approximately 0.5% annually from their small-cap bias.2 Together, we estimate these risk factors boosted the S&P 500 relative to hedge funds by approximately 1.8% per annum or 13.7% cumulatively.

Reduced Risk

While we do not know the precise magnitude of the underlying beta in the Bet’s fund of funds, we believe the underlying funds averaged 40–60% net long. Assuming these funds carry half the risk of the market (represented by MSCI ACWI and adjusted for a small-cap bias), the reduced market exposure subtracted another 1.8% gross of fees per annum, or 13.3% cumulatively relative to the S&P 500.3

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The Impact of the Fed

The lower market exposure and lack of risk-adjustment in the Bet did not concern us at the time of its launch. Back in 2007, we believed the high valuation of the S&P 500 relative to history did not augur well for Buffett’s benchmark selection. Putting numbers behind our contention, money manager GMO predicted at the time that the S&P 500 would return −1.1% real (approximately +0.6% nominal) per annum over the subsequent seven years.4 According to their estimates, history would suggest that the 7.3% annual gain of the S&P 500 since stood only a 15% chance of occurring.

Why did this outlier occur? Most commentators would point to the impact of central bank intervention on the US equity market. The absolute level of interest rates has a direct effect on hedge fund returns. In taking rates from a market-driven level to zero through quantitative easing (QE), we believe the Fed had a dramatic impact on lowering hedge fund returns over the last six years.

Level of Interest Rates

The investment of cash balances is a source of hedge fund returns, but an inconsequential one to the return of the S&P 500. In the ZIRP environment since 2009, hedge funds have earned 0% on their cash. Depending on the particular strategy, a hedge fund might hold anywhere from 0–90% of its net assets in cash.5 Assuming cash balances average 20%, for the long-short equity strategies in the bet, and short-term interest rates stood at an historical average of 2.8%, a hedge fund’s return would have been 0.6% per annum (4.3% cumulatively) higher than it has been over the last seven years.6

Cost of Shorting Stock

Over this period, we believe the cost for hedge fund managers to borrow stock rose significantly due primarily to low interest rates and secondarily to increased transparency and more competition in the stock loan market. When a manager shorts a stock, the security is borrowed from the beneficial owner, such as an index fund, through a middleman, a Wall Street bank’s prime brokerage division. The beneficial owner, in turn, receives cash collateral for the stock, pays interest to the borrower on the cash, and reinvests the proceeds at a higher rate to earn a spread.

Before 2009 beneficial owners generated most of their security lending income from the reinvestment of cash above a risk-free rate and a smaller component from the difference between the risk-free rate and the borrow rate paid to the lender. However, after taking a few lumps while chasing yield in 2008, lenders became more conservative in their reinvesting. As a result, we’ve found that beneficial owners have charged more (paid less in interest) to lend stock for desired shorts to fuel profits in their security lending effort.7

We believe that transparency in the stock loan market has structurally benefited lenders at the expense of middlemen and borrowers. New technology brought price discovery to the security lending market and attuned lenders to the market lending rate for each stock in their portfolio. When markets were opaque, middlemen and borrowers had asymmetric information about prices and took advantage of less-informed lenders. Today the playing field has leveled for good.

Lastly, the growth of the hedge fund industry has created more competition for desirable stock to short. With more demand, the market rate charged to hedge funds to borrow stock has risen. We estimate that the costs of stock borrowing are 5% per annum higher today than before 2009, the preponderance of this increase is attributable to the lower level of short-term interest rates.8 For a hedge fund with 40% short exposure, this cost would have detracted from returns by 2% per year or 14.9% cumulatively.

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Sum of the Parts

Putting together this set of hedge fund return drivers reveals a surprising set of results. After adjusting for the market environment, hedge funds had a positive residual return amounting to slightly more than the amount of fees they received. With all the hullaballoo created by lovers and haters of the investment vehicle, we appear to have a tie.

Hedge Fund Expected versus Actual Performance

Hedge Fund Expected versus Actual Performance

Source: Protégé Partners.

The KISS Principal Gone Awry

Public scrutiny of hedge funds tends to focus on the underperformance of traditional asset classes, which was embedded in the Bet. As the argument goes, surely all of these sophisticated alternative strategies have no use when we could have just invested in plain old stocks and bonds and performed better.

