The Thing That Could Really Bring This Market to an End

Stock market down

As revellers sip champagne and take in the fireworks, there will be one group of people for whom the end of the year won’t come soon enough.

While everyone else is reflecting on the year gone by — and making plans for the next — this group will be ruminating on the decade gone by.

For them, 31 December marks not only the end of the year, it draws to a close a decade-old bet.

Back in 2007, the world’s most famous investor, Warren Buffett, challenged their entire industry to a bet.

And the bet? Commencing 1 January 2008, Buffett bet $1 million that a hedge fund could not beat a plain old vanilla index fund over a 10-year period.

In part, it was a bet about investing strategies and asset allocation. However, what the bet was really about was fees.

It was the excessive fees charged by hedge funds that raised Buffett’s ire. This refers to the old ‘2 and 20’ model. 2% based on funds under management (FUM) and a 20% cut of any profits.

Buffett found it obscene that a hedge fund could charge such big fees, despite the market (index) often beating their returns.

For his side, Buffett picked a Vanguard fund that tracks the S&P 500. This fund, the Admiral Fund, charges a paltry 0.04%. Protégé picked five hedge funds with different strategies, although the name of these funds have never revealed.

If they were like you and me, Buffett and Protégé might have each put their half of the bet into any old bank account. But, of course, they had to make it a bit more complicated than that!

Rather than a bank, they each put $320,000 into a zero-coupon bond. A zero-coupon bond doesn’t make payments like a regular bond. Instead, it pays out the principal and total interest at expiry.

They calculated that $640,000 of these bonds in 2008 would be worth $1 million by the end of 2017. 

But the subprime disaster soon scuttled their calculations. As interest rates collapsed and bond prices soared, the value of their bonds hit the $1 million mark much sooner than they anticipated — by the end of 2012.

Rather than hold onto the bonds, they both agreed to sell. They took their profits and put the money into Buffett’s Berkshire Hathaway ‘B’ shares.

We’ll soon find out the value of the holding. However, there is every chance that the charity chosen by Buffett — Girls Incorporated of Omaha — could be in line to receive almost double the original wager.

Ted Seides, the co-founder of Protégé Partners, has already conceded the bet. Despite leaving the firm he co-founded two years ago, he has kept an active watch.

And while they didn’t participate, other hedge funds have also kept a close eye. For them, there is a lot at stake. Who would want to give up those kinds of fees?

After such a massive bull run, the result of the bet might now seem obvious. The Dow Jones has more than trebled over the last eight years.

However, it wasn’t always like this. With the markets in freefall for the first two years of the bet, it took five years before the index fund pulled ahead.

After an eight-year bull market, it might be hard right now to see what will bring this rally to an end. In the US, proposed tax cuts looked to have cleared the Senate. And the market is taking the Fed’s rate rises in its stride.

However, all bull markets end — just as bear markets do.

After peaking out near 10% in 2009, unemployment in the US is now closer to 4%. That’s something many economists believe to be full employment.

In other words, future upticks in US consumption (and the economy) will less likely come from new job growth. Instead, it will need to come from wage growth — something that could bring the current cycle to an end.

If companies have to pay more to attract and retain staff, they might choose instead to pass. That is, put a freeze on employment, or even look to cut their wage bill by letting staff go.

Markets always look to the future. A drop in consumption growth — even if it flattens — would flow through to corporate results…and a fall in the market.

Sitting in an index fund won’t protect you if the market does roll over. You need to be active in how you manage your investments. That’s why, at Total Income, we’ll continue to look for stocks that hold up best if the market does take a tumble — and that could pay you a reliable income as well.


Matt Hibbard,
Editor, Total Income

Matt Hibbard

Matt Hibbard

While many investors chase quick fire gains, Matt takes a different view. He is focused on two very clear goals. First: How to generate reliable and consistent income in a low-interest rate world. And second, how you can invest today to build wealth over the next 10–15 years.

Matt Hibbard

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