Hedge fund

Buffett widens lead in $1 million hedge fund bet

February 5, 2014: 5:19 PM ET

In year six of 10-year performance wager, index fund wallops hedge funds.

By Carol J. Loomis

Warren Buffett

Warren Buffett

FORTUNE -- Results are in for the sixth year of the competition sometimes called the $1 million bet, and Warren Buffett -- once a piteous straggler in this 10-year wager on stock market performance -- has opened up a sizable lead over his opponent, New York asset manager Protégé Partners. Buffett's horse in the bet is a low-cost S&P index fund, and Protégé's is the averaged returns to investors (after all fees) of five hedge funds of funds that the firm carefully picked for the contest.

At the end of 2013, Vanguard's Admiral shares -- the S&P index fund that's carrying Buffett's colors -- were up for the six years that began Jan. 1, 2008 by 43.8%. For the same period, Protégé's five funds of funds, on the average, gained only by an estimated 12.5% (a figure minutely uncertain because some of the funds lack final figures for 2013).

By the terms of the bet, the names of those five funds of funds have never been publicly disclosed (though Buffett knows their identity). It has always been assumed that one of the five is a hedge fund of funds run by Protégé itself.

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As for the $1 million moniker, it comes from the amount that was ultimately to be delivered to a charity picked by the winner. Buffett's designee is Girls Inc. of Omaha, and Protégé's is Absolute Returns for Kids.

That $1 million, though, had some present-value mathematics behind it. Each side in the bet put up about $320,000, and the total was invested in zero-coupon bonds that at the contest's end would be worth $1 million.

But in the low interest-rate climate that enveloped the Great Recession, the zero-coupon bonds took off like a heat-seeking rocket. By the end of 2012, the bonds were close to their ultimate value, $1 million, which meant their appreciation potential was almost nil.

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So Buffett and Protégé partner Ted Seides reworked the bet, agreeing that the bonds would be sold and the proceeds put into Berkshire Hathaway stock (BRKA). That switch took place just as the great American stock market year of 2013 was coming on. S&P's Admiral Shares, with dividends included, rose by 32.3% during the year; Berkshire stock, which pays no dividend, beat the index by a nose, gaining 32.7%. By the end of the year, the amount slated for the winning charity was close to $1,270,000.

Meanwhile, most hedge funds were doing what hedge funds do -- hedging by shorting some stocks, investing in other geographies (like emerging markets), and along the way imposing their biting costs on their investors. The five funds backed by Protégé appear to have followed that crowd: They gained only 11.8% in 2013.

"We've got our work cut out for us," said Protégé's Seides last weekend, as he contemplated the four years remaining in the bet. And on the next day of trading -- that would be Monday -- the stock market pitched downward, and, wherever they were, the shorts made money.

Carol Loomis, the writer of this article, is a longtime friend of Warren Buffett and a Berkshire Hathaway stockholder.

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