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. Protégé Partners LLC accepted, and the two parties placed a million-dollar bet.

Buffett has won the bet, Ted Seides wrote in a Bloomberg op-ed in May. The Protégé co-founder, who left in the fund in 2015, conceded defeat ahead of the contest's scheduled wrap-up on December 31, 2017, writing, "for all intents and purposes, the game is over. I lost."

Buffett's ultimately successful contention was that, including fees, costs and expenses, an S&P 500 index fund would outperform a hand-picked portfolio of hedge funds over 10 years. The bet pit two basic investing philosophies against each other: passive and active investing.

A Wild Ride

Buffett may be the quintessential active investor himself, but clearly doesn't think anyone else should try. He said as much in his most recent letter to Berkshire Hathaway Inc. (BRK.A, BRK.B) shareholders, dated February 225, 2017. Buffett boasted that there was "no doubt" who would come out on top when the contest ends. (See also, The 'Next Warren Buffett' Curse Is Real.)

His victory didn't always seem so certain. Not long after the wager started on January 1, 2008, the market tanked, and the hedge funds were able to show off their strong suit: hedging. Buffett's index fund lost 37.0% of its value, compared to the hedge funds' 23.9%. Buffett then beat Protégé in every year from 2009 through 2014, but it took four years to pull ahead of the hedge funds in terms of cumulative return. (See also, Hedge Fund Fees: Exotic Expenses.)

In 2015, Buffett lagged his hedge fund rival for the first time since 2008, gaining 1.4% versus Protégé's 1.7%. But 2016 saw Buffett gain 11.9% to Protégé's 0.9%. Another downturn could conceivably have handed the advantage back to Protégé, but that didn't happen. At the end of 2016, Buffett's index fund bet had gained 7.1% per year, or $854,000 in total, compared to 2.2% per year for Protégé's picks – just $220,000 in total.

In his shareholder letter, Buffett said he believed the hedge fund managers involved in the bet were "honest and intelligent people," but added, "the results for their investors were dismal – really dismal." And he noted that the two-and-twenty fee structure generally adopted by hedge funds (2% management fee plus 20% of profits) means that managers were "showered with compensation" despite, often enough, providing only "esoteric gibberish" in return.

In the end, Seides admitted the strength of Buffett's argument: "He is correct that hedge-fund fees are high, and his reasoning is convincing. Fees matter in investing, no doubt about it." The index fund Buffett chose (see below for details) charges an expense ratio of just 0.04%, according to Morningstar.

In his letter, Buffett estimated that the financial "elites" had wasted $100 billion or more over the past decade by refusing to settle for low-cost index funds, but pointed out that the harm was not limited to 1%-ers: state pension plans have invested with hedge funds, and "the resulting shortfalls in their assets will for decades have to be made up by local taxpayers."

Buffet also floated the idea of erecting a statue to the index fund's inventor, Vanguard Group Inc. founder Jack Bogle.

All About the Fees?

Seides did push back against some of the Berkshire CEO's passive triumphalism. "Fees will always matter," he wrote, "but market risk sometimes matters more." The S&P 500's run-up following the financial crisis defied reasonable expectations, Seides argues, and "my guess is that doubling down on a bet with Warren Buffett for the next 10 years would hold greater-than-even odds of victory."

He also raises doubts that fees were the deciding factor, pointing out that the MSCI All Country World Index has performed almost exactly in line with the hedge funds in the bet. "It was global diversification that hurt hedge fund returns more than fees," Seides concludes.

The terms of the bet pit incomparable vehicles against each other – apples and oranges, or as Seides put it, the Chicago Bulls and the Chicago Bears: "hedge funds and the S&P 500 play different sports." Then again, Seides did take the bet on these basketball-v.-football terms, and he recognizes that Buffett came out on top: "Forget the Bulls and Bears; Warren picked the World Series Champion Chicago Cubs!"

What Exactly Is the Bet?

A few details about Buffett and Protégé's wager. The money Buffett has put down is his own, not Berkshire's or its shareholders'. His chosen vehicle is Vanguard's S&P 500 Admiral fund (VFIAX). Protégé's is the average return of five funds of funds, meaning that the fund-of-fund managers who select the choicest hedge funds themselves take a cut. These funds-of-funds have not been disclosed, in line with SEC rules on hedge funds' marketing.

The million dollars will go Girls Incorporated of Omaha, since Buffett won. A win for Protégé would have seen Friends of Absolute Return for Kids win the pot. In an odd twist, the prize money – stashed away in the most boring and secure instruments available – has seen by far the best return. The sides initially put $640,000 (split evenly) into zero-coupon Treasury bonds that were structured to rise to $1 million over 10 years. But the financial crisis saw interest rates plunge and sent the bonds up to nearly $1 million in 2012.

By mutual agreement, the bettors sold the bonds and bought (actively managed) Berkshire B-shares, which were worth $1.4 million as of mid-February 2015. That 119% return blew both the Vanguard fund and Protégé's funds of funds out of the water; the stock returned an additional 19.1% from the end of February 2015 to September 8, 2017. If the share price had dropped, the winning charity was guaranteed $1 million anyway; since the pot remained larger than the originally agreed amount, the charity will get the surplus.

The money has been held by the Long Now Foundation in San Francisco, a non-profit which holds parties to long-term bets accountable. To give a sense of how long-term they like to think, the site lists the bet's duration as: "10 years (02008-02017)." The site has not assigned victory to one party or the other yet, Seides' admission of defeat notwithstanding.

The Tortoise and the Hare

To mere mortals, this may look like a bet between a handful of Masters of the Universe and the world's third-richest person, the Oracle of Omaha. But Buffett has characteristically hit on a humbler metaphor for the wager: Aesop's tortoise and hare. While the hedge funds and funds of funds – the hares – bound around between exotic asset classes and elaborate derivatives, charging high fees for their troubles, passive index investors – the tortoises – worry about other things while the market, significant short-term turbulence aside, gradually gains in value.

Protégé sees things differently, writing before the bet started, "Hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional 'relative-return' investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls" (by these standards, Protégé delivered exactly what it promised). Protégé argues that "there is a wide gap between the returns of the best hedge funds and the average ones," which justify the fees at the center of the argument. (See also, The Multiple Strategies of Hedge Funds.)

The Bottom Line

Everyone and their mother has an opinion about low-fee, passive index investing versus actively managed investments. The Buffett-Protégé contest provides fodder for arguments on both sides. While Buffett won according to the terms of the bet, the hedge fund side showed the merits of a bit of extra tweaking and pruning following the 2008 crash, which put them ahead of Buffett's Vanguard fund until 2012. And Protégé did beat the market in the previous cycle: their flagship fund returned 95% from 2002 to 2007, net of fees, versus 64% for the S&P 500. If the period running from the beginning of 2008 though 2017 had seen a second swoon, Protégé's co-founder might be writing sassy declarations of victory rather whatboutist op-eds. While this battle has been won, the active-passive war will rage on. (See also, The ETF Economy: Overpaid Execs and 'Absurd Valuations.' )

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