That Bet With Buffett | The Acquirer's Multiple®

In his recent interview with Tobias, Ted Seides from the Capital Allocators Podcast discussed That Bet With Buffett. Here’s an excerpt from the interview:

Ted: That was it. We’re going way back now. This was the summer of 2007, and to put the markets into context, I was running a hedge fund to funds, risk had worked for many years, lots of things felt a little frothy, the markets were high, credit spreads were tight. Around that time, we had found the subprime mortgage short. Before it played out, you were sitting on, for us, I would say, I don’t remember 2% or 3% of our portfolio, that was a 10 to 1 risk-reward, where we could look at it and say, “Well, if the rest of the world risk on keeps working, we’re going to keep doing great. If not, we have this incredibly low-cost hedge.” I was just feeling that’s probably the best I’ve ever felt in my investment career. I was like, “Wow, we’re winning on every side. No matter what happens, this is going to be great.”

Around that time, someone sent me a transcript of one of Warren’s talks with a group of students. Maybe it was about a year after he had talked about in his annual letter, the hadrocks and the gotrocks, the whole concept of fees. In this transcript, a student had said– I might not have been at that meeting, or maybe I was getting food downstairs or something, but at some point in time, someone had asked him specifically some comment about that. He made some off-the-side remark that he didn’t think a group of hedge funds could beat the market. I saw the transcript, and someone asked him about it in the transcript. He said, “Well, no one took me up on it, so I guess I must be right.”

I was sitting around, it was in the summer, it was a quiet day. I just thought it was such a cheeky response because hedge funds are so different from the market. The market was trading at historical high valuations. And keep in mind interest rates then were 4% or 5%, you can’t even make the case that valuation multiples should have been higher, because rates were lower in a discounting mechanism. I just thought he made a bad bet. I still think he made a bad bet. He made a bet. I didn’t really care, but I sent him a one-page letter in the mail, regular mail, in part because I had heard so many stories of how legendary he was, and how he responded to people’s letters. I was mostly just curious how he would respond. He did. He sent a little pithy response. “Well, it has to be this and that,” and it turned into a– what was a letter, most of the emails and PDFs and that’s a whole separate story about why he doesn’t have email, that consummated in the bet. Again, it was the summer into the fall of ‘07. I really thought for another good year and a half, two years, that was a really, really good bet to make.

Tobias: The market topped June, July, August 2007– [crosstalk]

Ted: Yeah. 2008. Right.

Tobias: But you put the bet on in 2007?

Ted: No, it started on January 1 of 2008.

Tobias: Oh, I see. Okay, so the market had come off. I don’t think that people would have necessarily thought that we were in the middle of a crash by then because the crash didn’t really come until the back half of 2008 through the first quarter of 2009. You must have been feeling pretty good out of the gates. You’re a long way ahead in that bet.

Ted: Yeah, let me give you some historical context. By February, March of 2009, the hedge fund side of the bet was probably– I wasn’t really looking at numbers, was probably ahead of the market by 50%. In the prior 10 or 15 years, the gap between the market and a hedge fund index return was probably like 1% to 3% per year. The dispersion just was never really that high, because there’s beta in the hedge fund side. At that point in time, yeah, it looked pretty good. In fact, at the end of his 2009 annual letter, I used to have a presentation and I pulled a quote from that letter that I referred to as his concession speech two years in, because he said something, he was comparing Berkshire to underperformance of the S&P. I think he had just gone through his first five-year stretch of underperformance. He said, even in this period, as long as 10 years, and keep in mind, the bet was 10 years, the results can be heavily influenced by the starting or ending point. I think if he ended up losing the bet, we know exactly what he would have said. It sure felt that way at the time. Now Fed came in, the world changed and didn’t end up that way.

You Never Know What The Market’s Going To Do

Tobias: What’s the lesson from that? Don’t do something when you’re bored or don’t bet against Buffett?

Ted: [laughs]

Tobias: What’s the lesson?

