In their recent episode of the VALUE: After Hours Podcast, Cassel, Taylor, and Carlisle discussed You Should Expect To Be Down 50% At Some Stage. Here’s an excerpt from the episode:
Tobias: Which is one of the other things we were talking about before we came on. Berkshire Hathaway is very, very stable set of businesses that have very consistently generated higher returns on equity and lots of free cashflow for more than 50 years now. Berkshire Hathaway has drawn down more than 50% twice in the last 20 years.
Who knows if this turns into a real correction then it is a correction a real bear market then it could easily be down 50% again. That’s just what happened. You got to believe that will happen to everything that you hold. I think Buffett and Munger have said that. You just got to expect that you’d be down 50– “Any money that you can’t have drawdown of 50% shouldn’t be in the market.”
Jake: Yeah. I think he said something like, “If you can’t tolerate a 50% drawdown with some equanimity, then you shouldn’t be invested in equities.” I think that’s Munger’s quote.
Tobias: What if I can do it without the equanimity?
Jake: [laughs] Well, you tied yourself to the math. So, that’s how you’re able to stomach the sirens song, but–
Tobias: I’m not at 50% drawdown, yet.
Jake: No, not yet.
Tobias: I managed to avoid it in 2020. I was down 37%. That might as well think that last 13% didn’t matter.
Jake: There is an interesting phenomenon. I think that in least in professional money management, where if you’re down 10% or 20% and you tell your LPs like, “Hey, I’m seeing great deals right now.” They send checks in, right?
Tobias: That’s noise.
Jake: You’re down 50%, then I think they’re like, “Well, you have bad risk management. They’re punching out.” And then if you’re down 90%, though, they’re like, “Well, this is a lot of–” [crosstalk]
Tobias: What’s that? [crosstalk] [laughs]
Jake: Yeah, it’s already blown up. I might as well try to write it back and so, then they don’t leave. There’s a weird– [crosstalk]
Tobias: Is that like that bell curve thing with the super smart guy, the moron on the two ends of the bell curve?
Tobias: Once you are down 90, it’s just all gone.
Jake: Might as well free roll it back and see what you can get it.
Ian: Yeah, to that point, I think if you are managing other people’s money, I think it’s also the best thing you can do. I manage a small fund. It was outside investors. The best thing to do is always be honest with people upfront about the volatility of a portfolio. Listen, we’re when we say volatility, nobody uses volatility describe the upside, but downside. I think it’s always the best is to be upfront.
Jake: You can tell them that though–
Ian: I know.
Jake: And it doesn’t really have to really sink in.
Ian: Yeah. You have to just be very blunt about it. Whether they actually can live through it, it’s another thing. But I think it’s important to make mention– One of the first things I tell everybody that came in was, if the markets down 30, I’m going to be down 45. Are you still interested? It’s hidden between the eyes. Because if you’re not, you can’t see through this to the end. Then don’t start, because it’s just inherent. The type of strategy that I do, so, I think it’s important to always be honest not describe yourself as something you’re not, which is always up into the right.
Tobias: I think David Tepper is one of those investors, who is quite open about that. He’s like, “It’s a high volatility strategy. There’s going to be a lot of vol both ways.” You know what you’re getting. [crosstalk] Yes, size your investment accordingly.
Tobias: You got to get that downside volatility to get that upside volatility, sometimes, I think.
Ian: It’s a spring.
Jake: Coil spring right now.
Jake: Getting more coiled every day.
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