96 percent of stocks are no better then TBills

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qwertyjazz
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96 percent of stocks are no better then TBills

Post by qwertyjazz »

I have read on this site and others about how index funds work by catching the rare stock that does well. Reading through a working paper linked from MRU, it looks like the skew is even higher than I thought. Only 1000 companies do better than a T Bill per the study.Glad entrepreneurs exist, but wow that is a tough racket. On my end, I will be buying the haystack.
https://poseidon01.ssrn.com/delivery.ph ... 11&EXT=pdf
Last edited by qwertyjazz on Thu Feb 02, 2017 7:28 am, edited 1 time in total.
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Re: 96 percent of stocks are no better then TBills

Post by sperry8 »

qwertyjazz wrote:I have read on this site and others about how index funds work by catching the rare stock that does well. Reading through a working paper linked from MRU, it looks like the skew is even higher than I thought. Only 1000 companies do better than a T Bill per the study.Glad entrepreneurs exist, but wow that is a tough racket. On my end, I will be buying the haystack and maybe decrease my dislike of bonds.
https://poseidon01.ssrn.com/delivery.ph ... 11&EXT=pdf
Nothing in the article states to decrease like of bonds. Rather it argues for ownership of the market as a whole. It is that way you get access to the few stocks that generate significant returns.
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qwertyjazz
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Re: 96 percent of stocks are no better then TBills

Post by qwertyjazz »

sperry8 wrote:
qwertyjazz wrote:I have read on this site and others about how index funds work by catching the rare stock that does well. Reading through a working paper linked from MRU, it looks like the skew is even higher than I thought. Only 1000 companies do better than a T Bill per the study.Glad entrepreneurs exist, but wow that is a tough racket. On my end, I will be buying the haystack and maybe decrease my dislike of bonds.
https://poseidon01.ssrn.com/delivery.ph ... 11&EXT=pdf
Nothing in the article states to decrease like of bonds. Rather it argues for ownership of the market as a whole. It is that way you get access to the few stocks that generate significant returns.
Sarcasm - joke missed - edited initial post
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Re: 96 percent of stocks are no better then TBills

Post by in_reality »

qwertyjazz wrote:I have read on this site and others about how index funds work by catching the rare stock that does well. Reading through a working paper linked from MRU, it looks like the skew is even higher than I thought. Only 1000 companies do better than a T Bill per the study.Glad entrepreneurs exist, but wow that is a tough racket. On my end, I will be buying the haystack.
I don't believe this paper reflects the reality of index investors using market capitalization to weight their holdings.

Take for instance one company Sears. An index investor isn't reinvesting Sears dividends only in Sears. Sears dividends will be accumulated with other dividends and that will be reinvested in the market and weighted per market capitalization. I don't think the 4% figure cited reflects this.

For instance, the paper states:
If I weight the results by beginning-of-month market capitalization, I obtain that 53.3% of the market value of stocks in a given month deliver a return that exceeds the one month Treasury return, while 54.5% of the market value of stocks in a given month deliver a return that is positive.
Yet the author concludes:
less than four percent of common stocks account for all of the stock market gains. The other ninety six percent of stocks collectively matched Treasury-Bill returns over their lifetimes.
Why ignore the fact that the majority of the market value of stocks outperform the Treasury-Bill returns each month?

So yeah, only about 4% of companies each month outperform Treasury returns. So what? You have no idea which ones they will be. I see no need to try and find the 4%. Market capitalization and reinvesting dividends and making new contributes will find them naturally.

I bet there has been a time when Sears dividends got reinvested into Apple (or other growing company) because Apple's (or other growing company's) capitalization was huge from expectations. I mean dividends get pooled in an index fund and stocks are repurchased based on capitalization right. It's not that the Sears dividends bought only more Sears and Apple dividends bought only more Apple.

NOTE!

If you don't weight by market capitalization, you will see that:
47.7%, of CRSP monthly stock returns exceed the one-month Treasury return in the same month. In fact, less than half (48.3%) of monthly stock returns are positive
So if you don't weight by capitalization then only a minority of companies beat the Treasury-Bill returns and compounded over time, what do you expect? Over time you will see only a minority of companies beating the Treasury-Bill returns. What if you had reinvested those Sears dividends into a growing company as an index fund would have though?
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Re: 96 percent of stocks are no better then TBills

Post by lazyday »

When focusing on lifetime returns (from the beginning of sample [1926] or
first appearance in CRSP through the end of sample or delisting from CRSP, and including
delisting returns when appropriate), just 42.1% of common stocks have a holding period return that exceeds the return to holding one-month Treasury Bills over the same horizon, and more than half deliver negative lifetime returns.
Perhaps the most striking illustration of the importance of individual stock skewness to
stock market performance arises when measuring aggregate stock market wealth creation. I
calculate that the approximately 26,000 stocks that have appeared in the CRSP database since
1926 are collectively responsible for lifetime shareholder wealth creation of nearly $32 trillion
dollars. However, the eighty six top-performing stocks, less than one third of one percent of the
total, collectively account for over half of the wealth creation. The 1,000 top performing stocks,
less than four percent of the total, account for all of the wealth creation. That is, the other ninety
six percent of stocks that have appeared on CRSP collectively generated lifetime dollar returns
that only match the one-month Treasury bill.
If only the largest 500 companies were considered, I think the results would have been quite different. If you use a dartboard to choose 25 megacaps, you'll likely do about as well as the market. 25 microcaps is a different story.
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qwertyjazz
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Re: 96 percent of stocks are no better then TBills

