Diversifying our stock portfolio(s)

Langtang

AnotherJoe said:

Relying on oil for your pension.
Not the best plan IMO. 

I prefer to call it energy...

Steve182

Linton said:

ZingPowZing said:

Prism said:

JohnWinder said:

Bessembinder, Hendrik (Hank), Do Stocks Outperform Treasury Bills? (May 28, 2018). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2900447 or http://dx.doi.org/10.2139/ssrn.2900447

'Four out of every seven common stocks that have appeared in the CRSP database since 1926 have lifetime buy-and-hold returns less than one-month Treasuries. When stated in terms of lifetime dollar wealth creation, the best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926, as other stocks collectively matched Treasury bills. These results highlight the important role of positive skewness in the distribution of individual stock returns, attributable both to skewness in monthly returns and to the effects of compounding. The results help to explain why poorly-diversified active strategies most often underperform market averages. '

What is interesting is the Baillie Gifford use that paper as one of their main tenants of their style of active investing. Try and find the 4% or in fact the less than 1% that generate most of the returns.

Looks like a plan. 
Although advocates of "rebalancing", "top-slicing," indeed "diversification" will dilute most the potential gains that way.

Baillie Gifford have the resources and expertise to attempt this.  You as a private investor dont stand a chance.

But there is a downside.  In 2007 the BG flagship IT, Scottish Mortgage, fell by about 60%.  If you are just playing with investing with a very small investment pot then you can just shrug your shoulders, easy come easy go.  However if you are investing your life savings perhaps you may take a different view.

I'm not advocating holding just one investment, but those unfortunates who held SMT in 2007 lost about 63% if they invested at the absolute peak at £1.35 in Oct 07, dropping to a low of 50p. However keeping the faith and waiting a few years until say Oct 2017 saw that initial £1.30 increasing to around £4.30. 10 year CAGR from 07 to 17 was >11%

I doubt many would be disappointed by that?

Prism

ZingPowZing said:

Prism said:

ZingPowZing said:

The paper says one month Treasuries. 
They pay something .
They cannot be saying that holding cash beats an investment in most shares. 

One month treasuries are pretty much cash. Currently for example they pay the equivalent of 0.04%
They are really saying that - most equities over the long term return less than cash.

Is that consistent with the returns from Treasuries since 1926, Prism? I'll take your word for it.

But even if that is the case, the dataset of common stocks in this paper is 25,300. The dataset of stocks in most portfolios appears on one page of a daily newspaper, nearly all beat cash. 

But even if 4/7 of popular shares proved to be worse investments than cash, the likelihood of exceeding the benchmark with a handful of shares is nothing like as slim as most diversification strategies imply. 

Locating growth stocks is not difficult and it is not random but, if it were, no amount of diversification will improve overall returns, just bring them closer to the average.

Not my word for it, just what the study says. It sounds about right. Over the long term most companies grow, slow down and eventually either die or get bought. A few last the distance. Its very hard to select the few that do really well and drive the stock market. 
Its difficult to imagine over the last few years but there are massive periods when stocks clearly underperform cash. 2000 until around 2012 is the most recent example, but if we go back to the 1970s it took nearly 20 years before stocks even matched inflation.

The point that the index holders would make is that they hold that small percentage of stocks that blitz the market. The point that Baillie Gifford make is that they can find a few of those stocks ahead of time.

Thrugelmir

Apple and Microsoft between them account for 6.15% of net growth in the entire US markets between 1926 and 2019. Between 2016 and 2019 the top 50 US stocks accounted for 47.5% of net growth in US markets. Bottom line is that over recent years fewer and fewer companies have been driving markets upwards. Hence the apparent outperformance by concentrated investment vehicles. 

[Deleted User]

Apologies. I made an error in my earlier calculations, giving a positive performance stock a value of 150 against 100 for a negative one.
To conform to an overall market growth of zero, the values should be 123 and 82, which means a three stock portfolio would still underperform the benchmark in c 60% of cases. 

As the paper correctly states, increasing the number of stocks increases the probability of a portfolio outperforming the benchmark. What is not stressed in this paper is that returns move closer to the average at the same time: more portfolios exceed the market, but by smaller margins, up to the point where a portfolio containing all common stocks would simply reflect the overall growth rate, which in this paper - where the top 4% performing stocks are excluded - is zero.

If the 4% of top performing stocks appear randomly within the sample, then the number of individual stock holdings needed to make it probable that you have one is seventeen, which is higher than I would have imagined.

AnotherJoe

Steve182 said:

Linton said:

ZingPowZing said:

Prism said:

JohnWinder said:

Bessembinder, Hendrik (Hank), Do Stocks Outperform Treasury Bills? (May 28, 2018). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2900447 or http://dx.doi.org/10.2139/ssrn.2900447

'Four out of every seven common stocks that have appeared in the CRSP database since 1926 have lifetime buy-and-hold returns less than one-month Treasuries. When stated in terms of lifetime dollar wealth creation, the best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926, as other stocks collectively matched Treasury bills. These results highlight the important role of positive skewness in the distribution of individual stock returns, attributable both to skewness in monthly returns and to the effects of compounding. The results help to explain why poorly-diversified active strategies most often underperform market averages. '

What is interesting is the Baillie Gifford use that paper as one of their main tenants of their style of active investing. Try and find the 4% or in fact the less than 1% that generate most of the returns.

Looks like a plan. 
Although advocates of "rebalancing", "top-slicing," indeed "diversification" will dilute most the potential gains that way.

Baillie Gifford have the resources and expertise to attempt this.  You as a private investor dont stand a chance.

But there is a downside.  In 2007 the BG flagship IT, Scottish Mortgage, fell by about 60%.  If you are just playing with investing with a very small investment pot then you can just shrug your shoulders, easy come easy go.  However if you are investing your life savings perhaps you may take a different view.

I'm not advocating holding just one investment, but those unfortunates who held SMT in 2007 lost about 63% if they invested at the absolute peak at £1.35 in Oct 07, dropping to a low of 50p. However keeping the faith and waiting a few years until say Oct 2017 saw that initial £1.30 increasing to around £4.30. 10 year CAGR from 07 to 17 was >11%

I doubt many would be disappointed by that?

And now its £12. So Linton quipped "easy come easy go', but its more like "easy come, easy go, easy come with knobs on"

[Deleted User]

Thrugelmir said:

Apple and Microsoft between them account for 6.15% of net growth in the entire US markets between 1926 and 2019. Between 2016 and 2019 the top 50 US stocks accounted for 47.5% of net growth in US markets. Bottom line is that over recent years fewer and fewer companies have been driving markets upwards. Hence the apparent outperformance by concentrated investment vehicles. 

If Apple and Microsoft are a problem, it is not that they have ben "really hard" to find - the brands have been front and centre for a long time - the problem lies with those who decided that the companies were overvalued many years ago and missed out on their continued rise. Awkward.