Why the S&P 500 beat the hedge-fund picks
The wager was a contest between two ways of investing in large U.S. companies. Warren Buffett chose a low-cost S&P 500 index fund, which aims to track the performance of the index by holding shares in many of its companies. His opponent, Protégé Partners, selected hedge funds expected to use active strategies—trying to beat the market through choices such as which securities to buy and when to trade.
That distinction creates a hurdle for active investing: a manager must earn enough extra return to cover the costs of trying. Hedge funds can charge substantial management and performance fees, and Protégé’s selections added another layer by investing through funds that held other funds. The wager compared results after fees, so the costs came directly out of the investors’ returns.
Compounding made the gap larger
Over the decade ending in 2017, Buffett’s fund returned about 7.1% a year on average, while the selected portfolios returned about 2.2% annually after fees. Those figures may look like a difference of only a few percentage points, but each year’s gain—or loss—affects the amount invested in the next year.
As an illustration, $100 growing at those rates for ten years would become about $199 at 7.1% a year, versus about $124 at 2.2%. The gap is not a separate fee charged at the end; it emerges as slower growth compounds year after year.
What the wager did—and did not—show
The result illustrated Buffett’s argument that consistently finding investments good enough to overcome high costs is difficult. It did not establish that every index fund will beat every hedge fund: the outcome belonged to these particular selections over this particular period. But it made a practical point about the burden active managers face. Before a more complex strategy can deliver an advantage to its investors, it has to earn back what it costs to run.