Post by qwertyjazz »

lazyday wrote:
When focusing on lifetime returns (from the beginning of sample [1926] or
first appearance in CRSP through the end of sample or delisting from CRSP, and including
delisting returns when appropriate), just 42.1% of common stocks have a holding period return that exceeds the return to holding one-month Treasury Bills over the same horizon, and more than half deliver negative lifetime returns.
Perhaps the most striking illustration of the importance of individual stock skewness to
stock market performance arises when measuring aggregate stock market wealth creation. I
calculate that the approximately 26,000 stocks that have appeared in the CRSP database since
1926 are collectively responsible for lifetime shareholder wealth creation of nearly $32 trillion
dollars. However, the eighty six top-performing stocks, less than one third of one percent of the
total, collectively account for over half of the wealth creation. The 1,000 top performing stocks,
less than four percent of the total, account for all of the wealth creation. That is, the other ninety
six percent of stocks that have appeared on CRSP collectively generated lifetime dollar returns
that only match the one-month Treasury bill.
If only the largest 500 companies were considered, I think the results would have been quite different. If you use a dartboard to choose 25 megacaps, you'll likely do about as well as the market. 25 microcaps is a different story.
Interesting point - microcaps have such a large skew that would dominate - diversification would be even higher rewarded and in the past when it was harder to do so might have even paid a premium - wonder how the ease of diversification will impact future underweighting
Although with such an exponential curve it is still might hold
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Re: 96 percent of stocks are no better then TBills

Post by AlohaJoe »

lazyday wrote:
When focusing on lifetime returns (from the beginning of sample [1926] or
first appearance in CRSP through the end of sample or delisting from CRSP, and including
delisting returns when appropriate), just 42.1% of common stocks have a holding period return that exceeds the return to holding one-month Treasury Bills over the same horizon, and more than half deliver negative lifetime returns.
Perhaps the most striking illustration of the importance of individual stock skewness to
stock market performance arises when measuring aggregate stock market wealth creation. I
calculate that the approximately 26,000 stocks that have appeared in the CRSP database since
1926 are collectively responsible for lifetime shareholder wealth creation of nearly $32 trillion
dollars. However, the eighty six top-performing stocks, less than one third of one percent of the
total, collectively account for over half of the wealth creation. The 1,000 top performing stocks,
less than four percent of the total, account for all of the wealth creation. That is, the other ninety
six percent of stocks that have appeared on CRSP collectively generated lifetime dollar returns
that only match the one-month Treasury bill.
If only the largest 500 companies were considered, I think the results would have been quite different. If you use a dartboard to choose 25 megacaps, you'll likely do about as well as the market.
I don't see how this follows from the study. 5 stocks made up 10% of all equity returns in the 20th century. If those 5 aren't in your 25 randomly chosen set, your returns will be very different.
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Re: 96 percent of stocks are no better then TBills

Post by lazyday »

You can look at the performance of a fund like BRLIX, it has tracked the US market pretty well with only about 35 stocks.

There's some papers about how many stocks are needed for diversification. As I recall, it's surprisingly small when using large stocks. Of course, an index fund would still provide better diversification.

I don't know how the above is reconciled with a small number of stocks having produced the majority of market wealth creation. Maybe if you rebalance to always hold megacaps, then you will end up holding some of those super performers over time?
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Re: 96 percent of stocks are no better then TBills

Post by junior »

The paper seems to be saying most companies don't last longer than 7 years. I'm going to guess most stock pickers are not going to see 50% of their stocks go out of business unless they are picking micro caps or randomly throwing darts at a board.

Most stock pickers will probably start with companies they know of like Coca Cola, Wells Fargo, or whatever.
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Re: 96 percent of stocks are no better then TBills

Post by Waba »

in_reality wrote: For instance, the paper states:
If I weight the results by beginning-of-month market capitalization, I obtain that 53.3% of the market value of stocks in a given month deliver a return that exceeds the one month Treasury return, while 54.5% of the market value of stocks in a given month deliver a return that is positive.
Yet the author concludes:
less than four percent of common stocks account for all of the stock market gains. The other ninety six percent of stocks collectively matched Treasury-Bill returns over their lifetimes.
Why ignore the fact that the majority of the market value of stocks outperform the Treasury-Bill returns each month?
The individual stocks that make up the majority change from month to month. E.g. IBM may outperform T-Bills in january and then GS may do so in february while IBM drops 5% that month.

This is similar to active managers, every year a sizable percentage of them outperforms the market. But their performance is not persistent and changes from year to year. If you look at longer periods such as 5 or 10 year, you see that the percentage that outperforms over the entire period becomes smaller and smaller.
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Re: 96 percent of stocks are no better then TBills

Post by AlohaJoe »

lazyday wrote:You can look at the performance of a fund like BRLIX, it has tracked the US market pretty well with only about 35 stocks.