Making an accurate prediction is hard, especially about the future. As it turns out, alongside the Bet we created an unintended experiment that tests this theory and calls into question the logic of those who claim today that indexing in stocks and bonds was obviously the way to go seven years ago.

At the launch of the Bet, we split and pre-funded the proceeds that would eventually go to the victor’s charity of choice. We decided at the time that having more than $1 million in 10 years would be wonderful for the charity, but having less would be unpalatable. As a result, we placed the present value of $1 million in a zero-coupon bond with the intention of letting it sit and mature 10 years hence.

As revealed on the Long Bets Foundation website, commentators on the wager were universally appalled at this decision. Those weighing in on the choice to buy a zero-coupon bond at the low yield of 4.5% went as far as to claim that the only loser in the Bet would be the charity that receives the funds at the end, proclaiming, “Can’t [this] money go to the Girls Inc. of Omaha now to get better value on [the dollars?]”

As it played out, the zero-coupon bond was one of the best performing investment vehicles in the world during the financial crisis. By the end of 2012, the Bet proceeds had risen over 50%, from $640,000 to approximately $950,000. With the prospect of making only 5% cumulatively for the next five years, we switched the collateral into shares in Berkshire Hathaway stock.9 At the end of December 2014, those proceeds had grown to $1.68 million. The 14.8% annual performance of the Bet collateral has dramatically surpassed the S&P 500, hedge funds, and almost anything else over the period. As the cliché goes, hindsight is 20/20!

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The Next Seven Years

One conclusion to draw from this analysis is that hedge funds may have been no better or worse than traditional strategies per se, offering instead a different return stream and set of risk factors that can be beneficial in a diversified portfolio of assets in the right environment. Proper consideration of an allocation to hedge funds going forward should consider the pricing and outlook for these particular risk factors relative to those embedded in traditional asset classes.

As a starting point, our outlook for traditional stocks and bonds is far from rosy. Bonds generated a 10.9% annual return over the last six years, leaving the 10-year Treasury below 2.0% today.10 It’s hard to imagine a repeat of that performance over the next stretch.

Stocks may not fare much better. After returning 17.2% per annum over the last six years and trouncing active managers across the board, the S&P 500 and its rapid rise should give investors pause. Jim Grant recently took the move towards indexation to task, stating “passive equity investing is a good idea. It is such a very good idea, in fact, that it has become a fad . . . Today we have a Nifty 500.”11 Grant further quoted an active manager, whose words about the cyclicality of passive and active management resonate strongly:

Long bull markets tilt the investment debate in favor of the autopilot approach . . . it’s at that moment that everybody says, “Why do I need a manager?” . . . If you go back and look at 2000 and 2007, there were strong calls for indexing, and the data looked very pro-indexing at those moments . . . And everybody completely forgot about that when active managers beat the market on the way down.

As far as hedge funds are concerned, we think structural characteristics are moving in favor of investors. First, fees are coming down. In response to a period of challenging returns, the industry is in the midst of a wave of innovation geared towards offering the attributes of hedge fund allocations at a lower cost. Second, as the US economy appears on stronger footing and QE comes to an end, interest rates may rise in the ensuing years. In a “normal” environment, hedge fund returns will increase due to higher interest rates on cash balances and short rebate proceeds. Third, although global diversification has hindered returns over the last seven years, the same outcome may not occur in the next seven.

In summary, the upcoming environment will likely be more conducive to hedge fund success than it has been — a point echoed elegantly by Ben Inker of GMO:

If we are in an environment today where we aren’t sure whether stocks are very overvalued or whether they have been repriced to give a lower, but still fair, return, taking equity risk in a fashion that has less duration looks like a pretty good idea . . . The strategies that most fit the bill are the very “hedge fund-y” strategies that have so disappointed investors in recent years . . . if you can find a way to do it more cheaply (or you can actually find some managers talented enough to pay for their fees), we believe now is a pretty good time to be on the look-out for shorter-duration ways to take standard risks.

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These seven lean years for hedge funds may go down in the annals of market history as a period driven singularly by central bank stimulus. Using that lens, it becomes less clear that the Bet, if lost, proves that hedge funds are not worth an investment across a cycle.

If the Bet continues on its current course, there’s always the next 10 years. We happen to know firsthand that Warren couldn’t be more excited to watch that period unfold.

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1. Geographic headwind calculation: S&P 500 return (+7.3%) minus the MSCI ACWI return (+2.7%) = 4.6%, multiplied by the 50% net equity exposure in hedge fund portfolios = 2.3%.

