The anxiety of portfolio underperformance
Rather than staring at the screen, a better use of time is to revisit the rationales you had written while buying the stocks
An inescapable facet of being a relative return fund manager is that your performance is always measured against a benchmark index. A layperson may not take it kindly if they are asked, “How’s your performance?” But we fund managers are quite used to the question and the words underperformance and outperformance, though not very common in everyday usage, are quite common in the money management lexicon.
Equally inescapable is the fact that every fund manager, however good, will go through phases of underperformance, i.e. their fund’s returns will be lesser than the benchmark index. The only known exception to this was possibly Bernie Madoff but we all know how that ended. Not even Warren Buffett has escaped this truth. In fact, he puts a simple table with Berkshire Hathaway’s per share book value growth and S&P index returns on the first page of every annual letter that he writes to shareholders. The 2017 letter shows that in six out of the past 10 years, Berkshire’s book value growth underperformed the S&P 500 and yet nobody would debate the fact that the cumulative return, both absolute and relative, over many decades has been astounding. However an average investment committee whose patience generally wears thin after a couple of consecutive years of underperformance would have sacked Buffett as a fund manager thrice in his career. Not having an investment committee breathing down his neck is perhaps Buffett’s biggest competitive advantage.
Lesser mortals though have to play this relative performance game and the unfortunate part is that index returns can be computed for all time periods from minutes to decades. I vividly recall a conversation with a fellow fund manager who was lamenting that he was already down 25 basis points against the index and it was only 10.30 in the morning.
Availability bias means that what’s measurable will be measured, irrespective of whether it is signal or noise. There are a few tell-tale symptoms of a fund manager who is underperforming even if it’s for a short period of time, like a few months. The first symptom is obsession with daily relative performance. Waking up bleary eyed to check this first thing in the morning is the most common sign. An extension of this is an unhealthy obsession with the performance of one’s peer group funds. Once done checking your own fund’s net asset value (NAV), you go through the NAV of your peer group funds to see if they are doing better or worse. This also morphs into obsession with peer group portfolios and who is buying or selling what.
Another symptom is to dissect index returns and focus too much on stocks that are in the index and have done well over the last few months. While being sure of why you don’t own a certain stock is important, spending too much time analysing stocks and sectors just because they have done well in the recent past will lead to biases. Shying away from investor communication is another sign. This is true not only for underperforming fund managers but also for companies which are going through a soft patch in their business cycle. All of us know of companies that are on multiple business news channels and investor roadshows when the going is good, but go into a shell when things turn for the worse. Loss of productivity due to fleeting attention span, given the pre-occupation with price movements and a constant state of irritability, that in an advanced stage leads to viewing everything negative through lens of a conspiracy theory are some of the other pitfalls.
The symptoms might seem formidable and yet you are not the first fund manager to exhibit them. Through self-observation and learning from seasoned investors who have seen these cycles multiple times, there are a few hacks to better contend with the symptoms. The one that helps most is knowing your investment style. Every fund manager should be able to clearly articulate in what kind of a market environment their style would work and when it wouldn’t. This should be mandatory material in every marketing pitch and should be emphasized, especially in the good times.
In times when the portfolio is underperforming the index, having this clarity can give tremendous confidence. Buffett alluded to this quite early in his investing journey. In his second annual letter to limited partners written in 1957, he said: “Our performance, relatively, is likely to be better in a bear market than in a bull market… In a year when the general market had a substantial advance, I would be well satisfied to match the advance of the averages.”
Rather than staring at the screen, a better use of time is to revisit the rationales you had written while buying the stocks in your portfolio and see if they are still valid. Engage with management teams again to ensure that your conviction still holds and weed out names where the original thesis is not playing out. Also, this should be a time when you pro-actively communicate with your investors and re-emphasize your style. It is important to know that your investors derive comfort from your confidence and getting into a shell in such times is detrimental.
Lastly, at the risk of sounding philosophical, cultivate a healthy sense of detachment from your portfolio and markets. This does not mean you abdicate responsibility but it means that you should be able to prevent the symptoms from taking over all your waking moments. All this is obviously easier said than done and this is much more a note to self rather than a sermon for anybody else. But if this helps a fellow investor cope with the symptoms even slightly better, it would have more than served its purpose.
Swanand Kelkar is managing director at Morgan Stanley Investment Management. These are his personal views.
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