When we look into the future it soon becomes apparent that a crystal ball would be useful – unfortunately they are in short supply.

At times of uncertainty, such as this, it can be tempting to run ‘what if’ scenarios in our heads, such as ‘perhaps I should move into tech stocks and pharmaceutical companies – as surely these sectors will do well’ or to pick out specific companies that appear likely to thrive in the future. Two challenges exist. The first is that you won’t be the first person to have thought this and these views in aggregate are already reflected in market prices. The second is that in making such concentrated bets you have a high chance of being wrong and missing out on the companies that actually end up driving future returns – Amazon didn’t exist 30 years ago.

To get a feel for what these concentration risks look like, academics are fortunate to be able to dig around in a vast bank of stock market data in the US, known as the CRSP database. One such study1 reveals some surprising and useful findings using data from 1926 to 2015. Whilst investment wisdom and empirical evidence support the notion that stocks – in aggregate – outperform cash over longer periods of time, a forensic look at individual stock returns tells a very different story. Here are some of the insights that the paper provides:

As the author 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 underperformance.’

At times like this – and in fact across all time periods – it makes enormous sense to remain highly diversified, as the risk of missing out on the next Exxon (the firm that has added most value to the US market ever), Apple or Amazon leads to missing out on the companies that actually end up driving future returns. Simply looking at the changing guard of the top ten US firms by revenues in 2000, 2010 and 2020 is revealing.

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product.

Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

While Magus uses reasonable efforts to ensure that the information contained within articles is current and accurate at the date of publication, no warranties are made, either expressed or implied, as to reliability, accuracy or completeness of the information. Magus accepts no liability for any loss arising directly or indirectly from the use of or action taken in reliance on such information. Please note that clicking on links to external websites will cause you to leave the Magus website.

Magus Wealth is a trading style of Magus Private Wealth Limited, which is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3611274. Registered address: Endeavour House, Crawley Business Quarter, Manor Royal, Crawley RH10 9LW

 

Magus icon

Get in touch

Back to the top