“While concentrated stock positions can create substantial wealth, there is also a high probability of dramatic losses that have the potential to derail the financial future you had envisioned for you and your family.”
Madison Faller, Global Investment Strategist, J.P. Morgan Private Bank
Olivia Schwern, Global Investment Strategist, J.P. Morgan Private Bank
Andres Cassinello Herrera, EMEA Head for Strategic Equity, J.P. Morgan Private Bank
The growth of wealth does not come without risks. As industries evolve and change, some firms have adapted and thrived, while others have struggled to survive. These experiences, both positive and negative, may be magnified by the level of concentration an investor holds in a specific company. While one investor might experience the thrill of rapid wealth creation, another could confront the pain of wealth erosion.
In short, while concentrated stock positions can create substantial wealth, they also come with a high probability of dramatic losses that can potentially derail the financial future you envision for you and your family.
Michael Cembalest’s influential paper, The Agony & the Ecstasy (updated most recently in 2021), explored the risks and rewards of concentrated wealth for U.S. investors, presenting a range of diversification strategies that families can deploy. Building on this work, we broaden the scope to Europe. In this paper, we aim to quantify the risks of concentrated stock positions(through an example of the U.K. stock market), highlight several case studies of business failure in Europe, and examine strategies to manage concentrated portfolio risk.
Here are 3 key take aways from the paper:
1. How likely is it to invest in a “losing” company?
History suggests the risks are high. Taking the example of the U.K. stock market, just over 40% of all companies that were ever traded in the FTSE All-Share ex-Investment Trusts Index from January 1986 through October 2022 experienced a “catastrophic price loss,” where the stock declined 70% or more from peak levels and has not since recovered. Conversely, rarely can a stock come out on top—and then stay there. While the most successful companies generated massive wealth over the long run, only 11% of all stocks in the index since 1986 met the definition of “mega winners,” defined as outperforming the index by over 500%.
Analysis of the FTSE All-Share ex-Investment Trusts Index, 1986–2022
This table shows an analysis of the FTSE All-Share ex-Investment Trusts Index between 1986 and 2022. • Looking at all sectors, 42% had a catastrophic loss, 41% had negative absolute returns, 61% had Negative Excess Returns Vs Index and 11% were “Mega winners” • For Information Technology, 66% had a catastrophic loss, 53% had negative absolute returns, 65% had Negative Excess Returns Vs Index and 8% were “Mega winners” • For Energy, 49% had a catastrophic loss, 49% had negative absolute returns, 67% had Negative Excess Returns Vs Index and 6% were “Mega winners” • For Consumer Discretionary, 48% had a catastrophic loss, 48% had negative absolute returns, 67% had Negative Excess Returns Vs Index and 8% were “Mega winners” • For Health Care, 44% had a catastrophic loss, 45% had negative absolute returns, 60% had Negative Excess Returns Vs Index and 11% were “Mega winners” • For Communication Services, 43% had a catastrophic loss, 37% had negative absolute returns, 55% had Negative Excess Returns Vs Index and 15% were “Mega winners” • For Real Estate, 40% had a catastrophic loss, 50% had negative absolute returns, 69% had Negative Excess Returns Vs Index and 8% were “Mega winners” • For Industrials, 37% had a catastrophic loss, 33% had negative absolute returns, 58% had Negative Excess Returns Vs Index and 13% were “Mega winners” • For Materials , 36% had a catastrophic loss, 35% had negative absolute returns, 63% had Negative Excess Returns Vs Index and 10% were “Mega winners” • For Financials , 35% had a catastrophic loss, 43% had negative absolute returns, 61% had Negative Excess Returns Vs Index and 11% were “Mega winners” • For Consumer Staples , 27% had a catastrophic loss, 27% had negative absolute returns, 57% had Negative Excess Returns Vs Index and 14% were “Mega winners” • For Utilities, 10% had a catastrophic loss, 7% had negative absolute returns, 19% had Negative Excess Returns Vs Index and 12% were “Mega winners”
Here’s another visualization. The winners have generated enormous excess returns, but the median stock has underperformed the FTSE All-Share ex-Investment Trusts Index.
Distribution of excess lifetime returns on individual stocks vs. FTSE All-Share ex-Investment Trusts Index, 1986-2022
This bar chart shows the distribution of excess lifetime returns on individual stocks relative to the FTSE All-Share ex-Investment Trusts Index between 1986 and 2022. The median excess lifetime returns came in at -3.36%, and registered the following frequencies within 10% ranges: • < -70% - 22, • (-70%, -60%) – 17, • (-60%, -50%) – 36 , • (-50%, -40%) – 63. • (-40%, -30%) – 83. • (-30%, -20%) – 146. • (-20%, -10%) – 288, • (-10%, 0%) – 620, • (0%, 10%) – 541, • (10%, 20%) – 148, • (20%, 30%) – 62, • (30%, 40%) – 23, • (40%, 50%) – 6, • (50%, 60%) – 8, • (60%, 70%) – 3, • > 70% - 12
2. What causes a business to fail?
Hindsight is 20/20. The causes of most catastrophic losses may appear obvious after the fact. Yet, at the height of a company’s success, many involved—either direct participants such as management, boards of directors and employees, or external observers such as stock analysts and credit rating agencies—are lulled into believing the strong returns of the past will persist. But in most instances, the cause of business failure tends to be out of management’s control: government policy changes, regulation, commodity price risks, foreign competition, technological innovation, fraud or changes in consumer behavior.
In the paper, we dig into the dynamics at play for business failures in broader Europe over the last several decades—brought to life by potent company case studies.
3. How can an investor best manage a concentrated portfolio?
However a position is acquired, it leads to outsized, idiosyncratic risks when it represents a concentrated position in a portfolio. While the position may have created great wealth, it increases the probability of dramatic losses and reduces the certainty of financial plans. