At the tip of the Trojan War Odysseus sets sail to return to his family, wealth and kingdom on the Greek island of Ithaca.The journey must have taken 10 days. Instead, it took 10 years.
On his journey home, Odysseus faces unexpected challenges. He is captured by a goddess. He battles the Cyclops. He navigates terrible storms. And while he wrestles with these trials, his rivals back home in Ithaca devour his riches and vie for his wife’s affections.
When Odysseus finally reaches Ithaca at the tip of the last decade, he defeats his wife’s suitors and secures his wealth and inheritance.
My opinion on Homer’s epic poem: Odysseus would have been an amazing investor.
Why? Because patience is a virtue in investing. And even when we invest with an above-average lively manager, this virtue continues to be essential. That is the conclusion of our research what type of courage it takes to navigate the ups and downs that include actively managed strategies.
Definition of patience and drawdowns
We defined patience based on three dimensions:
- : Has the fund underperformed? How often did these periods of relative underperformance occur?
- : What was the worst relative underperformance over different time periods? Which funds experienced particularly heavy losses?
- : What was the longest period of relative underperformance, measured by the point between a fund’s peak and its subsequent return to that peak?
Historical patience results
So what does a patient investor in an above-average lively equity fund need to endure and what does he get in return?
To answer these questions, we analyzed U.S.-based, actively managed mutual funds that generated at the least 10 years of returns over the 25 years ending December 31, 2019. The sample included 2,593 funds, of which 1,173 outperformed their style benchmark, with the median outperforming fund generating an annualized net excess return of nearly 1%.
Overall, we’ve found that just about all outperforming managers have frequent periods of underperformance relative to their respective style or benchmarks. Some of those periods of underperformance are large in magnitude and long in duration.
We found that almost 100% of the higher performing funds experienced a decline relative to their style and average benchmarks over one, three and five years. In addition, 80% of the higher performing funds were in the underside quartile of their peer group. This is very necessary to know because the outcomes of a 2016 State Street executive survey with responsibility for asset allocation at large institutional investors. The survey found that 89% of those executives wouldn’t tolerate poor performance for greater than two years before in search of a substitute.
In addition, some investors lose patience when a manager underperforms by certain amounts. We found that over half of actively managed equity funds that outperform underperform their style and average benchmark by 20% or more.
Most of one of the best performing funds recorded losses of over -20%
Sources: Vanguard calculations based on data from Morningstar, Inc.
Finally, three-quarters of the funds recovered from their sharpest decline after underperforming for at the least three years. 1 / 4 of those funds even recovered after greater than seven years of underperformance.
For three quarters of the outperforming funds, the recovery took longer than three years
Sources: Vanguard calculations based on data from Morningstar, Inc.
Investors who know what to anticipate, are confident of their position and have the suitable risk tolerance usually tend to have the patience needed. They are in a position to prepare for and tolerate the frequency, magnitude and duration of price declines.
Odysseus also struggled with fears and the urge to provide in to short-term needs. As he sailed to Ithaca, the seductive song of the Sirens tempted him to deviate from his course and lured him into shipwreck. But he had prepared himself: he had his crew plug his ears with beeswax and tie him to the mast with instructions to not let him go or obey his orders while the Sirens were inside earshot. As much as he was entranced and drawn by the song of the Sirens, he couldn’t change his course. Odysseus knew that impatience and panic would result in disaster for him and his men.
His answer is a crucial lesson for investors who want to realize higher performance with lively strategies.
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Photo credit: ©Getty Images / ZU_09
