Cautious Optimism on Relative Performance

There are times when I feel “in sync” with the markets, and times when I don’t.  Example: for the four months from June 2002 to September 2002, my broad market portfolio lost 32.5% of its value.  Needless to say, I questioned my sanity while BBB bonds traded at 400 basis points over Treasuries.  (Yes, I had those to worry about also, I was managing several billion in corporate and other bonds at the time.)

So what did I do? I kept doing what I always do.  If I found a trade that improved the fundamentals of the portfolio, I did it.  I kept following my discipline, even though it hurt.  In late September, I scraped together my spare cash and invested it into the portfolio. On October 7th, we hit bottom for both the equity and credit markets.  (After the European financial regulators were done making their financial companies sell US stocks, in order to preserve their solvency.)   Over the next 15 months, I had my best period of outperformance ever.  Including the four-month drawdown (worst in my life), the full nineteen month period gave me a 26% return, which was pretty good for that time period.

In general, the time to give up on a strategy is not when it is hitting you hard and negative.  Instead, look for the fundamental reasons why your strategy isn’t working, and ask how long lasting those factors are, and whether/when they might reverse.  If after that analysis, you realize that the factors are long lasting, and unlikely to reverse anytime soon, then change.  But if they are likely to be transitory, it is time to maintain the discipline and press on.  It will not feel good at the time to do so, but it will likely pay off.  I experienced this while doing small cap value in the 90s, managing corporate bonds 2001-2003, and with my broad market equity strategy 2000-2007.  Things always hurt the worst near bottom turning points, and vice-versa in top formation.

The third quarter did not work so well for me.  Part of it was value investing being out of style.  With all of the new growth investors over at RealMoney, it is interesting to hear them perk up and crow a bit.  They’ve suffered enough over the past seven years.  But as for me, my sector rotation discipline covers some of that, while staying in a value framework.  In the last few weeks, I might be seeing a turn in my relative performance.  At least, it feels that way.  Ideas are working for the reasons that I would expect.  So, I am guardedly optimistic on relative performance.  But what would you expect?  I’ve been through worse, and bounced back, so I keep doing what I do.