May 2, 2017 · 1h 14m · capital-allocators
The Bet with Buffett (Capital Allocators, EP.05)
0:00 / 0:00
gold bands on the timeline = statements, start to end. Hover to read, click to jump. CC turns on captions
In this special episode of Capital Allocators, host Ted Seides and guest host Patrick O'Shaughnessy conduct a comprehensive post-mortem of Seides's famous ten-year million-dollar wager against Warren Buffett, exploring hedge fund mechanics, valuation fundamentals, institutional governance, and market psychology.
How this conversation actually went
Every chapter scored 0–10 on four independent dynamics. Hover any point for the reasoning behind the score. Ted holds 68.3% of the talking time here. How this is scored →
Ted as informed peer 6.8 Guest teaching 1.5 Guest disagreement 0.4 Ted pushing back 0.6
speaking balance: gold is Ted, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 14:34 Pushing back on the anti-hedge fund fee narrative
Ted rejects Patrick's dismissal of Buffett's fee argument as a silly headline, insisting the fee drag is real and legitimate.
Hardest push from Ted ▶ 42:46 Ted defending and clarifying the Yale ModelTed counters David Salem's two-bucket framing by detailing how Swenson actually constructed diversification and discipline around perpetual equity capital.
Biggest teaching moment ▶ 24:34 Patrick's deep-dive breakdown on Shiller P/E mechanicsPatrick provides a comprehensive statistical explanation of trailing normalized earnings and historical 10-year real return correlations after Ted yields the floor.
Ted holds their own ▶ 1:12:38 Ted revealing the collateral investment outperformanceTed demonstrates ultimate practical mastery by explaining how shifting the bet's zero-coupon bond collateral into Berkshire shares generated a 300% return, outperforming both contest assets.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Ted as informed peer | Guest teaching | Guest disagreement | Ted pushing back | Why |
|---|---|---|---|---|---|---|
| Contextualizing the Decade-Long Buffett Wager | 0 | 0 | 0 | 0 | Ted opens the episode solo to provide context on his decade-long wager with Warren Buffett. Because this is a monologue setup, all interaction scores are baseline zero. | |
| Berkshire Hathaway Annual Meeting Memories | 5 | 0 | 0 | 0 | Patrick prompts Ted about his first Berkshire Hathaway meeting in 2000. Ted shares personal anecdotes about how the meeting evolved from a small, substantive gathering to an entertainment spectacle. | |
| Origins of the Wager with Warren Buffett | 6 | 0 | 0 | 0 | Ted details the origin of the bet, tracing it back to Andre Perold's HBS case and Buffett's 2007 comments. Patrick listens as Ted outlines the initial written exchange with Buffett. | |
| Structuring and Negotiating the Wager Terms | 7 | 0 | 0 | 0 | Ted describes negotiating the legal mechanics, collateral terms, and involving the Long Bets non-profit. The dynamic is collaborative and informational with Ted demonstrating intimate knowledge of the transaction. | |
| Public Relations Dynamics and Annual Tracking | 7 | 1 | 2 | 3 | Ted pushes back gently on Patrick's characterization that Buffett's fee argument is just a silly headline. Ted then breaks down the annual meeting disclosures and the public relations timeline of the wager. | |
| The Investment Thesis and Bulls Versus Bears Analogy | 8 | 0 | 0 | 0 | Ted articulates the core thesis behind the bet using the Bulls versus Bears cross-sport analogy. He explains why Shiller P/E multiples made the S&P 500 seem like an easy hurdle ex-ante in 2007. | |
| Analyzing Portfolio Exposures and Risk Profiles | 8 | 0 | 0 | 0 | Ted breaks down the mechanical risk exposures of long/short equity hedge funds versus 100% long-only S&P exposure. He explains market beta differences and geographic diversification in depth. | |
| Valuation Fundamentals and the Shiller P/E Framework | 5 | 7 | 1 | 0 | Ted invites Patrick to explain valuation analytics given Patrick's quantitative background. Patrick provides a thorough masterclass on Shiller P/E mechanics and ten-year return correlations. | |
| Target Audiences and Structural Headwinds for Hedge Funds | 8 | 0 | 1 | 1 | Ted differentiates between retail index investors and institutional active strategies, explaining crowding and structural headwinds in long/short equity. He offers deep technical context on short interest metrics. | |
| Ridgeline Sponsor Advertisement | 8 | 4 | 1 | 2 | After an ad break, Patrick references AQR's Buffett's Alpha factor replication research. Ted responds with nuanced analysis of factor replication limits versus dynamic multi-strategy asset allocation. | |
| The Allocator's Edge and Governance Constraints | 8 | 1 | 0 | 0 | Ted discusses the allocator's edge, return dispersion in alternatives, and governance pitfalls. He cites CalPERS's flawed exit from hedge funds as a primary case study of governance constraints. | |