2. Small cap tailwind calculation: S&P 500 return (+7.3%) minus the Russell 2000 (+8.2%) = −0.9%, multiplied by 50% net exposure = −0.45%.

3. Market exposure calculation: MSCI ACWI return (+2.7%) * 50% net exposure = 1.35%.

4. GMO Seven Year Forecast (January 2008).

5. If an average hedge fund runs 80% long/40% short, it will hold uninvested cash of 20% (100 − 80%). Additionally, it will hold 40% of NAV in cash from short rebates, the impact of which is omitted in this calculation and later incorporated in the Stock Loan section. Strategies like global macro and commodity trading advisors have minimal need to post collateral and generally hold close to 100% of NAV in cash.

6. The average 3-month Treasury bill yield 1994–2014 was 2.8%. Source: Bloomberg. Annual returns calculated are compounded in estimating the cumulative impact for the seven year period.

7. Most of the money that beneficial owners earn in stock loan emanates from “special” issues, typically highly shorted stocks in high demand. In a higher-rate environment, lenders can earn returns on “general collateral” as well, but with short-term interest rates at 0%, lenders cannot make money on general collateral.

8. Hedge funds typically pay a net rate to prime brokers. The net rate is the difference between the interest received on their cash collateral and the borrowing cost for the stock. Before 2008, an average hedge fund paid a net annual rate of −3% (paid to play) and today a typical hedge fund pays a net annual rate of +2% (pays to play) to execute the same trades. Data received from the underlying data of two large hedge funds and confirmed in conversations with Goldman Sachs, Morgan Stanley and BAML Prime Brokerage groups.

9. Actually, our intent was to make a bet within the Bet and split the investment of collateral half in BRK stock and half in our flagship Protégé Partners, LP fund. Unfortunately, the Long Bets Foundation was not a Qualified Purchaser and could not invest in Protégé Partners, LP, so we elected to put all the proceeds in Berkshire stock.

10. Barclays US Aggregate Index. Source: Bloomberg.

11. Grant’s Interest Rate Observer, 14 November 2014, page 1–2.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Photo Credit: ©AP Photo/Nati Harnik

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About the Author(s)
Ted Seides, CFA

Ted Seides, CFA, created Capital Allocators LLC to explore best practices in the asset management industry. He launched the Capital Allocators podcast in 2017 and the show reached five million downloads in January 2021. Barron’s, Business Insider, Forbes and Value Walk each named it among the top investing podcasts. Alongside the podcast, Seides works with both managers and allocators to enhance their investment and business processes. In March 2021, he published his second book, Capital Allocators: How the World's Elite Money Managers Lead and Invest, to distill the lessons from the first 150 episodes of the podcast. You can follow him on LinkedIn and Twitter.

26 thoughts on “Betting with Buffett: Seven Lean Years Later”

  1. Jackey says:

    This article reads like a rather long winded apology for losing a bet to Buffet.

    And what exactly are hedge funds? An Orwellian twist to their more befitting name, “risky funds.”

    Gambling with other people’s money, taking fees that are in the domain of greed rather than profit, and then failing to perform — that’s all so normal and expected for “risk funds”.

  2. peter says:

    Buffet won a million? Is that news?
    I’m another news fire burnt someone…

  3. Brad Case, PhD, CFA, CAIA says:


    Thanks for putting together such a thoughtful, carefully documented analysis. It’s really excellent. With great respect, though, I think the story for hedge fund managers is much worse than you acknowledge.

    The argument in favor of hedge funds basically comes down to investing where “the best and brightest spend their time” (to use your own phrase). And the problem with The Bet—and the 7-year period you analyze—it that it made you (plural, meaning hedge fund managers generally) look like anything but “the best and brightest.” You thought the S&P 500 was overvalued in 2007; it turned out it was not. You were caught off-guard when global equity markets underperformed the S&P 500. You were caught off-guard when the Fed pursued its Zero Interest Rate Policy. You were caught off-guard when the cost to borrow stock for shorting “rose significantly.” As a result of your failure to anticipate these shifts and events, the random actions of comparatively stupid people ended up soundly defeating the extraordinarily thoughtful (and costly!) actions of “the best and the brightest.”

