Warren Buffett’s Bet

The Bet

In 2008, Warren Buffett issued a challenge to the hedge fund industry, which in his view charged exorbitant fees that the funds’ performances couldn’t justify. Mr. Buffett contended that, including expenses, a passive strategy invested the low-fee Vanguard S&P 500 index fund would outperform an actively managed portfolio of hedge funds over the 10 years ending Dec. 31, 2017. Protégé Partners LLC accepted, and the two parties placed a $1,000,000 bet.

Who is winning

By the end of 2016, Warren Buffett’s passive investment in Vanguard’s SP500 fund is up 85.5% compared to 22% for Protégé. This is after Protégé got off to a better start during the 2008 bear market.  With less than a year left for the bet, Protégé has conceded defeat barring a market crash by the end of the year.

But wait, I entered Sy Harding’s semi-passive strategy to the bet last year.  He is still winning but it could be close by the end of 2017… close only if Sy Harding strategy sits in cash and earns no interest when he is sitting on the sidelines.

Who is Sy Harding?

Sy Harding developed a semi-passive strategy that is one of the few strategies to beat the market over the full market cycle – bull and bear market.  It is “semi-passive” is the sense that it only holds stocks for half of each year – the favorable season for equities.  During the unfavorable season, it invested in a low-risk interest-bearing fund.

Sy not only wrote a book about the strategy, he published a newsletter until he passed away leaving a track record of real-world success. Since we have his objective formula, we can calculate how his strategy fared in the competition.

Buffet SP500

Sy Harding used the Dow Jones Industrial Averages for his two timing signals each year.  In the chart above, I used his signal to enter and exit the same SP500 index fund Warren Buffet used.  Sy’s semi-passive strategy applied to the SP500 was up 86.2% compared to Warren’s 85.5% buy and hold strategy by the end of 2016. It’s neck and neck.

Remember, Sy’s strategy is sitting in cash half the year.  If you add a little interest earnings during this time, Sy Harding would maintain a good lead. If we used the SP500 index instead of the DOW for his timing signals, his strategy returned 92%. If we invested in the DOW instead of the SP500 through the DIA ETF his strategy returned 98%.

Both strategies take advantage of the low-fee SP500 index fund.  Both strategies hold the fund during the favorable season for equities.  The only difference is Sy’s strategy moves out of equities into a safe fund during the unfavorable half the year.

Stress-adjusted Returns

What does not show up under return comparisons is investor stress.  In Ted Seides’ Bloomberg article Why I Lost My Bet to Warren Buffett he brings up the difficult situation a buy and hope investor faces:

The S&P 500 index fund fell 50 percent in the first 14 months of the bet. Many investors lacked Warren’s unparalleled fortitude, and bailed out of the markets when the pain became too severe. An investor who panicked and only later re-entered the market would have found that his bank account at the end of the bet was a lot smaller than a hypothetical account in which he earned the index-fund returns for the whole period.

With the market today sitting at valuation levels similar to 1929 and 2000, an investor should not assume the market will bounce back to break-even in a few short years when the next bear strikes.  It took the market over 25 years to break-even after the 1929 market crash and  Japan’s Nikkei 225 is still well below its peak over 30 years ago.

After the 2000 market crash, it took massive central bank interventions and 13 years for the SP500 reach new highs. I expect the market to dive below the 2000 levels once again.

Warren Buffett’s investing life correlates to two impressive secular bull markets and one secular bear market that allowed him to get in at historically low valuations.  Buy and hold looks great looking through Warren’s rear-view mirror.

Unfortunately we can’t drive retirement accounts forward while looking back.  Passive buy and hold will not have the same outcome in the next 10 years or 50 years simply based on today’s valuations.

About Sy Harding

Sy Harding exploited a seasonal tendency observed for 300 years in England’s stock market and for over 100 years with the Dow and 60 years with SP500 index in the US.  He simply sat out the unfavorable half the year for equities and this navigated the last two bear markets exceptionally well.

Sy Harding’s investment newsletter was professionally tracked and Mark Hulbert of Market Watch often mentioned him as one of the few market analysts who was able to beat the indexes when looking at up and down markets by following an advanced version of what Mark called the Halloween Indicator.

When I was researching investment newsletters and timing strategies, I was impressed with the simplicity of Sy’s strategy. I have found no other investment strategy that is as simple-to-execute for retirement accounts.

Since most retirement plans do not offer the Dow Jones Industrial Averages as an option, I researched optimizing Sy’s basic premise to the SP500. Look out Warren!

A Seasonally-Modified Buy & Hold Strategy

Our own strategy (built upon Sy Harding’s concept) applied to Vanguard’s SP500 strategy is up 128.8% through the end of 2016.  We call our strategy a Seasonally-Modified Buy & Hold Strategy™ to make the point it is a semi-passive strategy that only holds equities during the favorable season for equities.

Buffett Bellwether Chart

The strategy is more impressive when applied to small caps such as the Vanguard VXF ETF that tracks all the US-listed companies not in the SP500. For the bet, this small cap fund is up over 204% sitting in cash the other half of the year.  This compares to 106% for the small cap index fund or 85.5% for the SP500 index.

Buffet S fund

Since I optimized the strategy for the government TSP retirement funds we see that switching to a safe interest-bearing fund (TSP G fund) when out of equities adds another 30% to the strategy’s total return bringing the total return to 234% or 14.3% annualized.

Unlike most claims that you need to assume more risk to increase your returns, the seasonal strategies increased returns because they *lowered* risk.  No hedge fund fees or complex trading strategy… Warren Buffett’s passive strategy doesn’t have a chance.

Invest Smart

TSP & Vanguard Smart Investor reminds investors twice a year to move in and out of equities in order to avoid the unfavorable season.  We also monitor and warn of conditions that have lead to bear markets in the past. View our Levels of Service for more information.


Categories: Perspectives, The Smart Bird, TSP Allocation Strategy, TSP Charts