Most people prize excellence. But in all things, true excellence is difficult to find, and consistent excellence is nonexistent in many fields.
A good example is the Beatles. The band was together for only eight years, and has sold more records than any other. (Along with Michael Jackson and Elvis Presley, they are among the top in sales among former or deceased musical artists.) But out of the 275 songs they released, only 35 — fewer than 13 percent — were hits in North America. So, when using hit status (sales) on this continent as the criterion for excellence, we see that even the Fab Four did not achieve it consistently. (Neither have the Rolling Stones who, after being together for 50 years, have had 17 hits out of 439 songs.)
Inconsistent excellence is a fact of life among the top individuals in many professions, including writers, actors and salespeople. It’s also true of investment managers, who are often judged by standards of excellence that even the Beatles didn’t achieve. Investors want consistency that just doesn’t exist. They should settle for long-term averages that are pretty darned good, though these averages may be dragged down a bit by performance periods that are below hit status. In any endeavor, including the Beatles’ incredible career, the long-term average is what counts. And in many challenging endeavors where variable performance is unavoidable, down periods are inevitable.
Because it’s the long-term average that counts, the critical questions are: How often do these down periods occur and how long they last?
Davis Advisors examined the records of many investment managers widely regarded as being highly successful. This research found that, contrary to the ordinary conception that successful investment managers never underperform, they inevitably do. This study examined the long-term records of top-performing large-cap investment managers from January 2004 to December 2013. It found that about 95 percent of them fell to the bottom half of their peers for at least one three-year period, and that 73 percent ranked in the bottom quarter of their peers for at least one three-year period.
Though each of the managers in the study delivered excellent long-term returns, almost all suffered through a difficult period. Investors who recognize and prepare for the fact that short-term underperformance is inevitable — even from the best managers — may be less likely to make unnecessary and, sometimes, destructive changes to their investment plans by changing advisors. The key for these investors is to get their head around the concept that, statistically speaking, short-term underperformance isn’t a clear indicator of the prospects for long-term success.
During such doldrums, these managers might appear to be has-beens. Whether that characterization turns out to be accurate, of course, depends on whether they come out of their slumps; some do and some don’t. But many of those averaging in the top quartile for the long term have a short-term period in their past that, like most of the Beatles’ songs, isn’t a hit.
For investors shopping around for advisors, those with great long-term records who are currently in a slump might be attractive. If the chances of their climbing out of the slump look good, this might be an opportunity to get an advisor or get into a fund that might otherwise be inaccessible.