November 22, 2024
Why it’s way easier to call US elections than pick stocks
 #NewsMarket

Why it’s way easier to call US elections than pick stocks #NewsMarket

CashNews.co

One of my close friends has two stocks in his self-managed pension plan, which is roughly the same size as mine. By contrast, adding up the holdings in the four equity funds in my Sipp comes to 1,736. Who’s right?

To be fair, David loves risk. He pushes boundaries — to put it politely — and is a fearsome poker player. Post-Covid, he purchased International Airlines Group and Deliveroo when everyone said we would never fly or order a curry ever again,

Well we did and his money doubled. Easy peasy. But then, so was predicting the result of the US election to Donald Trump supporters. I, on the other hand, have written endlessly of my distrust of stock picking. Requires a lot of hindsight, it seems to me.

How does such a chasm in views exist? On one side, the worship of Warren Buffett, the riches of hedge funds, the $15tn odd still invested in global active strategies. Roughly two-thirds of the assets on UK retail platforms are individual shares.

On the other side, a long and unequivocally dire record for stock pickers. Over the past two decades, less than a quarter of active US equity funds have outperformed their benchmarks, according to LSEG Lipper data. Of European and Asian funds, it’s a fifth and 30 per cent respectively.

For reference, US opinion pollsters are omnipotent in comparison. A Haas School of Business study of 1,400 polls over 11 election cycles showed that 60 per cent of them conducted a week before an election predicted the outcome.

That finding was considered damning, ironically. But even superstar active managers would fly economy for life for such a hit rate (so too Roger Federer, who recently said he only won 54 per cent of points played over his tennis career).

For the sake of the argument, however, let’s say I fancied myself at picking stocks. Certainly a long time ago I did, even if they were mostly Japanese ones — and although I often beat my index, clients rarely made money.

Let’s also pretend I’m jealous of my friend’s stellar returns or that enough readers email my editor demanding that Skin in the Game is allowed to own stocks because my portfolio — and hence the column — is too boring.

Assuming all of that, what is the right number? At least US voters only had to choose between two presidential candidates. There are 70,000 listed companies globally, reckons my Capital IQ database. Should I buy one? All of them?

While the former is tempting so David looks like a wuss in comparison, I’m guessing few people know just how risky it is. Over the past century in the US, for example, the chance of owning a single stock that has both survived for 20 years and outperformed is one in five, according to Dimensional data.

Still, many investors today look at the prolonged success of some of the biggest technology names and conclude these will outperform indefinitely — be it due to network effects, capital firepower, or whatever. Why not simply own those?

Recently this would have been the thing to do. The so-called Magnificent Seven of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla now comprise a third of the S&P 500’s market capitalisation and account for half its gains this year.

History suggests that defying the inevitable is hard, though. And a glorious track record is no indicator of future performance. A stock’s chance of surviving and outperforming over a subsequent decade is exactly the same whether it beat or trailed the index over the previous 20 years.

And therein lies the problem with this whole debate on active versus passive management, it seems to me. It is a truism that if you can identify winners early you will beat the market. Stock pickers reckon they can; their results prove otherwise.

But what if you wanted to have a go regardless? After all, it’s fun having a flutter or pitting one’s wits against a benchmark. How many stocks chosen at random do you need to hold in order to have a fair chance of picking the next Nvidia or Novo Nordisk?

The answer, sadly, is quite a lot — certainly more than the popular idea that 30 holdings is the magic number, which came from a famous academic paper by Meir Statman in 1987. But he was concerned with diversification and volatility, not outperformance.

Reducing risk is one thing, relative returns quite another. A while back, Vanguard created nine hypothetical portfolios 10,000 times, consisting of 1, 5, 10, 15, 30, 50, 100, 200 and 500 equally weighted US stocks, each randomly selected.

Over a 30-year period, the least diversified funds performed worst on average, those with the most stocks best. And it was only when you reached 500 names did returns more or less match the Russell 3000 index. An investment of £10,000 in 30 stocks would have been £20,000 shy of what you would have made owning everything.

This simulation goes to show just how many companies you need to own to guarantee having some mega-winners before their share price goes bananas. Trouble is, that gets us back to where we started. Humph.

One solution maybe — if we wish to ensure our savings don’t lag an index by too far, while also amusing ourselves picking some stocks — is to keep 95-odd per cent of assets in passive funds and crap-shoot the rest.

Indeed, Nassim Nicholas Taleb recommends a similar approach in his seminal book Black Swan — although he would hold much safer bonds for the most part. If (when) a sliver of one’s portfolio keeps failing, no real harm is done.

But imagine landing a 10-bagger! I’d like at least to give it a try.

The author is a former portfolio manager. Email: [email protected]; Twitter: @stuartkirk__

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