AQR's Cliff Asnes highlights that a prolonged period of underperformance is psychologically and professionally more damaging than a sharper, shorter drop. Enduring a multi-year drawdown erodes client confidence and forces painful business decisions, even if the manager's conviction in their strategy remains high.
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Permira's co-CEO highlights a critical challenge in industries with long feedback loops, like private equity: the temptation to prematurely kill initiatives that appear to be failing. The key leadership skill is discerning if a strategy is flawed or simply needs more time to compound.
Scott Barbie's value fund experienced a massive drawdown before a 91% rally. This illustrates that systems with high variability show the strongest regression to the mean. If your investment theses are sound, a period of severe underperformance can be a leading indicator of a powerful recovery.
The textbook value investing response—buying more as a stock falls—is often impractical. In firms focused on short-term performance, a stock dropping from $70 to $30 after a buy recommendation can get an analyst fired, even if the thesis is ultimately correct. This institutional pressure shortens time horizons.
While long-term focus is a virtue, investment managers at WCM warn it can become an excuse for inaction. During periods of significant market change, blindly "sticking to your knitting" is a liability. Recognizing when to sensibly adapt versus when to stay the course is a critical and nuanced skill.
Professional fund managers are often constrained by the need to hug their benchmark index to avoid short-term underperformance and retain clients. Individuals, free from this 'career risk,' can make truly long-term, contrarian bets, which is a significant structural advantage for outperformance.
Average drawdown is superior to metrics like standard deviation because it measures both the magnitude and duration of a portfolio's decline. This combination better reflects the actual emotional discomfort clients experience during a market downturn, making it a more practical gauge of risk.
When WCM refreshed its portfolio, the new holdings initially lagged behind the old ones as the market snapped back. This created a "lonely" period of intense self-doubt and internal questioning. This highlights the emotional difficulty of sticking with a process change before results validate the decision.
Marks uses the analogy of a six-foot man drowning in a stream that's five feet deep on average. This illustrates that portfolio construction must account for worst-case scenarios, not just average outcomes. Survival through every market phase, especially the low points, is a prerequisite for reaching long-term goals.
Contrary to expectations, drawdowns in managed futures frequently occur when equity markets are performing well. The strategy's recovery periods, however, often coincide with equity market turbulence, highlighting its counter-cyclical nature and making it behaviorally difficult to hold.
Even long-term winning funds will likely underperform their benchmarks in about half of all years. A Vanguard study of funds that beat the market over 15 years found 94% of them still underperformed in at least five of those years. This means selling based on a few years of poor returns is a flawed strategy.
