Concentrated Portfolios: The Agony and the Ecstasy

A recent report from J.P. Morgan titled Eye on the Market focuses on the perils of a concentrated portfolio. One eye-opening statistic presented in the report is that a solid 40% of all stocks in the Russell 3000 since 1980 have suffered a permanent 70%+ decline from their peak value

In order to highlight the risks of highly concentrated portfolios, Michael Cembalest of J.P. Morgan Asset Management points out that after adjusting for single stock volatility, the statistics show that 75% of all concentrated stockholders would have benefited from at least amount of diversification.

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Median stock return vs Russell 3000 Index

In one especially eye-opening statistic, Eye on the Market also notes that the return on the median stock in the Russell 3000 Index since its inception vs. an investment in the Russell 3000 Index was -54%.

Moreover, two-thirds of all stocks in the index underperformed vs. the Russell 3000 Index, and for more than 40% of all stocks, their absolute returns were negative.

Concentrated Portfolios

Concentrated Portfolios

7% of stocks were big winners

The J.P. Morgan analysis also highlights that there were a number of “extreme winner” stocks. They note the right tail of the distribution represents around 7% of the universe, “…and includes companies that generated lifetime excess returns more than two standard deviations over the mean.”

If you had chosen one of these extreme winner stocks in your highly concentrated portfolios, then you would have made somewhere between 500% and 2050% return.

However, given the statistics presented above, it boils down to this. Unless the one stock you pick for your concentrated portfolio is one of the 7% of “extreme winners”, you are better off with a diversified portfolio. No matter how smart you are or how much research you do, are you sure you want to try to beat 7 to 93 odds?

Catastrophic loss sector analysis

Concentrated Portfolios

Cembalest also offers a breakdown of stock performance by sector. He notes that that technology, telecom, energy and consumer discretionary sectors suffered the highest loss rates. In terms of subsector performance, biotech (part of health care) and metals & mining (part of materials) suffered loss rates greater than 50%.

See the full report here