There's some papers about how many stocks are needed for diversification. As I recall, it's surprisingly small when using large stocks. Of course, an index fund would still provide better diversification.
The 15-Stock Diversification Myth

The Illusion Of Diversification: The Myth Of The 30 Stock Portfolio

Most of those studies measured the wrong thing (standard deviation), making their results questionable.

An attempt to measure the right thing (tracking error), found that you need over 100 stocks to track the S&P 500. And you'd still have annual tracking error of around 3%. http://www.aaii.com/journal/article/how ... ied-.touch
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Re: 96 percent of stocks are no better then TBills

Post by Waba »

lazyday wrote:You can look at the performance of a fund like BRLIX, it has tracked the US market pretty well with only about 35 stocks.

There's some papers about how many stocks are needed for diversification. As I recall, it's surprisingly small when using large stocks. Of course, an index fund would still provide better diversification.

I don't know how the above is reconciled with a small number of stocks having produced the majority of market wealth creation. Maybe if you rebalance to always hold megacaps, then you will end up holding some of those super performers over time?
I backtested some quant-based stock-picking approaches and got pretty robust results with as little as 20 stocks. It was robust in the sense that I could change parameters around and it would end up buying different stocks and at different times without much change to the overall result. This didn't include any large caps. That was an active trading approach though, it had criteria for selling stocks. I wouldn't be comfortable to Buy&Hold only 20 stocks.

I suppose it depends on the return distribution of the pond that you are fishing in.
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Re: 96 percent of stocks are no better then TBills

Post by lazyday »

By "megacap" I mean the very largest stocks. Today, maybe the 100 largest.

The S&P 500 includes megacap, largecap, and some midcap stocks, or it did when I last looked at it.

AlohaJoe, I wonder how that chart at the end of "The 15-Stock Diversification Myth" would look with megacaps instead of S&P 500. I assume the dispersion would be much lower, but don't really know.
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Do Stocks Outperform Treasury Bills?

Post by jbranx »

[Thread merged into here, see below. --admin LadyGeek]

Has anyone read or have comments on this paper by ASU professor Hendrik Bessembinder?

https://papers.ssrn.com/sol3/papers.cfm ... id=2900447
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Re: Do Stocks Outperform Treasury Bills?

Post by DonCamillo »

According to my reading of the article, a few companies account for most of the wealth created in the stock market, and the majority of stocks underperform TBills over their life times. But the growth of the winners is greater than the losses for the losers, which is an argument for investing in the Total Stock Market, so you don't miss the winners. The illustration of GM returning massive amounts through dividends despite going bankrupt shows how dividend reinvesting in a Total Stock Market mitigate risk compared to reinvesting in a stock. I wonder if there is a way to improve returns by weeding out a group of likely losers?

I am letting three ideas bounce around in my head as a result of this article:

1) I should probably stop reinvesting dividends in the handful of stocks where I am doing so, mostly in my Roth, and start investing them in one of my broad index funds.

2) Keeping my dividend growth stocks when I switched to an index fund strategy was not such a bad idea, since most of the dividends are then invested in Total Stock Market.

3) I should reduce my fear of treasuries based on recent low returns and begin gradual increases in that part of my fixed income portfolio.

I will probably spend a considerable amount of time thinking about these ideas before doing anything.
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Re: Do Stocks Outperform Treasury Bills?

Post by nisiprius »

I'm not sure if it amounts to exactly the same thing, but this is very much in tune with what William J. Bernstein wrote in The 15-Stock Diversification Myth:
The [terminal wealth dispersion] of [random-selected 15-stock portfolios] is staggering—three-quarters of them failed to beat "the market...."

The reason is simple: a grossly disproportionate fraction of the total return came from a very few "superstocks" like Dell Computer, which increased in value over 550 times. If you didn’t have one of the half-dozen or so of these in your portfolio, then you badly lagged the market. (The odds of owing one of the 10 superstocks are approximately one in six.) Of course, by owning only 15 stocks you also increase your chances of becoming fabulously rich. But unfortunately, in investing, it is all too often true that the same things that maximize your chances of getting rich also maximize your chances of getting poor.

If the O’Neal data are generalizable to stocks, and I believe that they are, then even 100 stocks are not nearly enough to eliminate this very important source of financial risk.

So, yes, Virginia, you can eliminate nonsytematic portfolio risk, as defined by Modern Portfolio Theory, with a relatively few stocks. It’s just that nonsystematic risk is only a small part of the puzzle. Fifteen stocks is not enough. Thirty is not enough. Even 200 is not enough. The only way to truly minimize the risks of stock ownership is by owning the whole market.
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Re: Do Stocks Outperform Treasury Bills?

Post by jbranx »

I came away with pretty much the same conclusions. Best to just invest in total US and total International at one's preferred allocation(s) levels and rebalance. Interesting that none of them listed are exactly small or midcaps, though I guess some like Apple were on multiple occasions and he doesn't list the portion of the 26,000 that were on CRSP at one time that contributed positive returns by being acquired etc.

