STILL Entirely Within the Range of Normal
It's been about six weeks since my last blog addressing the performance of the Flex in 2018. It has rallied some since then but really very little has changed as the Flex has continued to lag behind the S&P 500 year-to-date. As I said six weeks ago, I absolutely hate poor (relative) performance! That said, it’s normal.
What’s it mean to say this performance is "normal"?
If we have seen similar performance before, we can argue that the performance is normal (or at least within the range of normal). If we have seen similar performance many times, it’s no longer an argument but instead a fact that it is normal. We have seen performance similar to this 2018 Flex performance multiple times.
While I'm going to highlight a variety of periods of negative performance for the Flex relative to the S&P 500, keep in mind that the Flex has performed meaningfully better than the S&P 500 since its launch and has done so relatively recently as well.
The accompanying graph shows the DIFFERENCE between the returns of the Flex and the S&P 500 for every 12-month period since its launch in January 2010. As an example, and as highlighted, the last bar on the far right is for the 12-month period of 7/31/2017 – 7/31/2018. It shows that the Flex UNDERPERFORMED the S&P 500 by -8.2% (the Flex has gained +7.8% while the S&P 500 has gained +16.0% for a difference of -8.2%).
The graph shows this is certainly NOT the first time the Flex has underperformed the S&P 500 during a 12-month period. As you can see, it has happened many times and many times the difference has been meaningfully more. This is why I say the 2018 performance is "normal."
Note also that this graph only represents performance since the launch of the Flex in January 2010. Our research data going back to July 1963 on the Flex provides substantial additional evidence supporting the same conclusion.
It’s not just the Flex that performs like this.
Warren Buffett's Berkshire Hathaway has been one of the best performing long-term investments in modern history. Similar to the long-term performance of the Flex Strategy, investors owning Berkshire Hathaway for the long-term have meaningfully outperformed the S&P 500. That said, it is very normal for Berkshire to NOT perform as well as the S&P 500 during shorter periods of time.
Identical to the graph for the Flex Strategy, the accompanying graph shows the DIFFERENCE between the returns of Berkshire Hathaway and the S&P 500 for every 12-month period since January 2010. Similar to the Flex, Berkshire has had many 12-month periods when it underperformed the S&P 500 and sometimes by are wide margin.
This is a great example illustrating the fact that exceptional long-term performance will come with periods of short-term underperformance.
A traditional fund’s performance.
Both our Flex Strategy and Berkshire Hathaway are striving for long-term market-beating performance. Warren Buffett clearly takes a different approach to investing than the traditional investment fund proven by his long-term market-beating performance. Our Flex Strategy is similarly taking a very different investment approach and also delivering long-term market-beating performance. The vast majority of investment funds are not enjoying the same long-term success.
The American Funds Investment Company of America (AIVSX) mutual fund is one of the largest actively managed stock funds in the country. It has produced long-term returns that are difficult to distinguish from the S&P 500.
The accompany graph, showing the same analysis as was done above for the Flex and Berkshire, shows the DIFFERNCE in the 12-month performance periods for the American Fund and the S&P 500. Since January 2010 this fund has had periods when it underperformed the S&P 500 by up to -5% and other periods when it outperformed by +3%.
The fact is that this fund is doing very little different than simply investing in the S&P 500 therefore producing performance with little difference. Furthermore the long-term performance of this fund, as is the case with the vast majority of traditional funds, has produced disappointing long-term performance.
Will it ALWAYS be "normal"?
There's no way to know if the performance of the Flex will always stay inside the range of "normal". We do know that the longer our track record, and length of our research, the more likely it is to stay within a range that has been experience before but there are absolutely no guarantees.
An important fact to keep in mind about performance since the launch of the Flex in 2010 is that it has been a bull market the entire time. "Normal" during a bull market will be different than "normal" during a bear market. Therefore, when we do experience a bear market, we will have to consider the performance of the Flex relative to performance of other bear markets from our research.
The bottom line is that the current performance is certainly within the range of normal but it is entirely possible that at some point we will experience performance unlike we've seen in the past.
Why, and What, I Still Believe
I believe our Flex Strategy will continue to produce great long-term returns. I do not see any evidence otherwise. The recent performance is simply to be expected along the way. This is the case with all great long-term investment performance.
Will our Flex Strategy continue to work? There are no guarantees but it has served us extremely well during the past 8 ½ years since its launch and research further suggests it would have been very successful all the way back to 1963. I’m willing to bet it will continue.
The Flex Strategy is about systematically taking advantage of other investors’ poor human behavior (see our website for more information). Although human behavior is never repeated perfectly, over time it has tended to demonstrate repetitive similarities. In spite of all kinds of arguments that “this time is different”, and every period of time has differences from others in the past, I don’t believe this changes the basic underlying human behavior that has resulted in our strong long-term performance.
We are comfortably staying the course.