Practical Applications of Patience with Active Performance Cyclicality: It’s Harder Than You Think

Abstract

In Patience with Active Performance Cyclicality: It’s Harder Than You Think, from the June 2021 issue of the The Journal of Investing, authors Chris Tidmore and Andrew Hon (both of the Vanguard Group) analyze how patience influences the long-term prospects of active investors. Patience in actively managed investing is the willingness to wait out periods of underperformance in hopes of eventually outperforming the market. This raises the question of whether historically outperforming investments have gone through periods of underperformance—and if so, how long and how bad were they?

The authors analyzed 25 years of data on actively managed equity funds. They found that the funds that outperformed the market provided a median annualized net return of 0.9% above the market average—a significant excess gain over 25 years. However, most of those outperforming funds also had frequent periods of underperformance below the benchmark for their peer group. About half underperformed by 20% or more at one time or another, and most can be expected to continuously drop in value below their benchmark for at least 2 out of every 10 years. Financial advisors should therefore consider using the authors’ findings to coach their clients, help them manage their expectations, and build up their patience.