January 1st of 2008 commenced one of the most exciting bets of this century (at least to us finance nerds 😊). “The Bet” pitted Warren Buffet, arguably the world’s most successful investor against Protégé Partners LLC, a hedge fund based out of New York City. Buffet believed that the fees associated with the active management of the hedge fund could not be justified, and a simple low-cost S&P 500 Index would outperform (when adjusted for fees) over a 10-year period.

Several factors contributed to making this wager so fascinating, but at its core, “The Bet” sought to settle the age-old debate of active versus passive investing. Considering the title of this blog is Why Your Investments Should be Boring, you can probably determine for yourself who won, but I think a deeper dive into the how and the why along with some supporting data can really help to shine some light on this issue

Defining our Terms: Active vs. Passive

For the purposes of this post, active investment management refers to a more hands-on approach in which the investment manager buys and sells securities in an attempt to outperform the market. Passive management can be defined as a portfolio mirroring different sectors of the overall market. In other words, passive investing attempts to return what the greater market returns and active management attempts to beat what the overall market is returning.

Back to “The Bet”

As I stated before “The Bet” began at the beginning of 2008. Many reading this certainly remember the 2008 stock market crash! For Buffet and his passive management strategy this was worst case scenario because hedging (limiting losses) is a hedge funds specialty…go figure.

Year one ended with Buffet’s index fund losing 37% of its value while the hedge fund fared quite a bit better only losing 24% of its value. However, the tides turned quickly as this kicked off a period in which Buffet’s index fund beat the hedge fund in 8 of the next 9 years. In the end, it was a considerable defeat for Protégé Partners LLC, as their fund returned 22% while the S&P 500 Index Fund returned 85.4%.

While this certainly gives us a nice anecdotal story to highlight the benefits of passive investing, could it simply be the case that one of the most intelligent investors of all time outsmarted the hedge funds at their own game? Maybe…but I don’t think so.

Warren Buffet is incredibly shrewd and has proven to be successful investing over several decades, so it is certainly reasonable to believe that he simply snuffed out the market conditions in the upcoming decade better than this hedge fund. However, when evaluated with a larger lens, this looks less like ‘Oracle of Omaha’ magic and simply fits into the big picture that the body of data lays out for us.

The Real Reason We Believe in Passive Investing: SPIVA

No SPIVA isn’t a sweetener that you put in your coffee…SPIVA stands for S&P Indices Versus Active. Ultimately this is a research metric which measures the performance of actively managed funds against their index benchmarks. Paraphrased for the less financially inclined, this data looks at mutual funds whose managers make active decisions regarding the fund’s holdings and market timing strategies and compares them to the greater market in that category.

The data is incredibly convincing. Nearly 90% of actively managed large cap funds underperform the S & P 500 when adjusted for fees over a 10- or 15-year period. The fact that this data is up to date as of June of 2022 makes this even more compelling as this data contains the lion’s share of the stock market downturn in 2022. This is significant because, historically, actively managed funds perform better during downturns in the market. Last year 55% of actively managed funds underperformed…so in their best showing in over a decade, on average you were still better off being in passively managed funds, and in the last decade only one out of every ten funds outpaced the benchmark.

Look at the SPIVA Data Here: SPIVA | S&P Dow Jones Indices (spglobal.com)

Whether you are a DIYer or you utilize the services of a financial advisor, this may raise several questions about your own investment portfolio. Check back in with next week’s blog where I will tackle the most common questions I receive.

This post is for educational and entertainment purposes only. Nothing should be construed as investment, tax, or legal advice.