Boom or Bust? Managing Expectations for Concentrated Positions and Risk

Active Tax Management
September 22, 2022

Diversification is a foundational principle of risk management. By deploying wealth across a range of securities, an investor becomes less susceptible to a disaster that may result from holding a concentrated portfolio. Historically, investors who had a large portion of their wealth invested in a single stock were especially vulnerable. A concentrated stock portfolio can occur in several ways: through inheritance or stock compensation, or by a rapid increase in the value of a single security. Regardless of the reason for acquiring the concentrated stock, its retention leaves investors exposed to company-specific risk.

To understand this risk, we look to history by studying the securities that were members of the Russell 3000® Index at any time between December 31, 1986, and February 28, 20221. Our analysis encompasses securities with different lifetimes, each with at least one month of return data. Historically, holders of single stocks experienced a wide range of outcomes, and for some, it was a boom-or-bust experience.

The worst outcome that we considered in our study was a permanent catastrophic loss resulting from a decline in the stock’s price of 50% or more without recovery2 (bust) . Nearly 40% of companies experienced such losses from their peaks, with examples including household names that were once big winners and headline-makers: Yahoo! (collapsed and never regained its dot-com highs); Sun Microsystems (was more than 95% off its peak value), Sears (lost nearly all its starting value), and GE (experienced several bouts of catastrophic losses). In most sectors, 30% or more companies experienced catastrophic loss, as seen in Figure 1. Although companies of all sizes and market sensitivities were at risk, smaller companies and those with higher market betas had a higher rate of catastrophic loss.

Figure 1: Historical rates of catastrophic loss (a security’s peak-to-end value decline of 50% or greater) for single stock portfolios by sector, based on MSCI’s classification. December 31, 1986‒February 28, 2022. Sources: Aperio Research and MSCI.

A company’s fame and success might suggest a concentrated position in its stock is a “solid” investment – a behavioral bias known as “anchoring”3. In fact, we found that past stock performance was a poor indicator of future returns. A portfolio consisting of the top 25 performers over a 10-year period, on average, underperformed the index over the next 10 years4. Within their respective lifetimes, only a small portion of securities exhibited extreme outperformance (boom), offering the rare chance for a big payoff on a relatively small investment when the share price rose significantly.

The most substantial insight was that holding on to a single stock prevented an investor from enjoying the benefits of diversification. While the US stock market soared over the past few decades, most companies delivered less attractive lifetime returns. Figure 2 shows that about two-thirds of the securities in Russell 3000 fared worse than the index, and more than half of those ended up with lifetime losses. A diversified index allows an investor to hold winners without having to pick them.

Figure 2: Breakdown of returns for individual stocks in the Russell 3000 Index. The analysis includes securities with different lifetimes. Each security contains at least one month of return data and each security return and excess return is measured over its own lifetime during the period from December 31, 1986, to February 28, 2022. Sources: Aperio Research and MSCI. 

Although diversifying a portfolio does not guarantee profit or protect against investment loss or market volatility, reducing the level of single-stock concentration can lower the downside risk in a portfolio. Our study shows that reducing concentration up-front through partial liquidation and investing the proceeds in the index has historically lowered the rate of catastrophic loss. In addition, given that individual securities typically underperformed the index, at lower concentration levels, their relative weights in the portfolio naturally declined and with that, the rate of catastrophic loss. Based on the historical tendency of single stocks to underperform the market or experience an unrecoverable catastrophic loss, it may be prudent for investors to shift their focus to manage risk, diversify, and avoid the boom-or-bust experience.

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1 We relied on a third-party data source, MSCI, Inc. Our data is necessarily incomplete and subject to certain limitations. Our full dataset includes all companies listed in the Russell 3000® Index from January 1987 through February 2022 with at least one month of return data, excluding those with noncontinuous return histories, which was approximately 10% of securities. Security identifiers and return histories are subject to MSCI’s handling of corporate actions and other events. For example, security end dates may correspond to bankruptcy, termination, delisting, acquisitions/mergers, or the end of the study period and may not take account of the continuation through mergers and acquisitions that an investor might experience in practice.

2 Measured from the time a security’s price peaked to the earlier of the end of the security’s lifetime and our study period. Sources: Aperio Research and MSCI.

3 Judgment under Uncertainty: Heuristics and Biases, Amos Tversky; Daniel Kahneman, Science, New Series, Vol. 185, No. 4157. (Sep. 27, 1974), pp. 1124-1131.

4 Analysis dates are end-of-month dates from January 1997–February 2012. Includes all securities that had a complete 20-year history starting from 10 years before the analysis date. Sources: Aperio Research and MSCI.


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