When the Index Beats the Algorithms

You might wonder why there wasn’t more media coverage of one of the most interesting bets ever made in the investment world. We’re not talking about betting on a company; this bet was made between Berkshire Hathaway chairman Warren Buffet and a hedge fund called Protégé Partners. At issue was whether a basket of hedge funds managed by algorithms and super investors would beat a simple S&P 500 index fund over a period of 10 years—which happened to include the Great Recession and one of the longest bull markets in history. Each side put in about $320,000 in 2007, with the proceeds—including all gains—going to charity.

The final score wasn’t even close. The index fund gained 7.1%, compounded annually. The basket of hedge funds returned a below-average return of 2.2%.

The original intent of the bet was to prove a point: that it is usually impossible to outthink the market, no matter how smart you are, no matter how cleverly you use derivatives, hedging and futures contracts. Yes, Buffett has been outperforming the market for most of his career. But he has unusual access to deals, and extraordinary patience—which can be more powerful than algorithms when it comes to beating the market.

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