Ted Seides - The Bet with Buffett – Hedge Funds vs. The S&P 500 - [Invest Like the Best, EP.35]

Episode Summary

Executive Summary: Patrick O'Shaughnessy interviews Ted Seides about his famous bet with Warren Buffett, using it to examine hedge fund fees, benchmarking, valuation, and the real-world impact of investor behavior. The discussion argues the headline “S&P beat hedge funds” is directionally true but overly simplistic.

Main Topics: Origins of the Buffett bet (Priority: 5/5): Seides recounts how a letter exchange with Buffett evolved into a public charitable wager. What the bet really measured (Priority: 5/5): The wager compared unlike exposures: S&P 500 beta versus diversified, lower-beta hedge fund portfolios. Fees vs. performance (Priority: 5/5): High fees matter, but Seides argues valuation, exposure, and market regime also drove the outcome. Hedge funds as a changing market (Priority: 4/5): He says long-short equity was crowded and harder post-crisis, while some niche strategies still work. Benchmarking and portfolio construction (Priority: 4/5): The conversation explores whether hedge funds are an asset class or just a contractual fee wrapper. Behavior gap and real investor returns (Priority: 5/5): They stress that dollar-weighted outcomes often lag paper returns because investors trade badly. Permanent capital and long-term ownership (Priority: 4/5): The episode closes on permanent equity structures as a powerful way to source and hold great businesses.

Key Arguments: The bet was largely about S&P valuation, not just hedge fund merit. High fees hurt, but even zero fees likely wouldn't have made all funds win. Long-short equity hedge funds are harder today because of crowding and lower rates. The S&P 500 is not a neutral benchmark; choosing it is itself an active bet. Real investor returns often trail index returns because of buying high and selling low. Permanent capital can improve both sourcing and long-term decision-making.

Data Points: bet start date: January 1, 2008 - Formal start of the wager fund-to-funds in the bet: 5 - Number Seides initially picked Buffett’s requested number: 10 - Buffett wanted more fund-to-funds in the wager S&P 500 performance in 2008: down 37% - During the crisis year hedge fund performance after Lehman: down 24% - Approximate decline cited for the fund-to-funds group S&P drawdown from bet start to Feb. 2009: 50% - Used to illustrate investor pain and behavior gap Shiller PE today: 30 - Presented as only the third time ever near that level historical average Shiller PE: 16, 17 - Long-run average cited for the market correlation of Shiller PE to future 10-year real returns: 0.7 to 0.8 - Used to argue valuation matters eventually short interest historically: 2 or 3% - Earlier crowded-short environment short interest today: 15, 20 - Shows much more crowded shorting now collateral starting value: $640,000 - Initial value of the pre-funded charity collateral collateral value after 4 or 5 years: $950,000 - Demonstrates bond accretion before the equity trade charity bet size: $1 million - Total amount effectively pre-funded for the wager public market timing window: 9 and a half years - Time frame repeatedly referenced for the wager market cap of the S&P 500: relatively small percentage of the world’s assets - Used to argue the S&P is one active choice among many

Pivotal Quotes: "The horse race component to this is kind of exactly what is wrong with asset management." — Ted Seides: Explaining why he initially wanted the bet to be quiet and not treated like a spectacle "Price matters eventually." — Patrick O'Shaughnessy: Summarizing the valuation argument behind Seides's original conviction "If you don't know that you can play the right way, you shouldn't play." — Ted Seides: On when institutions should avoid alternatives or hedge funds

Implications: The core unresolved issue is not whether fees matter, but which investors have the edge, discipline, and benchmark to use alternatives well.