the $1 million bet

the $1 million bet

Warren Buffett isn’t a huge fan of hedge fund managers. he feels they charge exorbitant fees in return for a questionable performance.

as an aside, hedge funds are companies formed by pooling together money. the people handling this fund use different strategies to grow money for their clients. in exchange, they charge a service fee. 

so, in 2007 the Oracle from Omaha challenged the hedge fund industry. Buffett bet $1 million on an index fund outperforming a basket of hedge funds over a decade. Ted Seides, co-founder of Protégé Partners, accepted the million dollar bet.

a decade later, Buffett won, as the S&P 500 index fund generated an annual return of 7.1% against 2.2% annual returns by the basket of funds of hedge funds selected by Protégé Partners. the winning amount, which was more than $2 million, was then donated to a charity in Omaha.

Buffett, an active investor and celebrated stock-picker himself, took a bet on passive investing beating active and won.

so, what is passive investing, and why does Mr Buffett have so much faith in it?

what is passive investing

passive investing is a strategy to generate returns by not relying on ‘actively’ buying and selling stocks but by mimicking a broader market benchmark like in case of Buffett’s bet the S&P 500 or in the Indian context the Sensex of Nifty.

passive investing came into existence in the 1970s in the US when John Bogle founded the Vanguard Group and launched the Vanguard 500 fund, which would track the S&P 500 index.

as a passive fund doesn’t require ‘active’ management from a fund manager, these come with substantially low-costs attached to them and have helped people save millions in fees.

since the 2008 financial crisis, many have moved towards passive investment products and as of May 2021 the total asset under management (AUM) in passive instruments stood at $15 trillion.

while index funds were the first of its kind passive product, over the years a lot of innovation has happened. and with the launch of exchange-traded funds (ETFs) the process has become even simpler for investors.

like an index fund, ETFs also track an underlying index or asset class like gold, but they are listed on the stock exchanges and units of them can be bought and held or sold like any other listed stock.

Bogle once said: “don't look for the needle in the haystack. just buy the haystack.” while many continue to try their luck with picking the next ‘multibagger’ stock, a boring buy strategy like passive investing, which bets on the broader wisdom of the market itself can help generate meaningful returns with more peace of mind.