The cost of outperformance
We simulated the performance of a “perfect foresight” fund manager to determine the drawdowns relative to the S&P 500 one may incur if such a strategy was selected. USD 1 invested in the ‘perfect foresight’ portfolio in June 1972 would be worth USD 430,970,849 at the end of April 2022, for a whopping 48.83% return per annum. This compares to investing in the S&P 500 which would have turned USD 1 into USD 158, for a return of 10.67% per annum.
So how much volatility would one have to bear to turn USD 1 into USD 430,970,849? We analysed the monthly drawdown of such a portfolio against the S&P 500 assuming our manager maintained the discipline of holding onto those 50 best performing companies despite the volatility. The maximum drawdown relative to the S&P 500 an investor would suffer would be 26.1% which occurred during the 2008 financial crisis. Other recent notable periods would also produce gut wrenching drawdowns. During the Dotcom bust of 2000 the fund would draw down by 11.4%, and during the Covid-19 crisis of 2020, by 16.8%.
Even a fund managed with perfect foresight would experience many periods of significant relative drawdowns in delivering the best possible portfolio return. The key lesson from this is that if one is invested in an investment process which delivers proven long term returns, one has to be willing to experience significant drawdowns to obtain better than benchmark performance. The key criteria for assessing whether or not to retain a fund manager should not be short periods of underperformance but rather the quality of their underlying investment process and how consistently their process is applied.
Read our full report as we examine the two main causes of the recent underperformance of growth stocks and if the secular growth trend is broken, as well as company case studies.
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