| Asset Allocation Frameworks: Yale Model Versus Salem Model | 8 | 2 | 2 | 3 | Patrick introduces David Salem's two-bucket critique of the Yale Model. Ted clarifies David Swenson's actual philosophy, correcting misconceptions regarding liquidity premiums versus perpetual equity orientation. | |
| Benchmarking Dilemmas and the Decision to Re-Run the Wager | 8 | 2 | 1 | 1 | Patrick and Ted explore customized benchmarking versus absolute hurdle metrics. Ted firmly asserts that given the ex-ante probabilities and valuation environment of 2007, he would make the exact same bet again. | |
| Passive Flywheels and Market Concentration Dynamics | 8 | 0 | 0 | 0 | Ted details the mechanical market impact of passive index flows into mega-cap equities. He notes that even Berkshire Hathaway underperformed the S&P 500 during this same extended period. | |
| The Paradox of Skill and Personal Highlights of the Bet | 7 | 3 | 0 | 0 | Patrick brings up Mauboussin's paradox of skill and rising competition. Ted reflects warmly on personal relationships built through the wager with Buffett, Ted Weschler, Todd Combs, and Carol Loomis. | |
| Permanent Capital Structures and Long-Term Value Creation | 8 | 0 | 0 | 0 | Ted examines permanent equity capital vehicles, citing Tom Russo's concept of capacity to suffer and Ted Weschler's transition from private equity to permanent public equity holding structures. | |
| Exemplars of Capital Allocation and Holding Companies | 6 | 5 | 0 | 0 | Patrick shares case studies of decentralized compounders like John Malone in Cable Cowboy and Mark Leonard at Constellation Software, with Ted adding Prem Watsa's Fairfax to the holding company roster. | |
| The Behavior Gap and the Winning Collateral Investment | 8 | 2 | 0 | 0 | Ted highlights the behavior gap and reveals the ironic twist that the bet's zero-coupon collateral, reallocated into Berkshire Hathaway stock, outperformed both the hedge funds and the S&P 500. |
Statements from this episode (32)
Seides: Berkshire annual meeting evolved from cartoon show to substantive
“And the first time I went after the bet, it was much more of a cartoon show. And I think in the last couple of years, it circled back to kind of a balance between really fun entertainment and substance about the company.”
Seides: Bet with Buffett began from a cold letter in 2007
“So I wrote him a letter, like, you know, figure, write an old fashioned guy, an old fashioned letter. I'd never met him before. I made the letter, I think, cutesy enough that I thought he would respond. And I had heard that he was just legendary in how he resp…”
Seides: Buffett's handshake charitable wager required a 25-page legal contract
“He has bought companies on a contract on a single sheet of paper. And yet this kind of handshake charitable wager ultimately was like a 25 page legal contract.”
Seides: Hedge funds dropped ~24% vs. S&P's 37% decline in 2008
“In 2008, the market, the S&P was down 37%. The hedge funds after Lehman, it was a big difference before and after, but after Lehman had a tough time, but were down, I don't remember the number, maybe it was 24%. This was the group of fund-to-funds.”
Seides: Buffett displayed the wager scoreboard right before lunch when trailing
“In the subsequent few years, he always put the results up, which he still does, right before lunch. And he would say, well, as you see, as you can see, I'm losing, so let's go to lunch.”
Seides: Hedge funds needed a market crash to win the Buffett bet
“For all intents and purposes, it is, because it'd be very difficult for, unless there's a market crash, for the hedge funds to come back”
Seides: S&P 500 was near historical valuation highs in 2007
“At the time, the S&P 500 was trading near its historical high on a Shiller P.E. Basis, P.E. Basis, whatever you want. Simple metrics, but the S&P was expensive.”
Seides: Believed Buffett was 'the patsy' for picking the S&P 500
“I thought Warren was the patsy at the poker table, because he threw out the S&P as the index. I thought that was the wrong index to be picking, and it was something that was going to be an easy hurdle to overcome.”
Seides: Long-short hedge funds carry only about 50% net market exposure
“The two key differences are the level of market exposure, where the S&P 500, every dollar you put to work is a dollar exposed to the market. In this group of hedge funds, and most hedge funds, let's just say for simplicity, it's about half of the exposure to t…”
O'Shaughnessy: Average Shiller P/E sits near 16-17, shifting higher post-1980
“Historically speaking, the average Shiller P.E. Is probably 1617, something like that. But there's definitely two regimes, and one is sort of pre-early 19 eighties, and one is post. And the average post, 19 eighties, is much higher.”