If the hedge funds in total are finding no exploitable alpha and even Buffett--who is included in the list of stocks that created a hefty portion of the wealth--is trudging in the recent decades, it's hard to imagine a poorly resourced liberal arts major like me could find any winners. Since CRSP remained "fully invested" over the whole period, it, of course, captured all the small, quality, momentum, value factors etc. Be interesting to run the numbers with levels of leverage to determine if the results beat Buffett since the Berkshire returns have been substantially enhanced by the "float" at little or no cost from the reinsurance entities.

Needless to say, no one got those returns because there were no index funds to capture them until the seventies, and then only a portion of the large caps (500) for a time. There would have been the awful spreads, the taxes due, the very high brokerage costs, and management fees. Remarkable that the Wellington fund results at 8% plus and 65-35 came so close to the /CRSP/S&P results from '26.

I don't know statistics, can't read Greek formulas, and depend on the observation of others on what all this means, but it does appear to be a strong endorsement of the Diehard/Bogle philosophy from an academic I had never heard of until now.
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Re: Do Stocks Outperform Treasury Bills?

Post by AlohaJoe »

viewtopic.php?t=209916

Sounds like a repost of last week's conversation on the paper.
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Re: 96 percent of stocks are no better then TBills

Post by LadyGeek »

^^^ Thanks! I merged jbranx's thread into here.

jbranx, Welcome!
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Re: 96 percent of stocks are no better then TBills

Post by nedsaid »

qwertyjazz wrote:I have read on this site and others about how index funds work by catching the rare stock that does well. Reading through a working paper linked from MRU, it looks like the skew is even higher than I thought. Only 1000 companies do better than a T Bill per the study.Glad entrepreneurs exist, but wow that is a tough racket. On my end, I will be buying the haystack.
https://poseidon01.ssrn.com/delivery.ph ... 11&EXT=pdf
I don't know, I just thought the study was plain wrong. Saying that 96% of stocks perform about the same T-bills seems absurd on the face of it. I can remember the Wall Street Journal column where darts thrown at a stock page would consistently outperform the top picks of money managers with suggests a small-cap effect. If this white paper is correct, the opposite would happen. All the money managers would have to do is concentrate their picks in the mega-caps and the darts would underperform. The darts would have a 96% chance of picking stocks that would about match T-Bills. I would also think there would be no small-cap effect.

There are a lot of stocks that trade on the NASDAQ bulletin boards and on the pink sheets. Listed but so illiquid but not really very investable. There are only about 3,300 - 3,600 stocks in the Total Market Index funds.
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Re: 96 percent of stocks are no better then TBills

Post by Clive »

qwertyjazz wrote:I have read on this site and others about how index funds work by catching the rare stock that does well. Reading through a working paper linked from MRU, it looks like the skew is even higher than I thought. Only 1000 companies do better than a T Bill per the study.Glad entrepreneurs exist, but wow that is a tough racket. On my end, I will be buying the haystack.
https://poseidon01.ssrn.com/delivery.ph ... 11&EXT=pdf
Consider a 100 stock universe, $1 initially invested in each. One does great, gaining 20% annualised for 100 years. The other 99 one by one all totally fail. Your $100 original investment has grown to $82,817,974.52, at a 14.6% annualised rate.

Extreme, but highlights the general concept. Also note that if you had instead invested half as much in stock, kept half back in bonds, and assuming bonds all totally failed as well, then your $100 grew to $41,408,987.26 i.e. at a 13.8% annualised rate (0.8% annualised less than 100% fully invested in stocks).

Yet another consideration is taxation. If you fully invested and had that earlier example $82,817,974.52 final date amount, then selling and incurring perhaps a 20% tax = $16,563,594.90 tax liability, reducing the $82,817,974.52 amount down to $66,254,379.62, which is still a reasonable 14.3% annualised rate compared to the above 14.6% gross figure (0.3%/year difference). In contrast, regular dividends that are taxed at perhaps 20%, then a 4% historic type dividend yield might have incurred a 0.8% yearly tax liability. Pushing that up to half of the 20% annualised single stock gains having come from dividends, taxed at 20%/year rate = 4%/year tax. Despite those sorts of effects, many still push for or prefer higher yields/dividends. Fine if held in a tax exempt manner, not so good otherwise.

Back to the real world, and if you look at the historic strongest sector since something like the 1950's IIRC is was Consumption. Drill down further and the reason was because of Coce Cola. Had you bought Coca Cola in 1919 after its IPO and held through to 2012 reinvesting dividends it compounded at a 14.27% rate. If Coca Cola was one of 100 total original stocks bought for a portfolio (assuming equally weighted at the time of purchase) and all of the other stocks totally failed then that portfolio would still have annualised 8.75%. If it was 1 of 1000 original stocks bought and the other 999 all totally failed then the portfolio would have annualised 6% (5.3% if stocks had originally been 50/50 weighted with bonds (that also totally failed)). In practice failures aren't so common, and the rest of the portfolio might collectively pace T-Bills - that for 1 year bills averaged around 4.5% over the same period (uplifting total returns to around 9% to 13% nominal depending upon how many stocks, whether mixed with bonds etc).

