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, 2022.¹ 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, Inc.

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 years.⁴ 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, Inc. 

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.

Send questions or comments to aperio.blog@blackrock.com.

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.

Important notes
Aperio Group, LLC, provides this material for informational purposes only and for the sole use of the recipient. The information contained herein was carefully compiled from both internal data and external data, but we do not guarantee its accuracy. The information is provided with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in these areas. The strategies and/or investments referenced may not be suitable for all investors, because the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. None of the examples should be considered advice tailored to the needs of any specific investor or a recommendation to buy or sell any securities. The fees and expenses Aperio charges may be higher than the fees and expenses of other investment advisors and may offset profits. Additional information about the firm, and our fees and expenses, is included in our Form ADV.

Investing involves risk, including possible loss of principal. Asset allocation and diversification may not protect against market risk, loss of principal or volatility of returns. There is no guarantee that any investment strategy discussed herein will work under all market conditions. Many factors affect performance, including changes in market conditions and interest rates, as well as other economic, political, or financial developments.

You should not assume that investment decisions we make in the future will be profitable or will equal the investment performance of the past. With respect to the description of any investment strategies, simulations, or investment recommendations, we cannot provide any assurances that they will perform as expected and as described in our materials. Past performance is not indicative of future results.

Any tax information provided herein is for illustrative purposes only and does not constitute the provision of tax advice by Aperio. Due to the complexity of tax law, not every single taxpayer will face the situations described herein exactly as calculated or stated, i.e., the examples and calculations are intended to be representative of some, but not all, taxpayers. Since each investor’s situation may be different in terms of income tax, estate tax, and asset allocation, there may be situations in which the calculations would not apply. Please discuss any individual situation with tax and investment advisors first before proceeding. For those clients using tax advantaged indexing, taxpayers paying lower tax rates than those assumed, or without taxable income, would earn smaller tax benefits from tax-advantaged indexing (or even none at all) compared to those described.

Any indexes referenced herein are used under license by Aperio. Indexes represent unmanaged groups of securities. Investing directly in an index is not possible. Reference to an index does not imply that the portfolio would achieve returns, volatility, or other results similar to those of that index. Further, an index’s composition may not reflect the manner in which a client portfolio is constructed in relation to expected or achieved returns, investment holdings, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility, or tracking error targets, all of which are subject to change over time. Any index referenced would necessarily be materially different in strategy and volatility from the client account.

The Russell 3000® Index is an equity benchmark for US stock performance. It is a capitalization-weighted index covering the largest 3,000 publicly traded US stocks. The index represents approximately 98% of the total market capitalization of the US stock market.

FTSE Russell is a trading name of certain of the LSE Group companies. The Russell index(es) referenced herein are trademarks of the relevant LSE Group companies and are used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company, which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this report.

Data from MSCI, Inc., or its affiliates are used under license. MSCI does not warrant or guarantee the originality, accuracy and/or completeness, of any data herein and expressly disclaims all express or implied warranties, including those of merchantability and fitness for a particular purpose. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such, nor should it be taken as an indication or guarantee of any future performance, analysis, forecast or prediction. MSCI shall have no liability for any errors or omissions in connection with any data herein, and no liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

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