Concentrated Stock Phenomenon

We often meet new clients who have heavily concentrated portfolios, sometimes with 15% or more held in a single company’s stock, or across just a handful of individual positions.

This concentration typically stems from one of three scenarios:

• Inherited holdings that have been in the family for generations
• Long-term employment with a company that offers stock-based compensation
• A portfolio managed in a concentrated style, often comprising a small number of funds and individual stocks

In many cases, the client will have an emotional attachment to these holdings, which can make them difficult to part with, leading to them being held for longer than is financially prudent.

While concentrated positions can offer the potential for outsized returns, they do not increase the probability of outperforming the market. History shows that, on balance, concentrated portfolios lead to poorer outcomes over the long term.

Analysis of historical data on individual US stocks highlights just how challenging it is to pick individual stocks that will beat the market:

• Since 1992, nearly half of all stocks in the Russell 3000 Index have experienced a drawdown of more than 75%.
• Of those, 80% never fully recovered, meaning even a few such stocks in a portfolio could have a devastating impact on long-term wealth.

Of course, the ideal solution would be to simply pick the winners but that is easier said than done. This is especially true when the stock held might have chosen us, rather than us choosing it, i.e. company stock options. Over the past 20 years, only 20% of US stocks have both survived and outperformed the market. The median stock underperformed the market across 5, 10, and 20-year periods.

Even more telling, stocks that outperformed the market over the previous 20 years had only a 30% chance of continuing to outperform over the next 10 years. This is no better than those who had underperformed.

So, rather than trying to find a needle in a haystack, the data suggests it is better to own the haystack – or in other words, the market.

Diversification not only reduces exposure to the risks of individual stocks but also increases the likelihood of capturing the returns of those that do perform well. As such, this is a more reliable path to long-term wealth creation.

Written by Jonty Brooks

General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.