Slow and Steady Wins the Race?
The mantra that shares deliver superior returns to cash over the long run has been the cornerstone of every financial adviser’s pitch for decades. But does the value of staying invested outweigh the difficulty of finding stocks that outperform the folding stuff?
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A Financial Times article looked at research conducted by Professor Hendrik Bessembinder from Arizona State University’s Department of Finance on the performance of single stocks.
He found that four out of every seven common stocks that have appeared in the Center for Research in Security Prices since 1926 have lifetime buy-and-hold returns lower than those of one-month Treasuries.
When stated in terms of lifetime dollar wealth creation, the best-performing 4% of listed companies explained the net gain for the entire US stock market over the last 100 years, as the other stocks collectively only matched the returns offered by Treasury bills.
In other words, the median stock was a loss-maker. In fact, the calculation showed that, of the almost 30,000 stocks listed over the last century, just 46 accounted for more than half of the overall return over that period.
Bessembinder says these results highlight the important role of positive skewness in the distribution of individual stock returns, attributable both to skewness in monthly returns and to the effects of compounding. They also help to explain why poorly diversified active strategies most often underperform market averages.
The article generated some interesting responses, with the chief investment officer at a private bank describing the results of Bessembinder’s research as a reminder of how asymmetric equity returns really are. He noted that if a small number of extreme winners drive most long-term outcomes, the implication is less about consistently picking the right stocks and more about staying invested to compound returns, diversifying broadly, and giving those rare outliers time to emerge - because missing just a handful of them can materially change overall results.
His view is that while the temptation is always to focus on finding the outliers, in practice, the real challenge is avoiding the permanent losers while staying invested. That is where diversification and discipline do the heavy lifting, especially when hindsight makes everything look more obvious than it was at the time.
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Finding the Clues to Solve the Investment Puzzle
Sherlock Holmes was not your average punter looking to squirrel away a few quid to provide for his old age. For example, the £6,000 he received from the Duke of Holderness at The Priory School in the early 1900s would be equivalent to around a million pounds in today’s money.
But Arthur Conan Doyle’s fictional detective does have something to teach us about investment strategy, according to Artemis fund manager Philip Wolstencroft.
In A Study in Scarlet, after Holmes has apprehended cab driver Jefferson Hope for murder, he surprises Dr Watson by referring to the case as ‘simple’. It is, he explains, a straightforward case of being able to ‘reason backwards’.
“Most people, if you describe a train of events to them, will tell you what the result would be,” he tells the doctor. “There are few people, however, who, if you told them a result, would be able to evolve from their own inner consciousness what the steps were which led up to that result.”
Wolstencroft observes that most investors look for the same end result – the highest total returns. So, what drives total returns? Rising share prices and dividends. What makes these go up? If a share starts off undervalued and/or its earnings grow quickly.
He differentiates the process of screening for factors that can help identify such shares from that of fund managers who reason forward rather than backwards. Some will use the index as their starting point, then try to eke out a couple of extra basis points here and there. Others will look for the next big thing or make a point of meeting management teams.
Wolstencroft says it is possible that this will lead them to pick shares that outperform, but asks why you would start out reasoning forwards and investing in a way that you hope will allow you to beat the market, rather than reasoning backwards and focusing only on those factors that you know for a fact drive returns.
“We know which factors push share prices up and down, and we know which factors indicate the direction these will move in,” he says. “Therefore, all fund managers should discard any theories that contradict these facts.”
Instead, he argues that many do the opposite and will talk of their ‘belief’ in a company or management team, even after a series of profit warnings. In other words, they twist facts to suit theories.
UK Savers Refuse to Take Stock
New research suggests the UK government still has plenty of work to do to convince savers to put their cash into stocks and shares.
A preference for cash over risk is perhaps the key finding, with only 2% of cash savings account holders transferring their savings to a stocks & shares ISA since the allowance for the former was reduced late last year.
The vast majority of account holders (90%) prioritised the protection of their initial capital over higher potential returns. Worryingly, one in four admitted that they do not understand stocks and shares, and only 11% said they planned to open a stocks & shares ISA despite the sharp reduction in the amount of cash that can be put into such accounts.
Savers under the age of 30 were more positive about investing in equities, but even then only two in five intended to do so before April 2027.
Analysis of a similar survey conducted this time last year suggests that understanding of equity investment has improved only marginally, despite an acknowledgement that stocks and shares outperform cash over the long term.
