Understand that Underperformance is Inevitable

"The basic question facing us is whether it’s possible for a superior investment manager to underperform.... The assumption widely held is 'no.' And yet if you look at the records, it’s not only possible, it’s inevitable."

Quote from Wall Street People, by Charles D. Ellis

When faced with short-term underperformance from an investment manager, investors may lose conviction and switch to another manager. Unfortunately, when evaluating managers, short-term performance is not a strong indicator of long-term success.

The study below illustrates the percent of top-performing large cap investment managers from January 1, 2001 to December 31, 2010 who suffered through a three year period of underperformance. The results are staggering:

• 93% of these top managers' rankings fell to the bottom half of their peers for at least one three year period.

• A full 62% ranked among the bottom quartile of their peers for at least one three year period, and

• 31% ranked in the bottom decile 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 often destructive changes to their investment plans.

Source: Davis Advisors. 192 managers from eVestment Alliance’s large cap universe whose 10 year average annualized performance ranked in the top quartile from January 1, 2001–December 31, 2010. Past performance is not a guarantee of future results.