We follow a long-term investment approach and know that these doubts can be counteracted by our evidence-based philosophy. But we don’t expect you to simply take our word for it. We review and compile the evidence so that you don’t have to take our, or anyone’s, word for it.
A common refrain is ‘shouldn’t I move into shares in technology and pharmaceutical companies – surely these sectors will do well?’ Or they might try to pick individual companies that seem likely to thrive in the future. This raises two main challenges:
- You won’t be the first person to have this thought and those views will already be reflected in how these securities are priced, and
- Concentrated bets have a high chance of being wrong. You can miss out on the companies that end up driving future returns. For example, 30 years ago Amazon did not even exist.
To understand the risk inherent in concentrated positions, we reviewed the CRSP database (the Centre for Research in Security Prices). One study* of this data revealed some surprising and useful findings. Whilst evidence supports the notion that shares – in aggregate – outperform cash over longer periods, a forensic look at individual share returns tells a somewhat different story. Some of the key findings:
- The average time that a share was listed on the CRSP database between 1926 and 2015 was only seven (7) years. That’s not very long.
- More than half of the individual shares delivered negative returns. The average lifetime return on any single share was -3.7% per annum (p.a.). That’s not very good.
- 26,000 shares have appeared in the CRSP database since 1926, yet only 36 shares survived the entire 90-year period. That’s not very many.
- From 1926 to 2015, USD$32 trillion of wealth was created by the shares in the CRSP database. This wealth was generated entirely by the top 1,000 shares, less than 4% of the total number of shares listed over that time. The top thirty shares (0.1% of all the shares in the database) accounted for approximately 30% of the total wealth creation. That’s pretty concentrated.
*Bessembinder, H., (2017) Do Stocks Outperform Treasury Bills? WP Carey School of Business, Arizona State University.
The author of this paper states:
‘Non-diversified portfolios are subject to the risk that they will fail to include the relatively few stocks that, ex-post, generate large cumulative returns. Indeed, the results help to understand why active strategies, which tend to be poorly diversified, most often lead to under-performance.’
At times like this – in fact across all periods – it makes enormous sense to remain highly diversified – avoid missing out when companies such as the next Exxon (the firm that has added most value to the US market ever), Apple or Amazon are coming up through the ranks.
Simply looking at the changes in the top ten US shares by revenue in 2000, 2010 and 2020 says a lot.
Top ten US companies by revenue over time (2000, 2010, 2020)
Source: Fortune 500
The picture in New Zealand is somewhat similar, although with fewer technology companies, we had a smaller number of breakthrough shares in 2020.
Top ten NZ companies by market capitalisation (2000, 2010, 2020)
Source: Smartshares NZ TOP 10 ETF (TNZ)
Correctly picking which few shares are going to drive overall market returns over the next decade or two will not be easy or even, based on the evidence, very likely. Instead, investors should seek to capture the market return by investing in a broadly diversified portfolio.
While it may lead to less exciting dinner conversations, an investment strategy that captures the overall return of the market should ensure that investors can consistently have that dinner out rather than relying on one share to shout the restaurant.
Our thanks to Cooper Parry for their assistance in preparing this article.