The year is 2007 and Warren Buffett is answering questions from investors at the Berkshire Hathaway shareholder annual meeting. An attendee asked Buffett to speak about hedge funds

Buffett rails against the fees charged by hedge funds and he makes a historic offer. Buffett tells the crowd that he is willing to bet that he can beat any hedge fund manager in the world over the next 10 years.

You’ve got to understand this is Warren Buffett, the 7th richest person in the world. The CEO of Berkshire Hathaway, a company that charges 345 thousand dollars for a single share of common stock. And here he is challenging an entire industry. One brave firm, Protege Partners stepped forward to take Buffett’s bet and on January 1st 2008 they make a 10 year one million dollar bet. The financial world waits with anticipation to see what strategy Buffett is going to use.

INTRODUCTION

By now I’m sure you have guessed the outcome of the bet. Buffett’s portfolio beat the portfolio from Protégé Partners so resoundingly that Protege’s co-founder actually conceded defeat early rather then continue the embarrassment. In the end it wasn’t even close, cumulatively Buffet’s portfolio returned 7.1% average annual return, or $854K whereas the Protégé portfolio returned just 2.2% annually for a return of $220K.

In Berkshire Hathaway’s 2016 Letter to Shareholders Buffett shares some thoughts about this challenge.

There are, of course, some skilled individuals who are highly likely to out-perform the S&P over long stretches. In my lifetime, though, I’ve identified – early on – only ten or so professionals that I expected would accomplish this feat. There are no doubt many hundreds of people – perhaps thousands – whom I have never met and whose abilities would equal those of the people I’ve identified. The job, after all, is not impossible. The problem simply is that the great majority of managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well.

Warren Buffett; 2016 Letter to Shareholders

Buffett is explaining to his shareholders that he understands the probabilities around beating the market index and the odds are such that he was comfortable making a bet of this magnitude in public.

This story is really fascinating but I don’t want to focus this video on re-telling it. If you’re interested in learning more you can find the episode of NPRs Planet Money on it here.

THE BUFFET PORTFOLIO

Sadly, the exact portfolio’s used in the bet have never been disclosed to the public but we do know that Buffett’s portfolio was made up of Vanguard Index Mutual Funds.

In Berkshire Hathaway’s 2013 Letter to Shareholders Buffett wrote that he has instructed the trustee of his estate to invest buffets assets into the following portfolio:

Allocation	Fund Name	Symbol
90%	Vanguard US Large-Cap Index Fund ETF	VV
10%	iShares 1-3 Year US Treasury Bond ETF	SHY

Asset Correlation

Looking at the correlation matrix we can see that Short Term Government Bonds are negatively correlated with the US Large Cap Stock Index. Remember that a 0 reading means that the assets are completely neutral to one another, whereas a numbers above zero denote a positive correlation and numbers below zero denote a negative correlation. Our goal is to always group assets that are not correlated.

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Returns Review

The portfolio results data can be found here.

Returns look great, about 18% 1Y with about 11% annualized since 1977. Note how the risk is dramatically reduced over time. 22% standard deviation is really only appropriate for retirement savers who have a long time horizon.

We can see that $1000 in 1977 grew to $94,531.

Worst drawdown since 1976 was the Great Financial Crisis. This portfolio declined for 16 consecutive months for a total loss of 45 and a half percent.

The next worst drawdown was the dot com crash of 2000. That recession was really bad for this portfolio with 25 months in a row of losses for a total loss of about 40%.

The rolling returns are really fascinating. The best 5 year period was up +27% and the worst 5 year period was down just 5%. Look at the 15 year numbers. That should be eye-opening, even for pessimistic perm-bears. Since 1977 this portfolio has never lost money over any rolling 15 year period.

Looking over the monthly heatmap we see that since 2000, this portfolio has only had 5 negative years.

FINAL THOUGHTS

What do I think about Buffett’s Portfolio? Well naturally I love it. Today we usually refer to this strategy as ‘The Simple Path to Wealth’.

I’d like to close this video with some words from Warren Buffet’s 2016 Letter to Shareholders. In the letter Buffet praises his friend and colleague, the late Jack Bogle, who is the Founder of The Vanguard Group and the inventor of the Index Mutual fund.

If a statue is ever erected to honor the person who has done the most for American investors, the hands down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value. In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me

Warren Buffett; 2013 Letter to Shareholders

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