David VanBenschoten managed the GE pension fund, and from 1976 – 1989 the fund’s equity portfolio on an annual basis never exceeded the 27th percentile nor lagged the 47th percentile in the universe of pension fund rankings. That is, if there were 100 managers ranked annually, in his best year he ranked 27th and his worst he ranked 47th. On an annual basis, he never suffered being in the bottom half of performers but also never achieved the top 25%, let alone the top 10%. We’ll return to David in a moment.
Prospective investors looking to hire advisors naturally settle on performance. It’s a metric that can be distilled to a single, understandable number. Returns are measurable, meaningful, and easy to compare. Give an investor a choice of 100 equity portfolios ranked by prior one-year returns and he will likely ignore portfolios 11-100. Rankings 6-10 may earn a passing glance. Most investors will only consider those in the top five.
Understandable.
And a dreadful framework for making investing decisions.
Back to VanBenschoten, the manager who never cracked the top 25% in annualized performance. When looking back over his full 14-year tenure, how did he perform?
4th percentile. In a pool of 100 managers, over that 14-year period he finished 4th.
Exactly the manager a long-term investor would like to hire. Exactly the manager they would likely ignore when making the hiring decision.
How can a portfolio manager never rank even among the top 25% of his peers in a single year yet finish in the top five over a longer timeframe?
Asset classes, sectors, styles, and regions’ relative performance fluctuate wildly over short time periods in the financial markets. The best performing managers any given year are almost always running portfolios concentrated in the sectors, styles, or regions that recently outperformed the broad market. Mean reversion eventually rears its ugly head and those sectors/styles/regions will eventually fall out of favor. In 2024, international stocks returned a paltry +3.5% (less than cash) while US large cap notched +24.9%. If you ranked portfolio managers by calendar year returns year-end 2024, the best managers were primarily running portfolios levered to US large cap stocks while those concentrated in international holdings languished at the bottom of the rankings.
Running the same analysis at the conclusion of 2025 found almost the reverse – international stocks trounced US large cap, leading to a direct correlation between the size of a manager’s allocation to international holdings and their degree of outperformance. The managers and their strategies who outperformed in 2024 then underperformed in 2025 and vice versa. Portfolio managers who find themselves in the top quartile of performance one year are likely to land in the bottom quartile another. Bouncing between the extremes exacts a hidden cost many investors are unaware they pay: volatility drag. Excessive volatility drag nearly guarantees long-term underperformance.
Volatility drag refers to the mathematical principle that losses are harder to recover from than they are to incur. If an investor sustains a 50% loss in his portfolio in one year, how much must he gain the next to return to even? Most people’s instinctive response is 50%. Not even close. A $100K portfolio that loses 50% declines to $50K. A 50% subsequent return brings the portfolio to $75K – only halfway back to the $100K starting balance. It will take a 100% return to recover from a 50% loss. This is volatility drag, an unseen enemy of long-term investors.
Any portfolio that has achieved extreme outperformance recently - those landing in the coveted first decile of annual returns - is likely positioned to endure substantial underperformance in the near term. The sectors/styles/regions that vaulted portfolio managers to the top of the rankings in one year will later sink them towards the bottom in another as mean reversion works through market cycles. That impending underperformance increases a portfolio’s volatility drag, further encumbering long-term returns. Live by the sword, die by the sword.
VanBenschoten – and all excellent long-term stewards of capital – achieve long-term superior returns by playing a different game. The very fact he never delivered returns in the top 25% of his peers any given year allowed him to rank in the top five percent over the long-term. You will find the finest long-term portfolio managers happily toiling in the obscurity of the second quartile of performers on a given short-term basis. They avoid the temptation to transmogrify a portfolio into a bet on a particular segment of the market. They sacrifice the opportunity to outperform in the short-term in order to maximize the probability of delivering superior long-term outcomes. Long-term stewards of capital happily accept that tradeoff. Building a portfolio to outperform some benchmark over a short time frame and stewarding wealth for decades are different endeavors entirely. A portfolio manager’s success in one reveals little of his capabilities in the other.
For those interested in the long-term stewardship of their capital towards the fulfillment of their cherished financial goals, we have a simple rule for portfolio construction:
Never live by the sword, so you may never die by it.
Sean Cawley, CFP®
Sources:
https://www.oaktreecapital.com/insights/memo/fewer-losers-or-more-winners
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Content here is for illustrative and educational purposes only. It is not legal, tax, or individualized financial advice; nor is it a recommendation to buy, sell, or hold any specific security, or engage in any specific trading strategy. Results will vary. Past performance is no indication of future results or success. Market conditions change continuously.
This commentary reflects the personal opinions, viewpoints, and analyses of Resolute Wealth Management. It does not necessarily represent those of RFG Advisory, clients, or employees. This commentary should be regarded as a description of advisory services provided by Resolute Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any time without notice.