Ted: Oh, I don’t know that they’re that– You can take a lot of lessons. I think the biggest one is, you really don’t know what can happen in markets, even if you think you do. Even if the odds are on your side. There was no one in 2009 that would have told you, “Oh, for the next 10 years, a 60/40 portfolio is the way to go. The S&P is going to be up to 18% or 19% a year from the depths of where we were.” That’s certainly one. There’s another lesson separate from investing. I think, if you’d call it that, in being able to watch how Warren chose to communicate about something I knew intimately was really– he’s so impressive in so, so many ways. Just to give you anecdotes about that, we started the bet in– it got consummated in the fall of 2007. The bet got started in January 1 of 2008. At the end of 2008, I think the hedge funds were up, I don’t remember what the number was, 30% or something like that. Carol Loomis wrote an article for Fortune magazine announcing the bet sometime in the middle of 2008. Warren had wanted to announce the results of the bet every year at his annual meeting.

In his 2009 annual meeting when there was incredible scrutiny on him and active management, he didn’t say anything about the bet. In 2010, when he was well behind, he didn’t say anything about the bet. He might have said a little bit, but I think he pretty much maybe said there was a bet and he was going to announce the results. For the next couple of years, the only thing he ever said was he put up the results right before lunch, and said, “Well, I promised I would tell you about this bet. As you can see. We’re losing let’s go to lunch.” It was just a fun joke. He really didn’t say anything about it until the seventh or eighth year when for the first time the S&P had crossed– it took maybe it was that long, maybe six years. Just from the first 14-15 months, it took the S&P, call it five or six years to catch up. Then he started talking about it and writing about it. Then, he basically declared that he was a victor before it was over, which is an interesting thing. Why would he do that and not wait for the other year? I don’t know the answer to that. I do have a supposition, which is fun to share. I don’t think– it’s no reason why it came out public, which was at the end of the ninth year, the S&P was a head of each of the five fund to funds in the bet for the first time. There was one fund of funds that had done meaningfully better than the others. That was the first moment in time that he could say, “Oh, by the way, here are the results and the S&P is better than everything.” There was still a risk that at least that one fund to funds would outperform in the 10th year. It turned out they didn’t because it was another strong year for the market.

My supposition is that he grabbed the one moment in time when he could tell exactly the story he wanted to. Then, as a fun afterthought, when we started the bet, Carol asked both of us the odds that we thought we would win. My partners and I said a big number like 80% or 85% and that had some historical precedent, and Warren said 60%. But if you read everything he said about the bet after the fact, he writes as if it were 100% certainty. I called him once a couple of years ago and said, “By the way, I’m just thinking about reviewing my own decision-making process. What were you thinking at the time when you said you had a 60% chance? Does that have to do with the valuation of the market?” He said, “Oh, I don’t remember.” There’s an element of this expression of certainty he didn’t have at the beginning, it may not have been that thought out. I really came away from it saying, I still think it was a good bet at the time. We hit one node that was wrong one, and maybe my assessment of the probability of winning was too high, entirely possible because something happened, I certainly couldn’t have envisioned. It was a really fun and I’ve spent a whole bunch of time with him, which is really great, too.

Tobias: As I said at the start, I thought you had the right side of the bet. I’m as surprised as anybody else, that the S&P 500 was so strong over this period of time. But the metagame part of it where you get a bet with Warren Buffet, and you get a lot of publicity that that must have been absolutely fantastic, get to spend some time with him too.

Ted: Yeah. The latter part is the part that I derived the most value from. We’ve had dinner together seven or eight times, and I’ve gotten to bring friends out that I thought he would find interesting and all kinds of cool things came out of that. For example, Jack Bogle showing up at the annual meeting was a direct result of my bringing Steve Galbreath, who’s a dear friend of Jack’s out to dinner, and that coming up in the conversation, and Warren saying, “Do you think he would ever be interested in coming?” Sure enough, that led to Jack coming. So, that there are a lot of little things. Yeah, there are a lot of like that that were great. A friend of mine said to me a few years ago as that was ending, “Could you imagine what the publicity would have been if you had won?”

Tobias: Yeah.

Ted: From that perspective, I think that’s right. I think it was a free option. I don’t think that the publicity did anything positive or negative for my business at the time. Part of that was that we didn’t use it as– Warren was out talking about it, we didn’t really say much. Even when we were winning, we weren’t out pounding our chest saying, “Ah, see, we told you.” There are other people in the industry who would have done that, but it’s not really my style.