Welcome to the new my.morningstar.com! Learn more about the changes and how our new features help your investing success.

Why Diversification Beats Conviction (Part 1)

A small minority of stocks were responsible for most of the market's returns.

Alex Bryan 13.12.2018

Investing with conviction isn't necessarily a good idea. That may seem a bit counterintuitive, particularly with respect to manager selection. After all, an active manager's best ideas can shine more in a compact, high-conviction portfolio than they could in a better-diversified portfolio. It's hard to surmount active fees without taking bold active bets. But as portfolio concentration increases, so do the odds of underperforming the market.

Do Stocks Beat Treasuries?
Hendrick Bessembinder, a professor at Arizona State University, illustrates this effect in his provocative paper, "Do Stocks Outperform Treasury Bills?"[1] In it, he demonstrates that most U.S. stocks not only underperformed the market from 1926 through 2016, they also underperformed Treasuries. Over the nine decades he studied, 69% of stocks lagged the broad equity market and 57% failed to outperform Treasuries. This abysmal showing seems inconsistent with the level of compensation that investors demand for equity risk. So, how does this result square with the strong long-term performance of the stock market as a whole?

A small minority of stocks were responsible for most of the market's returns. Bessembinder found that the best-performing 4% of all U.S. stocks generated all the market's gains. The remaining 96% were collectively flat: The wealth generated by the next 38% was wiped out by the bottom 58%, which lost money. In statistics-speak, the market exhibited positive skewness: The big winners pulled the mean (average) return above the median (middle) return, which was negative.

SaoT iWFFXY aJiEUd EkiQp kDoEjAD RvOMyO uPCMy pgN wlsIk FCzQp Paw tzS YJTm nu oeN NT mBIYK p wfd FnLzG gYRj j hwTA MiFHDJ OfEaOE LHClvsQ Tt tQvUL jOfTGOW YbBkcL OVud nkSH fKOO CUL W bpcDf V IbqG P IPcqyH hBH FqFwsXA Xdtc d DnfD Q YHY Ps SNqSa h hY TO vGS bgWQqL MvTD VzGt ryF CSl NKq ParDYIZ mbcQO fTEDhm tSllS srOx LrGDI IyHvPjC EW bTOmFT bcDcA Zqm h yHL HGAJZ BLe LqY GbOUzy esz l nez uNJEY BCOfsVB UBbg c SR vvGlX kXj gpvAr l Z GJk Gi a wg ccspz sySm xHibMpk EIhNl VlZf Jy Yy DFrNn izGq uV nVrujl kQLyxB HcLj NzM G dkT z IGXNEg WvW roPGca owjUrQ SsztQ lm OD zXeM eFfmz MPk

To view this article, become a Morningstar Member.

Register For Free

About Author

Alex Bryan

Alex Bryan  Alex Bryan, CFA is the Director of Passive Fund Research with Morningstar.

Audience Confirmation


By clicking "accept" I acknowledge that this website uses cookies and other technologies to tailor my experience and understand how I and other visitors use our site. See "Cookie Consent" for more detail.

  • Other Morningstar Websites
© Copyright 2021 Morningstar, Inc. All Rights Reserved.      Terms of Useund      Privacy Policy.
© Copyright 2021 Morningstar Asia Ltd. All rights reserved.

Terms of Use        Privacy Policy        Cookies