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Quarterly: Oct 17

Patientia, The Not-So-Secret Sauce

”Repetitio est mater studiorum” is a Latin proverb that says “Repetition is the mother of learning.” We are going to repeat a theme from the past because one of the biggest mistakes made by investors has the simplest of fixes.
If one were to study the traits that John Templeton, Warren Buffet, Benjamin Graham or Ray Dalio shared (or continue to share) in common, they would find that each of them employed (or continue to employ) a disciplined process for identifying market opportunities. Each of them put their capital to work in areas where they believed they had an edge or in areas where they had a reasonable level of conviction that the market was mispricing assets. And each of them were patient with their capital, knowing that the monetization of market mispricing can take time (see Three Marks of Great Investors).
Warren Buffet’s comment that “the stock market is a device for transferring money from the impatient to the patient” sums up his perspective on the value of being disciplined when seeking to harvest superior returns.
The challenge with patient investing is that it’s easier said than done. That’s because it’s a perfectly normal response for people to avoid pain. If you have a headache, you take an aspirin, or drink some water. You respond with an action to reduce the pain.
The simplest way for investors to avoid short-term pain is to exit the investment strategies that are underperforming, but that is the type of behavior that ultimately leads to underperformance.
In looking at Callan’s Periodic Table of Investment Returns, we can observe the bottom to top movements of both low-risk and high-risk asset classes from 1998 to 2017.

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Click Here for a full-scale view of Callan’s Periodic Table of Investment Returns from 1998 to 2017
In 1998 and 1999 the Russell 2000 Value Index (the light blue box in the bottom left corner) was at the bottom of the pack for two years in a row and then moved to the top of the pack in 2000 and 2001. But how many investors had the discipline to stay in small-cap-value-land when it underperformed the S&P 500 by a cumulative 63% in 1998 and 1999?
Or which investors had the discipline to remain in "low-risk" bonds (green boxes at the bottom, left of center) from 2003 to 2007 (when they were the worst performing asset class in four of those five years) to hold onto the only asset class that had a positive return in 2008?
Which investors pulled out of "high-risk" emerging market equities (orange boxes) after any one of the six bottom-of-the-pack years, causing them to miss out any one of the nine years that EM was the top performing asset class? (see How Intelligent Investors Use Fear To Their Advantage)
We are not saying that the Barclay’s Aggregate, or the Russell 2000 Value or Emerging Markets are the path to outperformance. We are simply saying that the only investors who benefited from exposure to these asset classes were the ones who had the conviction to remain after periods of significant underperformance.
Investment strategies that deliver superior long-term returns require investors to be incredibly patient, disciplined, and indifferent to short-term performance. That’s because the seasons of underperformance drive away demand by pushing away the impatient investors, making things more attractive on a relative basis, and act as the build-up to the seasons of outperformance.
While this is easy to comprehend, it is much more challenging to execute. Without strict discipline, and a deep understanding of how and why alpha-producing strategies generate their returns, even seasoned investors will want to pull out of a strategy after two or three years of under-performance.

It is these seasons of under-performance however, that effectively create the risk premium that patient investors capture when they keep their eyes fixed long-term. 
As long as investors continue to chase short-term performance, there will be opportunities for disciplined, process-driven investors to harvest superior long-term returns.

If you are still wondering about the title, "Patienta" is Latin for "Patience!"

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