In their latest Q4 2021 Letter, Hayden Capital discuss how investors can protect against drawdowns. Here’s an excerpt from the letter:
For an investor in the stock, they would realize a +302% return over their 10 year investment period, likely exceeding any of the major stock indices. But as an investor, would you rather have a consistent 14.9% return over 10 years? Or would you rather have a -40% year, and then +23.5% return over the following 9 years? The returns are the same for the long-term investor, but the emotional journey isn’t.
All things equal, we’d obviously prefer the steadier return. But it’s hard to know when that -40% draw-down comes… is it in year 1? In year 5? In year 9? It’s hard to know for certain, given the unpredictable factors that drive the multiple component, as discussed earlier.
So as long-term investors, we have to accept that the stock’s journey is going to be volatile and importantly, uncontrollable. Given this, the following question should be, how do we take this negative, and turn it into an advantage?
One way is to make the right decisions during these volatile periods – at the portfolio level, to “swap” into higher quality names, when everything in the portfolio is down by the same amount and the market is selling indiscriminately. And another is at the partner level, to add at the lows, provided they continue to have conviction in the aggregate trajectory of the portfolio’s earnings streams (which I try to transfer our confidence to partners by openly sharing our research “inputs” via these letters).
To use another analogy, cars traditionally weren’t built to avoid crashes. Sh*t happens, and you can’t control the actions of other drivers. Instead, car makers can focus on what’s in their control – making the vehicle sturdier and more resilient. So that if another car hits you unexpectedly, you’re shaken but generally okay and still able to continue along your journey. In investing, this structural resilience is the firm’s structure, and the alignment of quality LPs.
You can read the entire letter here:
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