Key Points
- Patience is a crucial virtue in investing, even with outperforming active managers.
- Investors should understand the frequency, magnitude, and duration of drawdowns when considering active strategies.
- Odysseus’ journey and responses to challenges offer valuable lessons for investors.
At the end of the Trojan War, Odysseus sets sail to return to his family, his wealth, and his kingdom on the Greek island of Ithaca. Instead of the expected 10 days, the journey took 10 years due to unexpected challenges along the way.
Odysseus encounters captured by a goddess, battles the Cyclops, and navigates through terrifying storms while his rivals back home consume his riches and compete for the affections of his wife.
Ultimately, after a decade, when Odysseus reaches Ithaca, he defeats his wife’s suitors and secures his wealth and legacy.
According to Homer’s epic poem, Odysseus’ traits would have made him a great investor, with patience being a crucial virtue in investment.
Understanding Patience and Drawdowns
Patience is defined across three dimensions:
- Likelihood of Occurrence and Frequency: Examining the frequency of underperformance and how often these periods occurred.
- Magnitude: Evaluating the worst underperformance over various time periods and drawdowns of particular magnitudes.
- Duration: Analyzing the longest period of underperformance between a fund’s peak and its subsequent return to that peak.
Historical Patience Results
An analysis of US-domiciled actively managed mutual funds with at least 10 years of returns during the 25 years ended 31 December 2019 revealed that almost all outperforming managers experienced frequent periods of underperformance relative to their respective style or peer benchmarks. Additionally, some of these underperformance periods were large in magnitude and long in duration.
Close to 100% of outperforming funds have experienced a drawdown relative to their style and median peer benchmarks over one-, three-, and five-year evaluation periods. It was also found that 80% of outperforming funds had at least one five-year period when they were in the bottom quartile relative to their peers. These findings are crucial, especially considering the results of a 2016 State Street survey of senior executives with asset allocation responsibilities for large institutional investors, where 89% of these executives expressed intolerance for underperformance for more than two years before seeking a replacement.
Furthermore, over half of outperforming active equity funds underperformed their style and median peer benchmark by 20% or more.
Of the funds that recovered from their largest drawdown, three-quarters did so after three or more years of underperformance, with a quarter recovering after more than seven years of underperformance.
Understanding what to expect and having high conviction and appropriate risk tolerance can lead investors to possess the necessary patience to prepare for and tolerate the frequency, magnitude, and length of the drawdowns.
Odysseus’ response and actions during his journey offer a powerful lesson for investors seeking to outperform with active strategies. His ability to resist short-term temptations and remain patient serves as a valuable example of successful navigation through challenges.
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All posts are the opinion of the author and should not be construed as investment advice. The opinions expressed do not necessarily reflect the views of CFA Institute or the author’s employer.
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