One For All or All For One?
The beauty of diversification is it's about as close
as you can get to a free lunch in investing.
Over the years we have spoken to so many clients and friends about their investments and we have encountered this in almost every instance. Many of them end up holding large concentrated positions in single stocks, especially so called “blue-chip” names. They found themselves holding these concentrated positions as a result of being drawn to the familiarity of the name, receiving “insider stock tips” from friends, or as part of employee compensation.
Sometimes past success from the concentrated investing in well-known companies discourage investors from diversifying their assets. Unfortunately, this can lead to one of the most well-known cautionary tales in finance:
Tragic declines in wealth resulting from losses in single securities.
Evolution Means Extinction For Some
Industry development and innovation are signs of a healthy economy and financial markets reflect this through the birth and death of public companies. Using the US market which has the longest data set possible, the data below shows that 1 out of every 5 companies delists within 5 years, with the survival rate dropping below 50% as the time period approaches 20 years.
Delistings Can Be Decent or Disastrous
Not all delistings produce the same experience for investors. For example, a stock delisting due to a merger would be a good delisting situation, as the shareholders of that stock would be compensated during the acquisition. On the other hand, a firm that delists due to its deteriorating financial condition would be a bad delisting situation since it would mean the collapse of the share price of the firm, eventually causing a suspension in trading — this leads to an adverse outcome for investors where they may not be compensated fully if at all. Across 20 years, about 18% of stocks on average went by way of the bad-delist route.
A Local SG Context
Taking a look at the Singapore market, only a handful of these blue-chip names were able to increase shareholder value over the years (some of the local banks for example). Many companies unfortunately, fell by the wayside. The recent collapse of some well-known names such as Noble Group, Hyflux, Ezion and Eagle Hospitality Trust amongst others, has undoubtedly caused wealth destruction amongst their shareholders (as shown by their share prices below).
Apart from stock suspensions, there are other stocks which have delisted as a result of being taken private — only after a tremendous decrease in the share price. With M1, Fragrance Group, and SPH being some examples.
In addition, there were numerous other smaller firms which have slowly dwindled in size over the years and disappeared. If you have invested in the local market for quite a while, you may be holding shares of companies which are now worthless. In a parliamentary reply in Jan 2020, then Senior Minister, and Minister in charge of MAS, Tharman Shanmugaratnam highlighted that over a 10 year period from 2009 to 2019, there were 279 new companies listed in Singapore compared with 302 which delisted.
Diversification May Seem Like a Downgrade
For investors holding stocks with a long history of beating the market, diversification might seem like “worsification,” reducing expected returns relative to a more concentrated approach. In many cases, these stocks represent successful companies that investors believe will continue to prosper and buck the broad trend of adverse outcomes for single stocks. However, the success of concentrated types of investing really depends on the price at which the investor first bought the stock, and whether they are willing to sell at the present price. Take our local bank DBS for example, as you look at their share prices below:
Not many investors would have been fortunate or lucky enough to pick it up at the low of $10 in past crises. So, if an investor bought it at a price of $22 sometime in 2007, and managed to sell it at $32 near its recent peak, this represents an annualised return of 2.6% per annum, and when you factor in inflation, the investor is barely breaking even.
Unfortunately, a long-term track record of outperformance generally has not been an indicator of future outperformance. Take for example stocks that have outperformed the market over the previous 20 years. The data presented below shows that only about 30% of these stocks continue to survive and outperform over the following 10 years on average. On the flip side, the stocks that have underperformed over the previous 20 years also has an average subsequent outperformance rate of 30%. In other words, winners have been no more likely than losers to beat the market in the future.
So how do investors ensure that they are holding more of a DBS-type stock and less of the Noble, Hyflux, and Ezions of the world? A well-diversified portfolio can help investors reliably capture market returns, limit individual stock risk, and improve the ability to tilt toward segments of the market with higher expected returns. Transitioning from a concentrated portfolio to a broadly diversified one can deliver higher growth of wealth not only directly into your pockets, but also help you mentally as well. There is less need to monitor your individual positions, trying to figure out when to buy or sell and wondering whether the company will do well in the future or just disappear.
If you need a second opinion on the shares you hold and whether it is worthwhile to continue, come and chat with us.