    As for the future, you point out big, big two secular problems. First, regarding short-selling, “the growth of the hedge fund industry has created more competition for desirable stock to short,” making short positions more expensive. More importantly—and this is likely true of all active investment, not just short-selling—“when markets were opaque, middlemen and borrowers had asymmetric information about prices and took advantage of less-informed” investors (not just lenders), but the opacity that managers depended upon has shriveled.

    Neither of those is a cyclical phenomenon, so both suggest that the risk-adjusted net total returns of hedge funds are likely to be worse in the future (relative to passive portfolios) than they have been in the past. Unfortunately, the days of outperformance by hedge fund managers already seem to have been in the past even before you took on The Bet seven years ago. In fact, 2007 was the same year that Naik, Ramadorai & Stromqvist ( reported that hedge fund “alpha generation occurred primarily during the peak of the bull market period between October 1998 and March 2000” but that “alpha in the hedge fund industry has severely declined in the most recent sub-period in the data, from April 2000 to December 2004. They concluded that “capacity constraints (too much capital) do exist at the level of hedge fund strategies, and are likely to be a concern for investors going forward.” That sounds like a much better prediction, circa 2007, than your own.

    The biggest problem for the hedge fund industry, in my mind, is simply that it represents an extremely high-cost way of achieving something that has always been easy to do at extremely low cost. When hedge funds are at their best, what do they accomplish? The answer is this: low beta relative to the equities market, and low returns that are nevertheless good on a risk-adjusted basis. But that is what bonds have always provided. The CEM Benchmarking study (sponsored by my employer, NAREIT, and available at bears this out using data on actual investment results for more than 300 U.S. pension plans over the period 1998-2011 (much longer than The Bet): hedge funds were the second-worst performing asset class at 6.02% per year even before investment costs, and their extraordinarily high investment costs (125.1 bps/yr) made them the absolute WORST asset class with net returns of just 4.77% per year—lower than all four fixed income categories, which had investment costs ranging from just 17.3 to 42.0 bps/yr.

    Also on the (lack of) diversification benefits of hedge funds, check out the new article “Fees Eat Diversification’s Lunch” by Jennings & Payne (, which finds that “investment fees consume 91% of the structural benefits of diversifying into hedge funds” (for a typical small institutional investor) and points out that “investment management fees are a certain deadweight loss while the riskiness of the diversification benefit remains, even when the allocation alpha is large.” The authors conclude that “investors might be wiser to increase their equity allocation than to seek additional returns from diversification to expensive alternative assets.”

    Finally, a significant long-term problem with the hedge fund industry is overconfidence among its managers. (I’m talking about overconfidence broadly as a set of cognitive biases that includes, for example, illusory superiority.) Among the causes of overconfidence is “retroactive pessimism,” which makes it easier to explain a failure even within the context of excessive self-regard. Tykocinski, Pick & Kedmi defined it this way: “In an attempt to regulate disappointments people may sometimes change their perceptions of the events leading to an undesirable outcome so that in retrospect this outcome seems almost inevitable.” That sounds a lot like your statement that “the residual performance after adjusting for the impact of this investment environment manifests a return stream that could have been beneficial to a diversified portfolio of risk assets under different circumstances.”

    Again, thanks for doing this excellent analysis.

    1. Ted Seides says:

      Thanks for the kind words Brad. I agree that competition and the cost of stock borrow will be secularly more expensive than they were historically and that hedge funds do cost a lot more than passive strategies.

      I don’t agree that anyone has or should have foresight in market timing or economic conditions, or that the success of hedge funds (and particularly long-short equity funds) is dependent on that.

      The Bet attempted to pit fees against security selection, and given what ensued over the last six years, the environment really hasn’t made the comparison apples-to-apples.

      Not sure if what I put together is an excuse or a rationalization, but it’s definitely the past. What happens going forward is what matters now.

      1. Brad Case, PhD, CFA, CAIA says:

        Fair enough, Ted. You’re right, the fees-versus-selection question certainly didn’t get a fair hearing.
        You may already have seen this, but if not it’s worth checking out “How Smart Are the Smart Guys? A Unique View from Hedge Fund Stock Holdings,” published in 2009 by Griffin & Xu ( They put together data from 13F forms to compare stock selection (on the long side) by hedge funds and mutual funds. They found that “hedge funds are better than mutual funds at stock picking by only 1.32% per year on a value-weighted basis,” and that the entire outperformance was concentrated in 1999 and 2000. (Their full historical period was 1986-2004.) They also found “there is no evidence that on average hedge funds have an ability to time styles or pick better styles.”
        Their conclusion basically sums up The Bet: “over our sample period, the unlevered hedge fund earning the average return did not come close to justifying its 20% performance fee on its long-equity investments.”