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Re: 96 percent of stocks are no better then TBills

Post by privatefarmer »

Wow. Just came across this article/thread. I am perplexed as to how small caps have supposedly outperformed from 1926-onward when this article is basically saying the exact opposite? 96% of stocks underperform treasuries?? Is it just that the author of this article is counting thousands of micro-cap stocks that a small cap fund would not have bought, and that the vast majority of these went bankrupt? Would love to get some more insight here. Glad I am a TSM-kind-of-guy...
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Re: 96 percent of stocks are no better then TBills

Post by clown »

I think the prior post (privatefarmer) is one the right track. If the study considered some 26,000 stocks, and there are some 3600 actively traded stocks in the total stock market at this time, that suggests there were over 22,000 others who either:
  • failed - think buggy whips
  • were bought out by some other corporation, or
  • were taken private
Let us remember that:
  • there is only ONE of the original Dow 30 stocks still in existence
  • remember all the railroads that were bought by another railroad. Southern Pacific, Great Northern, etc.Passenger service largely died, but freight service still exists and is profitable
  • remember all the airlines that were bought by another airline. Pan American, Eastern, Braniff, etc. The service still exists, albeit not as civilized as back in the day.
  • remember some of those that went private -- such as RJR Nabisco and Safeway Stores. Still in business but not publicly traded
.

My point is that there are a lot of moving parts here. The idea that 96% of the stocks underperform Treasury Bills seems highly unlikely to me in the real world (as opposed to academics). You would have to look at all 22,000 individual stories to see what happened, but that is not practical.
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Re: 96 percent of stocks are no better then TBills

Post by Lauretta »

Interestingly, in this WSJ article, active fund manager J Anderson (who also manages Vanguard International Growth fund) uses Bessembinder's finding to argue in favour of his own active management style, which consists in holding over the very long haul the companies with the highest growth rate:
https://blogs.wsj.com/moneybeat/2018/04 ... ut-limits/
He says:
“A small set of superior companies drive returns in the long run,” says Mr. Anderson, citing research by finance professor Hendrik Bessembinder of Arizona State University. That study shows that the stock market’s entire return over time has come from fewer than 4% of all stocks.
of course the difficulty is in finding out in advance which are those 4%...
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Re: 96 percent of stocks are no better then TBills

Post by nedsaid »

privatefarmer wrote: Sat Aug 19, 2017 12:54 pm Wow. Just came across this article/thread. I am perplexed as to how small caps have supposedly outperformed from 1926-onward when this article is basically saying the exact opposite? 96% of stocks underperform treasuries?? Is it just that the author of this article is counting thousands of micro-cap stocks that a small cap fund would not have bought, and that the vast majority of these went bankrupt? Would love to get some more insight here. Glad I am a TSM-kind-of-guy...
The article is just plain baloney. My guess is that probably 10,000 stocks trade here in the United States but most of them are not investable by investment companies such as mutual funds. My further guess is that there are probably 3,500 stocks are investable, you need a certain amount of liquidity for investment companies to buy in enough quantity to make a difference in returns. In really thinly traded stocks, a big purchase can dramatically effect the price. Most of us have zero investment in the 6,500 or so non-investable stocks, we invest in the 3,500. I would also guess that the lions share of our investments are in the S&P 500 stocks, which is about 70%-75% of market capitalization.

I have owned individual stocks for probably 30 years now, my guess is that I have owned probably about 40-50 companies individually during my lifetime. I own 22 now. I will say that my big success stories were a minority of those companies but way more than 4%. The National Association of Investment Clubs had a rule of thumb that if you carefully select five stocks, that one will perform beyond your wildest dreams, three will do about as expected, and one will bomb. My experience is not far from that. Last I looked, these stocks that I owned individually have just about matched the US Total Market Index over the last 15 years.
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Re: 96 percent of stocks are no better then TBills

Post by columbia »

Quick comparison of VT against two other global ETFs:

IOO (100 stocks)
DGT (150 stocks)

https://www.portfoliovisualizer.com/bac ... ion3_3=100

VT has had both highest CAGR and Sharpe Ratio since 2009.
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4 of 7 Stocks underperform 1 mo T-Bills

Post by bberris »

[Thread merged into here, see below. --admin LadyGeek]

I was about to title this "Stocks underperform T-bills" but that was too click baity.

https://papers.ssrn.com/sol3/papers.cfm ... id=2900447

Only the top performing 4 percent of stocks account for all of the gain in the market since 1926.
If you think about all those dart-board stock picking articles that seemed to appear years ago, it looks like they used some pretty clever darts.
Yes I know the indexes outperform t bills, but the degree of danger in individual stock picking was surprising to me.
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Re: 4 of 7 Stocks underperform 1 mo T-Bills

Post by Ged »

bberris wrote: Mon Apr 09, 2018 8:05 am I was about to title this "Stocks underperform T-bills" but that was too click baity.

https://papers.ssrn.com/sol3/papers.cfm ... id=2900447

Only the top performing 4 percent of stocks account for all of the gain in the market since 1926.
If you think about all those dart-board stock picking articles that seemed to appear years ago, it looks like they used some pretty clever darts.
Yes I know the indexes outperform t bills, but the degree of danger in individual stock picking was surprising to me.
The take away is this:

"The results help to explain why poorly-diversified active strategies most often underperform market averages."
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Re: 96 percent of stocks are no better then TBills

Post by LadyGeek »

I merged bberris's thread into here, which is a similar discussion.
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Re: 96 percent of stocks are no better then TBills

Post by Northern Flicker »

So yeah, only about 4% of companies each month outperform Treasury returns. So what?
That's not what the paper claims. Having 96% collectively return the 30-day t-bill rate doesn't mean each of those stocks return that. There is a small minority of those 96% that greatly pull down the average return of the 96%.
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Hendrik Bessembinder paper, active over passive?

