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On January 1, 2000, Jim Smith invested with Manager X. Jim had done his homework: he had compared Manager X’s performance over the prior decade against the relevant benchmark. Although Manager X stumbled in 1990, his returns had beaten the S&P 500 every year after that. This outperformance is illustrated in the following graph. If you had invested $1.00 with Manager X on January 1, 1990 it was worth $7.05 on December 31, 1999 (see green), far in excess of the $5.32 earned by the S&P 500 (see red).
Jim dug even deeper and reviewed several years of analysts’ reports. They were unanimous. Manager X’s performance warranted a role as core equity holding. Jim also hired his own financial analyst to analyze Manager’s X’s performance from a risk–adjusted perspective. Again, Manager X came through with flying colors. Although his returns were more volatile than the S&P 500, his higher returns more than compensated for the bumpier ride. With his homework done, Jim confidently selected Manager X as his core U.S. equity manager and allocated him a sizeable portion of his portfolio.
Fast forward to December 31, 2009, and Jim is ruefully assessing the results of his selection decision. Although Manager X’s performance had outstripped the S&P 500 through the first half of the decade, he suffered massive losses in the market meltdown. Every $1.00 Jim invested with Manager X in 2000 was worth 72 cents (see green) at the end of the decade, more than 20% less than the 91 cents yielded by the S&P 500 (see red).