  4. Robert Jones says:

    With a flair that would make a three-card monte player blush, Mr. Seides somehow takes apart, makes a few “adjustments” and then reassembles the pieces of his bet and finds… a tie! If only we all could have Mr. Seides’s magic wand of “adjusting for the impact of this investing environment” to clean up what are politely called massive screwups, and less politely known in more colorful terms. My goodness, it’s as if a mediocre baseball player undertook to show you how his singles and doubles should actually be home runs (if you just made adjustments for wind currents, curvatures of stadiums, an unprecedented number of talented pitchers) and, as a result, ties him with Barry Bonds’s home-run record. And then, just to show you there are no hard feelings, let’s you know that it’s not worth quibbling over messy past calculations, since what matters is next year! Time to play ball!

    Mr. Seides’ likes to remind us that no one can know the future, just in case you may have thought that the highly compensated “best and brightest” he knows do have some crystal ball. He then runs through several items that seemed so unusual and could never be accounted for in advance — zero-bound interest rates, S&P 500 outperforming global markets, added costs in shorting stocks, etc. Yes, the world is messy and chaotic, and hits us with unprecedented events. Is that news to anyone? Should that be a surprise? As Mr. Seides should appreciate, the future ain’t what it used to be. Unpredicted outcomes and events are not a free pass to adjust returns, massage numbers, and claim you’re just smoothing out the curve.

    One thing we do know (with all due respect, Mr. Seides) is that the next seven years will hit us with massive, unanticipated events, some of which may make the past seven years look mild by comparison. The next several years could have regional wars, natural resource shortages, massive cybersecurity breakdowns, and who knows what else. Does that allow anyone then to make a similar claim as Mr. Seides and insist that these singular events once more mitigate any incorrect assumptions?

    I have a suspicion that one sure thing over the coming decade will be hedge fund managers telling us why their fund performance is not nearly as poor as you think once they “adjust for the impact of this investment environment.” Plus ca change.

    1. Joe Walker says:

      Eloquent and articulate assessment of a loquacious sophistry. Clearly the pride of the “best and the brightest” is stinging at being on the short end of this bet. That’s the problem with so many of the so-called intelligensia – they often don’t see the forest for the trees.

      1. Joe Walker says:

        p.s. the use of intelligensia (sic) is an attempt at humor. Just before the intelligentsia rush in, half-cocked.

  5. Robert Jones says:

    At the risk of piling on (ah heck, why not), readers may want to take a look at Mike Santoli’s column from yesterday on Mr. Seides’s argument: When a seasoned, respected, straight shooter like Santoli tells you it’s a “tortured” defense and mocks the rambling eight-page letter, it may be time to call this one. In retrospect, Mr. Seides may conclude that public explanations are not his forte, no matter how many charts, graphs, and calculations you squeeze in.

  6. Ken Skarbeck says:

    Game, set and match to Robert Jones.

    It is almost uncomfortable to read the feeble defense the hedge fund apologists are pawning in public forums these days. The investment consulting industry bought into the hedge fund/alt investing theme hook, line and sinker about a decade ago and in return have done more damage to pension funds and high net worth portfolios than can be imagined.

    To the contrary, it can easily be argued that “under the microscope,” hedge funds are worse than they appear. The yawning gap between market returns and hedge fund returns represents a lost opportunity cost to their investors. Pension funds across the country are struggling to meet their liabilities while paying exorbitant fees for underperformance. This model is unsustainable.

    Why there is still significant money in these vehicles is beyond comprehension – perhaps other than with a handful of outperforming managers that deserve it. Calpers finally “got it” and you would think many more will see that the “emperor has no clothes” despite the attempts by their consultants and alt managers to obscure the view.

    It did not take a genius to discern that U.S. stocks were bargains in 2010 at 10 PEs and low valuations. Yet inexplicably, most hedge funds and consultants were counseling their institutional clients to seek investments that were “non-correlated” with the U.S. stock market. What a colossal mistake! The hedgies got stuck looking in their rear view mirrors (2008) and were so caught up trying to smooth volatility and protect for the tail risks that had already occurred, that they somehow didn’t notice that stocks were a screaming buy.