Post by DoctorPhysics »

[Thread merged into here, see below. --admin LadyGeek]

Ladies and Gents, have any of you read this? It’s a very lengthy read, 53 pages.

Paraphrasing a friend that quoted the following:

Looking at all common stocks on NYSE/Amex/Nasdaq from 1926 to todayish, Hendrik Bessembinder finds:

* The worst 12% had lifetime returns of -100%
* The worst 50% had negative lifetime returns
* The worst 57% had lifetime returns worse than treasuries
* The worst 98% had lifetime returns worse than the average stock
* The top stock (Altria/Philip Morris) had lifetime returns of 240,000,000%

https://papers.ssrn.com/sol3/papers.cfm ... id=2900447


The author seems to claim active investment wins(in the conclusion), though the abstract seems to imply a well diversified strategy that contains the top 4% of stocks explains all the market return.

Still curious what the collective and expert wisdom of folks here think.

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Last edited by DoctorPhysics on Wed Dec 26, 2018 6:00 pm, edited 1 time in total.
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Re: Hendrik Bessembinder paper, active over passive?

Post by livesoft »

I did not click on the link nor read the paper.

Back when I used some individual stocks I was amazed to see that a huge set of stocks had a 52-week-low that was half of their 52-week-high. That is the same as saying a huge set of stocks had a 52-week-high that was double their 52-week-low. So if one just picked the right stocks and kept switching them around, one could easily double their money every year. Or they could half it. Take your pick.
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Re: Hendrik Bessembinder paper, active over passive?

Post by sandramjet »

Hindsight is 20/20. The trick is finding out which stocks will perform like that over the next lifetime to match those returns...
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Re: Hendrik Bessembinder paper, active over passive?

Post by adamthesmythe »

Mildly interesting statistics, not useful for decision-making.
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Re: Hendrik Bessembinder paper, active over passive?

Post by Northern Flicker »

The worst 98% had lifetime returns worse than the average stock
* The top stock (Altria/Philip Morris) had lifetime returns of 240,000,000%

The author seems to claim active investment wins(in the conclusion),
Sure. Just pick the highest performing stock or highest 2% from among the roughly 3600 in a US total market index fund and you win.
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Re: Hendrik Bessembinder paper, active over passive?

Post by jbranx »

Professor Bessembinder's paper has been extensively discussed here in the past. Just google his name in the box above and you can see several threads on his work at ASU. Here is a link to one of the previous discussions:

viewtopic.php?t=209916
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Re: Hendrik Bessembinder paper, active over passive?

Post by dratkinson »

Active premise sounds simple enough. Just buy the best-performing stock over the upcoming 92 years (=2018-1926). Wonder why no one has thought of this before?
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Re: Hendrik Bessembinder paper, active over passive?

Post by 2015 »

Ah those academics. Another day, another discharge from the "publish or perish" world. A far more interesting read is this:

https://motherboard.vice.com/en_us/arti ... c-journals
“It's one thing for professors to try to polish their publication list and get more money or reputation, but it can be used for many other purposes,” Krause said last weekend during a talk at Def Con. “We as a society have this feeling that if something is scientifically proven and published, it has value. Usually science does just that, but in the case of the predatory journals it is quite different.”
Or see this excellent book for a deeper dive into the slippery world of "expertise":

https://www.amazon.com/Wrong-us-Scienti ... 0316023787
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Re: Hendrik Bessembinder paper, active over passive?

Post by DoctorPhysics »

jalbert wrote: Wed Dec 26, 2018 6:17 pm
The worst 98% had lifetime returns worse than the average stock
* The top stock (Altria/Philip Morris) had lifetime returns of 240,000,000%

The author seems to claim active investment wins(in the conclusion),
Sure. Just pick the highest performing stock or highest 2% from among the roughly 3600 in a US total market index fund and you win.

I think this actually might make a case against Fidelity’s new zero funds? They claim to track an index, using their proprietary blend of stocks, with less holdings. Time will tell!
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Re: Hendrik Bessembinder paper, active over passive?

Post by Northern Flicker »

There are stronger cases to make against these products.
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Re: Hendrik Bessembinder paper, active over passive?

Post by nisiprius »

DoctorPhysics wrote: Tue Jan 01, 2019 2:35 pm...I think this actually might make a case against Fidelity’s new zero funds? They claim to track an index, using their proprietary blend of stocks, with less holdings. Time will tell!...
This is fairly standard stuff. Many of Vanguard's index funds began by tracked indexes using sampling. In fact when the Vanguard 500 Index Fund was launched, it only contained IIRC about 275 stocks. It's only in relatively recent years that it has become feasible to manage index funds by replicating indexes with hundreds or thousands of stocks.

