Ted Seides is the founder of Capital allocators and former President of Protegé Partners.
On a slow summer day 18 years ago, I started to communicate with Warren Buffett over the bet that achieved the performance of hedge funds against the S&P 500.
The proposal became a non-profit 10-year commitment from January 1, 2008 to December 31, 2017.Buffett’s big bet”. It looked good for the hedge funds in the first few years around the global financial crisis, but the market then gathered strongly. At the time of Berkshire Hathaway 2016 Annual reportBuffett was able to take a round of victory.
Many virtual ink were buried about what the bet meant – Some of them pixel on pink. Warren initially assessed his chances of winning 60 percent (wrote in his annual letter from 2016, as if the victory was defined before). I first called 85 percent in our favor. Many results could have happened, but only one. In retrospect, I was cocky, but I warned those who read too much in the results.
Annie Duke calls this “resulting“”A behavior blocking in which people assess the quality of a decision that is based more on the result than on the decision -making process itself. I still believe that the chances at that time were strong for hedge funds, and an unprecedented act of the Fed saved the market from a lost decade.
Regardless of the cause and effect, the bet led to unexpected connections, relationships and experiences. Warren and I met almost every year for dinner, usually accompanied by one or two guests. These guests included Todd Combs; Ted Wechler; My partner at the time and now finance minister Scott Bessent; Hedge fund founder Bobby Jain; Podcast star Patrick O’Shaughnessy; The constant Equity founder Brent Beshor and investor Steve Galbraith, who led to Warren directly to honor Steves Engen Freund Jack Bogle At Berkshire’s annual conference in 2017, I had the opportunity to meet Charlie Munger, who said stereotypical that my bet was “stupid”.
The most important thing is that Girls Inc from Omaha received over $ 2 million with Warren’s victory and bought House protected Provision of support and guidance for the alumni of Girls Inc .. The growth of the 1 million dollar bet in $ 2 million in proceeds is a story in itself. We first divide the purchase of a zero coupon bond that would mature at 1 million USD in 10 years. After the Fed reduced interest rates to zero, the effort of $ 640,000 had increased by about 50 percent. We decided to sell the bonds and buy Berkshire Hathaway stock shortly before Warren bought the shares back for the first time. The performance of the security for the bet exceeded both the S&P 500 and the hedge funds.
Since then, many others have of course turned to me and suggested many different bets.
Everyone came with condemnation bitcoin Hodlers, China Bulls, Emerging Market Mean-Reverters and Japan Governance Reformers. I don’t know if I have communicated with Warren, but I haven’t seen a relevant comparison in one of them.
A few weeks ago I thought of another bet that has – or greater – meaning than the first. What is the bet you ask? Private equity against the S&P 500.
The comparison of a portfolio of North American buyout with the S&P 500 has important consequences, since private equity reaches asset management and opened access to pension plans. In fact, I would argue that this match-up could help to illuminate one of the most thorny and most controversial debates in finance today.
I imagine we know what Warren thinks -high fees and additional expenses will make private equity investors fail. Many external factors could have influenced the result of our first bet (I wrote about it here), but with this comparison it is unlikely. This bet is much closer to representing the initial premise of Warren too faithfully: that intelligent specialists with strong economic incentives to achieve a performance that cannot still be overcome the high fees they collect.
Both the S&P 500 and the North American Buyouts offer diversified commitment in the US economy. Companies in public and private markets are similarly influenced by macroeconomic variables and have a common geographical and sector exposure. (While the Mag 7 dominates the S&P 500, software and technology are the most represented sectors at Buyouts.) Your pricing (P/E of A shares and EV/EBITDA from Buyouts) correlated, partly because transactions between the two markets can carry large price discharpatities arbitrage arbi.
So the question is whether your differences are sufficient for Private equity To compensate for the costs for business. Lever, size, dispersion, illiquidity and control – theoretically – have a positive effect on private equity returns compared to the S&P 500.
– leverage: The S&P 500 is approximately 0.6x debt. Private equity is 1.5 times. Assuming positive returns over a decade and a Roa over the capital costs, the leverage would increase the private equity returns compared to the market.
– Size: Private equity companies are smaller than those in S&P 500. Historically, small companies exceeded large ones, although this has not been the case for some time.
– Dispersion: The distribution of returns about private equity managers was far wider than that on the public stock markets. This creates an opportunity to exceed within the wealth class.
– Illiquidity: Private equity is illiquid. While illiquidity may have no influence on the returns, she likes to avoid investors to avoid going in their own way. Dalbars quantitative analysis of investor behavior It consistently shows that investors for public markets achieve far lower returns than the investments themselves.
– Control: Private equity companies are control owners of companies and compensation management teams that match the results. Public companies tend to have less committed shareholders and fewer owners of the leadership.
Numbers for these concepts:, assuming a 10 percent return of the S&P 500 over 10 years, private equity would have to achieve a gross return of approximately 15 percent in order to exceed the index. A higher lever can make up 2-3 percentage points of this gap in the current interest rates and spreads. However, the forty -year -old tailwind decreasing interest rates will no longer support the private market returns as in the past.
Next, smaller companies can grow faster than larger, a factor that could benefit private markets over time. In the last century, small cap shares in the United States exceeded around 1.5 percent per year, even though this premium was somewhat negative Since the GFC.
The structural advantages of private equity could possibly make up 80 percent of the gap. The rest is allocators to select top-private equity managers, private equity companies to make above-average investments and management teams to achieve better operating results.
I have described twelve examples of private equity transactions in my book. Private equity deals. These managers have many tools available to create value. When reading your stories, it is difficult to imagine that you cannot find a way to deliver.
But as I learned from betting with Warren, the future is much more difficult to predict than the past. If you add it, I would exceed the likelihood of a private equity company on the S&P 500 fees with around 40 percent, which says almost nothing about what investors will actually experience.
In the next few months I will talk to some podcast guests to determine whether we can identify an investable option to represent North American buyouts and someone who takes up any side of the bet.
It could be fun to create a shadow bet from January 1 and report the results annually for the next 10 years. I am happy to see even more to see whether unexpected advantages and connections will appear this time.
So. . . What do you think?
