The greatest fear in the investment management industry is not what one might expect. It is not losing money but the fear of not making enough money when the market is moving relentlessly higher. This “fear of missing out” strikes terror into the heart of portfolio managers as clients will simply not tolerate it; it is the cardinal sin of the business.

The thinking was explained to me as follows. Lose money when the markets are going down and everyone else is suffering and you’ll be just fine. But fail to capture maximum upside during a raging bull market and you’ll soon be out of a job.

Since 1928, the S&P 500 has generated an annualized total return of 9.3%.

What if I told you that it was possible to exceed this return but in order to do so you had to be willing to accept only 63% of the upside when markets are moving higher? If you’re being honest, you’ll say that capturing only 63% of the market’s gain in up periods is unacceptable. There’s no way you would sit on your hands through those periods without the fear of missing out getting the better of you.

In our recent research paper on Lumber and Gold, this is precisely the upside capture ratio we illustrated in a strategy that outperformed the S&P 500 by roughly 4% per year over multiple market and economic cycles. How in the world was that possible if you only captured 63% of the upside?

Good question. As it turns out, the strategy did so by focusing on something way more important than participating on the upside: protecting on the downside. By limiting the downside capture ratio to only 31% over time, the strategy was able to not only outperform the broad market but do so with lower volatility and lower drawdowns. These secondary attributes (lower volatility and drawdowns) can be more important than returns, as they increase the likelihood than an investor will actually stick with a strategy.

Going back to 1928, if you had consistent upside capture of 63% while limiting downside capture to 31% in U.S. equities, you would have generated an annualized return of 12.9%. Contrast this performance with a more aggressive strategy that outperforms the market during up periods (110% upside capture) but exceeds the market’s losses in down periods (130% downside capture). The difference is telling. The aggressive strategy underperforms the S&P 500 by 3.6% per year (with higher risk) while the defensive strategy outperforms by 3.6% per year (with lower risk).