Ted Seides is a principal at Protégé Partners, a money management firm in New
York. Some time ago, Protégé bet $320,000 that, over the 10 years from January
2008 to December 2017, a portfolio of hedge funds would do better than the
S&P500, after deducting fees, costs and expenses. Together with $320,000 from
the person betting against Protégé, a total of $640,000 was given to a
Foundation. For a fee, the Foundation agreed to buy and hold a zero-coupon US
Treasury bond that would be worth a million dollars when the bet is settled.
Either way, the money will go to charity. If Protégé wins, the money benefits
Absolute Return for Kids based in London. Otherwise, it benefits Girls
Incorporated of Omaha, Nebraska which (given that you know the terms of the
wager) should be the only clue you need to identify Protégé’s
counter-party: Warren Buffett. The billionaire’s reasons are pithy:
“Costs skyrocket when large annual fees, large performance fees and
active trading costs are all added to the active investor’s equation.
Funds of hedge funds accentuate this cost problem because their fees are
superimposed on the large fees charged by the hedge funds.”
People enter into friendly wagers all the time, of course, but few attract so
much attention. Readers with long memories may recall a similar bet made a
quarter of a century ago by Julian Simon, an economist, and Paul Ehrlich, a
biologist. The late Mr Simon doubted that economic growth would lead to
scarcity and a concomitant rise in prices of natural resources. Instead of five
funds, Simon and Ehrlich settled on five metals: copper, chromium, nickel, tin
and tungsten. Simon won: 10 years later, all five were cheaper. Despite modest
stakes, the Simon-Ehrlich bet attracted plenty of attention. Indeed, with oil
touching new highs and increase in food prices causing turmoil from Haiti to
Italy, the bet seems as topical now as when it was made.
By distilling complex considerations into a provocative assertion, such bets
encourage us to grapple with controversial views about the world. In recent
years, the Internet has made it possible to do so on a grand scale. Sites like
intrade.com and Tradesports.com – prediction markets, as they are called –
aggregate a multitude of such bets on topics ranging from sports and current
affairs to such arcana as the replicability of experiments in cold fusion.
Meanwhile, companies looking for an edge are using prediction markets too.
Google, for example, has been at it for years. Bo Cowgill, manager of the
company’s internal markets for much of that time, says 80,000
transactions have spanned 275 issues, ranging from demand (“How many
people will use Gmail in the next three months?”) to performance (“Will
project deadlines be met?”). At Best Buy, an electronics retailer in the US,
prediction markets have yielded sales estimates far more accurate than
forecasts produced by the company’s paid experts.
Corporate sites tend to exclude outsiders, but the most vibrant prediction
markets are open to all. We are talking, of course, about stock markets. As the
University of Chicago’s Todd Henderson observes, “The price of a
stock is just a prediction market about that company’s future cash
flows.” But remember: gambling and sound investment policies are poles apart.
Given how easy it is to go astray, advice from our famous bettor may help.
We’ll let him have the last word, as recounted by his partner, Charlie
Munger: “When Warren lectures at business schools, he says, ‘I could
improve your ultimate financial welfare by giving you a ticket with only 20
slots in it so that you had 20 punches – representing all the investments that
you got to make in a lifetime. And once you’d punched through the card,
you couldn’t make any investments at all. Under those rules, you’d
really think carefully about what you did’.”
Shreedhar Kanetkar welcomes your comments. Write to [email protected]