The Total Bond Fund still uses sampling; the prospectus says
The Fund invests by sampling the Index, meaning that it holds a broadly diversified collection of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics.
I believe sampling was, not exactly invested by Gus Sauter, but developed and skillfully applied by him, and that it was a big contributions to Vanguard's success.
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Re: Hendrik Bessembinder paper, active over passive?

Post by DoctorPhysics »

nisiprius wrote: Tue Jan 01, 2019 9:29 pm
DoctorPhysics wrote: Tue Jan 01, 2019 2:35 pm...I think this actually might make a case against Fidelity’s new zero funds? They claim to track an index, using their proprietary blend of stocks, with less holdings. Time will tell!...
This is fairly standard stuff. Many of Vanguard's index funds began by tracked indexes using sampling. In fact when the Vanguard 500 Index Fund was launched, it only contained IIRC about 275 stocks. It's only in relatively recent years that it has become feasible to manage index funds by replicating indexes with hundreds or thousands of stocks.

The Total Bond Fund still uses sampling; the prospectus says
The Fund invests by sampling the Index, meaning that it holds a broadly diversified collection of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics.
I believe sampling was, not exactly invested by Gus Sauter, but developed and skillfully applied by him, and that it was a big contributions to Vanguard's success.
Interesting, I did not know this. Learn something new from here everyday. Thank you for this.
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Re: Hendrik Bessembinder paper, active over passive?

Post by Valuethinker »

nisiprius wrote: Tue Jan 01, 2019 9:29 pm
DoctorPhysics wrote: Tue Jan 01, 2019 2:35 pm...I think this actually might make a case against Fidelity’s new zero funds? They claim to track an index, using their proprietary blend of stocks, with less holdings. Time will tell!...
This is fairly standard stuff. Many of Vanguard's index funds began by tracked indexes using sampling. In fact when the Vanguard 500 Index Fund was launched, it only contained IIRC about 275 stocks. It's only in relatively recent years that it has become feasible to manage index funds by replicating indexes with hundreds or thousands of stocks.

The Total Bond Fund still uses sampling; the prospectus says
The Fund invests by sampling the Index, meaning that it holds a broadly diversified collection of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics.
I believe sampling was, not exactly invested by Gus Sauter, but developed and skillfully applied by him, and that it was a big contributions to Vanguard's success.
Corporate bonds are generally not liquid in the way stocks are. Corporate bonds are often bought by long term holders (e g insurance companies or Defined Benefit pension schemes) and then just sat on to maturity - the spreads are too wide for active trading.

Consider that GE's stock, say, has all the same rights, no guaranteed dividend, no maturity date. But each GE bond series has different legal rights, may have a different coupon, different maturity date.

You could not run a sizeable corporate bond fund with full replication, I don't think.

From the Long Term Capital Management experience, at least then (1990s), this was also true of many US Treasury securities.
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Re: Hendrik Bessembinder paper, active over passive?

Post by Valuethinker »

nisiprius wrote: Tue Jan 01, 2019 9:29 pm
DoctorPhysics wrote: Tue Jan 01, 2019 2:35 pm...I think this actually might make a case against Fidelity’s new zero funds? They claim to track an index, using their proprietary blend of stocks, with less holdings. Time will tell!...
This is fairly standard stuff. Many of Vanguard's index funds began by tracked indexes using sampling. In fact when the Vanguard 500 Index Fund was launched, it only contained IIRC about 275 stocks. It's only in relatively recent years that it has become feasible to manage index funds by replicating indexes with hundreds or thousands of stocks.
Given the size of index funds, now, I think it's probably the other way?

It is no longer feasible to manage an index fund using full replication ?

The debate now is replication (including sampling) vs synthetic (negotiating a swap transaction with counterparties, that mirrors the performance of the underlying index)?

The problem with the latter is that if we hit another financial crisis, those counterparties may not be able to fulfill/ may not be there to fulfill. Probably that is not likely, but I presume it's never been fully tested.
The Total Bond Fund still uses sampling; the prospectus says
The Fund invests by sampling the Index, meaning that it holds a broadly diversified collection of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics.
I believe sampling was, not exactly invested by Gus Sauter, but developed and skillfully applied by him, and that it was a big contributions to Vanguard's success.
As previous post, I doubt you could run a sizeable bond fund with pure replication - even US Treasury bonds it might be difficult to impossible.
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Re: Hendrik Bessembinder paper, active over passive?

Post by RadAudit »

2015 wrote: Thu Dec 27, 2018 7:56 pm the slippery world of "expertise":

More than several decades ago, an expert was a guy with a briefcase 50 miles from home. Nowdays, it's a little more difficult to claim the title of expert.
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Re: Hendrik Bessembinder paper, active over passive?

Post by 2015 »

RadAudit wrote: Wed Jan 02, 2019 7:53 am
2015 wrote: Thu Dec 27, 2018 7:56 pm the slippery world of "expertise":

More than several decades ago, an expert was a guy with a briefcase 50 miles from home. Nowdays, it's a little more difficult to claim the title of expert.
Not if you look at the noise. I'd like to see some kind of study concerning how many times the word "expert" is used in publications of all kinds. I find it fascinating how humans today are making the same kinds of errors in judgment as they were back in the day Edward Bernays birthed marketing.
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Re: Hendrik Bessembinder paper, active over passive?

