“…my estate attorney is going to think I’m out of my mind for complicating things.”
Warren Buffett (commenting on a 10 year bet, made when he was 77 years old)
Talking to an audience in 2006, Warren Buffett said he was “willing to take a bet” that the stock market performance of a simple “boring” investment could exceed a hedge fund’s results. His boring investment was an index fund. Typically requiring few if any investing decisions, index funds track whichever segment of the securities markets the fund chooses. If your index is the S&P 500, then S&P 500 securities compose the portfolio of that fund.
You can see below the composition of the equities in the Vanguard 500:
Where are we going? To connecting the bet to our financial intermediaries.
The Bet
Vanguard’s (S&P) 500 Index Fund was precisely what Buffett chose when a hedge fund executive offered to take the other side of the bet. So while one side primarily has a plain vanilla list of 500 stocks that varied only when the companies entered and left the index, the other was a composite of five hedge funds that could own securities long or short and buy and sell whatever and whenever they wanted, We also have a typical investing approach of the ultra affluent investor versus what the rest of us do.
The contest began on January 1, 2008 and will end next year on December 31, 2017. As of mid-February, with the Index fund up by 65.67%, it has a substantial lead over the 21.87% hedge fund increase. However, as we all know, the dates that frame a bet can determine its results. Were the same wager to have occurred from 2002 to 2007, the hedge funds would have trounced the S&P 500 index fund.
This is the Vanguard’s 500 growth through the end of February:
Our Bottom Line: Financial Intermediaries
Like blood circulates life-supporting nutrients around the human body, so too does a financial infrastructure bring sustenance to businesses, households and government.
During the nineteenth century, the U.S. banking industry evolved. After Alexander Hamilton’s First National Bank was established in 1791, gradually, a network of financial intermediaries evolved. The goal was to connect savers and borrowers, to get money circulating, to let businesses borrow and expand. By the end of the century, we had investment banks able to gather the huge money they needed to finance railroad building and massive business combinations like U.S. Steel. Meanwhile, insurance companies were accumulating the assets that meant they too were becoming financial intermediaries.
And now to our list of financial intermediaries, we can add index funds and hedge funds.
