Absolute returns get a lot of lip service, but we have a relative return bias. Peter Bernstein weighed in on the bias and suggest benchmarks don’t help.
The downsides are fairly obvious. Relative returns feel great during bull markets. But when a year like 2008 comes around, you beat the benchmark but still lose big.
To add to it, fund managers (and advisors) also have career risk that feeds the relative return bias. All of it leads to more opportunities for short term thinking and poor behavior.
Seth Klarman simplified the problem perfectly: “You can’t think straight with a gun to your head. If you have a relative performance gun to your head, on the way down and on the way up, you’ll do the wrong thing every time. You’ll be liking them when they’re up, and hating them when they’re down – when you should be doing the opposite.”
Absolute returns should be the answer but investors contend with a powerful force: return envy. You have to be comfortable with “losing” to the Jones or an arbitrary index in any given year. What matters is “Are you earning a good return?”
Here’s what Bernstein had to say: Continue Reading…