    It seems to me that if investors are willing to pay a king’s ransom in fees to a money manager, they should expect the manager to be intelligent enough to identify undervalued assets that offer above average appreciation over the long term. The vast majority of hedge fund managers have failed in that regard and not only have they terribly underperformed, they have effectively pickpocketed their investors.

    With apologies to Winston Churchill……….Never before in the field of money management has so much been confiscated from so many to benefit so few.

  7. Rufat says:

    Great comment on the hedge fund attribution over the last several years, and especially explaining details of the risk-adjusted/beta-adjusted performance of the hedge funds. Would have been helpful to provide some background of the hedge funds used to compare vs. S&P 500 TR.

    1. Brad Case, Ph.D., CFA, CAIA says:

      Rufat, I believe the terms of the bet are that Protege Parners would choose a set of hedge funds, but that the individual funds would not be disclosed. Check it out at

  8. Reid Culp says:


    Thank you for sharing this nice article. It was interesting to hear how well your investment of the Bet proceeds performed. I am interested to see how your forecast for the next seven years play out. (I am also a fan of GMO’s and Jim Grant’s writing.)

    Thanks again,


  9. Ken says:

    This entire article is ludicrous in its entirety. Most is intellectually damaging, some is grotesque in its mathematical absurdity.
    One example:
    “We estimate that the costs of stock borrowing are 5% per annum higher today than before 2009, the preponderance of this increase is attributable to the lower level of short-term interest rates.8 For a hedge fund with 40% short exposure, this cost would have detracted from returns by 2% per year or 14.9% cumulatively.”
    I really can’t remember seeing anything that is so wrong in its assumption, premise and mathematics in my experience. I spent a couple decades on the other side of securities lending and this leaves me speechless (well, obviously not entirely). Maybe I’m missing something. Desperation in the Hamptons I would guess.

  10. David Merkel says:

    The CFA Institute should be ashamed that they facilitated the publishing of this. It exemplifies all the worst aspects of explaining away performance shortfalls. This, from the organization that gave us the overly rigid GIPS?

    1. Brad Case, PhD, CFA, CAIA says:

      Hi David,
      If there weren’t opportunities to comment on the original article and engage in active discussion, I would certainly agree with you. That happens way, way too much in the investment world, but this is different: Ted Seides has engaged actively with the many critics (including myself) who think the progress of “The Bet” is simply additional confirmation that hedge funds have proven to be a poor way to invest, and are likely never (or at least never again) to provide the risk-adjusted returns or diversification benefits that unsuspecting investors have been led to believe they will. And when that conclusion becomes clear to everybody, it will also become clear to everybody that hedge fund fees are unconscionable.
      This is hardly the worst article published by CFA Institute, and I definitely applaud the back-and-forth.

  11. John Ouber says:

    What will it take for all the pension funds within the corporate and public sectors to wake up and smell the coffee? As dutiful taxpayers, shouldn’t we at least have the right to tell the public pension funds to stop investing our money in these high-cost, under-performing hedge funds and instead invest that money in simple low-cost index funds?

    Seems to me that the pension fund managers and the hedge funds (as well as with the mutual funds & private equity funds) are a bit too chummy with each other. This is understandable as many pension fund managers used to work at hedge/mutual/private equity funds and vice versa, but it is an obvious conflict of interest that is doing a great disservice to the general public. Having pension funds invest in low-cost index funds of domestic/foreign equities and bonds would seem like a cheaper way to generate returns, especially considering how “the Bet” has shown that hedge funds rarely outperform, especially once you net their costly fees.

  12. robert jones says:

    I returned to this post and comment section when I came across news that our dear, good friend Ted Seides has apparently departed his hedge fund and now, as he puts it on his profile, is a “free agent.” Alas, we will miss his rationalizations for hedge fund failures and his insights into why the “best and brightest” end up at places like his old firm. We can only hope that someone else at his prior firm will take up the torch and charge into the breach with a panoply of charts and graphs and obfuscating text to justify disastrous under-performance year after year. Those lucky devils who get this “free agent” next.

  13. Anirudha H says:

    You need to look at it from investor/customer perspective. As compared to hedge fund investment, investing in an index fund is convenient and has proven to be low cost alternative.
    While index fund had limitations on which stocks to invest, a hedge fund manager has no such restrictions. Still underperformance over 7 years!

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