STREET DOGS

Alternative views are dismissed not after consideration, but on contact. Facts are rejected even as they are offered. Perspectives and evidence are repelled somewhat like a magnet repelling iron filings. ”— Matthew Syed

The bizarre thing is that history and mathematics show us that it is actually what happens in a negative year that really defines one’s long-term track record.

Consider two funds: Hare and Tortoise against an index Y. The index compounds at 15% a year for eight years. Tortoise Fund underperforms the index by 500bps every year, compounding at 10% whereas Hare Fund blows the lights out, beating the index by 500bps, delivering 20% annual returns. At the end of year eight, Tortoise Fund has doubled your money up 114%, the index is a two bagger up 200% whereas Hare Fund looks like a hero; up 330%.

The problem comes in year nine, the index is -40% in a catastrophic year (they do happen) and Hare Fund falls -60% in that year because of owning all the stocks which everyone rushes to sell. Tortoise, having avoided a lot of the excess is -10% in that year. The outcome isn't immediately obvious but Tortoise now comfortably leads the pack vs the index and Hare.

This example isn’t just that, but actually demonstrable in the returns of the greatest investor of our time Warren Buffet. If you look at the excess returns that Warren Buffet has delivered over the last 30+ years vs the S&P 500 you will find that the three greatest years of outperformance were all in negative index years, secondly you will see that all the underperformance periods are found in positive index years. In other words it is no problem underperforming in up years, it is the down year when things matter.