Post by AlphaLess »

One very valuable (but not statistically supported) conclusion to make from this paper / post is that if you want an all-time winning stock, find an addictive ingredient, and make a product around that, and be good at selling it.
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Re: Hendrik Bessembinder paper, active over passive?

Post by David Jay »

Or the classic Will Rogers commentary on the market:

“Only buy stocks that go up. If it doesn’t go up, don’t buy it.”
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Re: Hendrik Bessembinder paper, active over passive?

Post by arcticpineapplecorp. »

DoctorPhysics wrote: Wed Dec 26, 2018 5:56 pm Ladies and Gents, have any of you read this? It’s a very lengthy read, 53 pages.

Paraphrasing a friend that quoted the following:

The author seems to claim active investment wins(in the conclusion), though the abstract seems to imply a well diversified strategy that contains the top 4% of stocks explains all the market return.
If you think that's lengthy, try reading Adam Smith's "An Inquiry Into the Nature and Causes of the Wealth of Nations":
source: https://www.google.com/search?client=fi ... ations+pdf

That being said, I find it interesting how different people can read the same paper, article, book and yet come to vastly differernt conclusions. Did you read the paper or are you just relying on your friend to tell you what it's about? Because if you actually read the paper, you can only come to the conclusion that it's passive over active, not active over passive. Before getting to the conclusion, right in the abstract he says:
The results help to explain why poorly diversified active strategies most often underperform market averages. (page 1)
In the actual conclusion of the paper (had you read it) you'd see the following which suggests active is not the way to go...unless you consider yourself lucky:
The results in this paper imply that the returns to active stock selection can be very large, if the investor is either fortunate or skilled enough to select a concentrated portfolio containing stocks that go on to earn extreme positive returns. Of course, the key question of whether an investor can reliably identify in advance such “home run” stocks, or can identify a manager with the skill to do so, remains. (page 37)
How does one determine he is in favor of active over passive? What he's saying has been said by Jack Bogle himself, "Don't search for the needle. Own the haystack." It's also been said eloquently by Dr. Bernstein:
“...concentrating your portfolio in a few stocks maximizes your chances of getting rich. Unfortunately, it also maximizes your chance of
becoming poor. Owning the whole market—indexing—minimizes your chances of both outcomes by guaranteeing you the market return.” (The Four Pillars of Investing by William Bernstein, pg. 102).
If half of all stocks back to 1926 underperformed t-bills, how are you supposed to know which half aren't?

If only 4% of all stocks back to 1926 created all the value of the stock market, how are you supposed to determine the 4% that determines the value to be created by the market going forward?

[OT comments removed by admin LadyGeek]
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Re: Hendrik Bessembinder paper, active over passive?

Post by DoctorPhysics »

arcticpineapplecorp. wrote: Wed Jan 02, 2019 9:54 pm
DoctorPhysics wrote: Wed Dec 26, 2018 5:56 pm Ladies and Gents, have any of you read this? It’s a very lengthy read, 53 pages.

Paraphrasing a friend that quoted the following:

The author seems to claim active investment wins(in the conclusion), though the abstract seems to imply a well diversified strategy that contains the top 4% of stocks explains all the market return.
If you think that's lengthy, try reading Adam Smith's "An Inquiry Into the Nature and Causes of the Wealth of Nations":
source: https://www.google.com/search?client=fi ... ations+pdf

That being said, I find it interesting how different people can read the same paper, article, book and yet come to vastly differernt conclusions. Did you read the paper or are you just relying on your friend to tell you what it's about? Because if you actually read the paper, you can only come to the conclusion that it's passive over active, not active over passive. Before getting to the conclusion, right in the abstract he says:
The results help to explain why poorly diversified active strategies most often underperform market averages. (page 1)
In the actual conclusion of the paper (had you read it) you'd see the following which suggests active is not the way to go...unless you consider yourself lucky:
The results in this paper imply that the returns to active stock selection can be very large, if the investor is either fortunate or skilled enough to select a concentrated portfolio containing stocks that go on to earn extreme positive returns. Of course, the key question of whether an investor can reliably identify in advance such “home run” stocks, or can identify a manager with the skill to do so, remains. (page 37)
How does one determine he is in favor of active over passive? What he's saying has been said by Jack Bogle himself, "Don't search for the needle. Own the haystack." It's also been said eloquently by Dr. Bernstein:
“...concentrating your portfolio in a few stocks maximizes your chances of getting rich. Unfortunately, it also maximizes your chance of
becoming poor. Owning the whole market—indexing—minimizes your chances of both outcomes by guaranteeing you the market return.” (The Four Pillars of Investing by William Bernstein, pg. 102).
If half of all stocks back to 1926 underperformed t-bills, how are you supposed to know which half aren't?

If only 4% of all stocks back to 1926 created all the value of the stock market, how are you supposed to determine the 4% that determines the value to be created by the market going forward?

[OT comments removed by admin LadyGeek]

Thanks for pointing out I should have used the search bar, someone had already kindly linked a more extensive discussion.

I think it supports passive over active.

I’m going to ask this thread be closed given the existence of the other thread.
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