O'Shaughnessy: 10-year real equity returns strongly inversely correlate with Shiller P/E
“When you look at the correlation Correlation between the current Shiller P.E. And the future 10 years of real returns in the market, it's very high. It's something like .7 or point, maybe even higher than that.7. So pretty reliably, what that means is if you b…”
O'Shaughnessy: Shiller P/E at 30 marks only the third time ever
“And we're at 30 today. Only the third time ever at 30 today.”
Seides: The passive S&P 500 trend sets investors up for disappointment
“I just think that we have a trend. That's happened now with passive investing, and particularly the S&P 500, that is setting people, those people up for disappointment in the same way that it did 10 years ago.”
Seides: Long-short equity hedge funds cannot replicate past success due to crowding
“Equity long short is this sort of existential question, which is, can this succeed in the way it has in the past? That's easy. No, it can't. It's more crowded.”
Seides: Hedge funds disproportionately concentrate investments in tech and consumer sectors
“Hedge funds tend to traffic in technology where there's a lot of winners and losers and consumer names where they can walk into the stores and understand them, and you see that in the data.”
O'Shaughnessy: Zero fund-of-funds fees would not have won the Buffett bet
“If the fund to fund fees had been zero, you still would have lost.”
Seides: Replicable alternative strategies have likely lost their edge
“I think that by the time you can replicate most of those strategies, the advantage that they have has probably gone away.”
Seides: Allocators without an edge should avoid alternative asset classes
“If you don't have that allocator's edge, and you don't think you should have it, you probably shouldn't play the game.”
O'Shaughnessy: S&P 500 still beats hedge funds on a Sharpe ratio basis
“I think on Sharpe ratio, it still would have been the S&P.”
Seides: Yale's illiquidity was a consequence of diversification, not intentional strategy
“If you were going to diversify away from sixty-forty, by definition, everything else had to be less liquid. And that was one thing I think people misinterpreted in what he did.”
Seides: Committee discipline and rebalancing matter as much as asset allocation
“And the ability to communicate with a committee and say, these are our targets. We want to shift it. Let's shift it this way and keep people on board was so powerful. I think that was as big of a component as just that particular asset allocation strategy.”
Seides: Would make the 10-year Buffett bet again based on favorable odds
“I would make the bet again, over and over and over again, enough times so that the odds played out.”
Seides: S&P 10-year return was historically anomalous given starting Shiller P/E
“In fact, I think from this starting Shiller PE valuation from nine and a half years ago, this was the best, if not one of the best tenure periods ever.”
Seides: Inflows and competition eroded hedge fund upside-downside capture post-Lehman
“The other thing that happened was, and it really started post Lehman, hedge funds disappointed. Hedge funds in the past, say equity long, short hedge funds, had a certain kind of Capture of, if the S&P went up 10%, you might expect them to make five or six per…”
Seides: Hedge fund-of-funds tied MSCI World over the bet's nine-year period
“If you measured these fund-to-funds against the Morgan Stanley World Index, which is not the right index because it's a hundred percent invested, it's almost a tie. International stocks, so everything but the US, are actually down over this nine-year period.”
Seides: Active outperformance is nearly impossible during heavy passive inflows
“As long as money is flowing there into exactly that strategy and buying those names more than it's buying other names. It is next to impossible to outperform that index.”
O'Shaughnessy: Alpha in financial markets depends strictly on relative skill
“Really all that matters in markets is relative skill. That if you've got, you know, 10 PhDs in a room, maybe 3040 years ago, that meant you were going to earn enormous alpha. But now everyone has those 10 PhDs, and they're fighting against each other. It's a r…”
Seides: Permanent capital makes buyers more attractive to retiring business owners
“If you can make the case credibly that you don't have to sell someone's business, you become a more favorable buyer. So if someone has bought, I'm sorry, built their own company over the years, and they're nearing retirement age, and they want to sell their ba…”
Seides: Ted Weschler left private equity to avoid forced business exits
“Ted went from investing at, he was at a private equity firm, And he switched to creating his own public equity vehicle. And he said that the reason he did that was he felt like if they did a great deal with a great business, it would take every year that went …”
O'Shaughnessy: Constellation Software operates like a disciplined Berkshire for software
“Effectively what that is, is a, like Berkshire, an almost decentralized collection of software companies. So the parent Constellation, forgetting the CEO's name and his team are basically buying up individual assets, not, not micromanaging them. And they're ki…”
O'Shaughnessy: DFA investors suffered a smaller behavior gap than S&P investors
“They've done an amazing job of convincing their investor base that they need to hold these strategies for the long term. Now, obviously, that works out well for DFA as a business, because they've got incredibly sticky money, but it has also worked out very wel…”
Seides: Buffett bet collateral held in Berkshire stock outperformed the S&P 500
“And there's one closing point I'd make that's an undercurrent of the bet, which is we all talk about and focus about how great the S&P five hundred's been. But what we actually did with the money, the collateral of the bet, outperformed the S&P 500 by a mile. …”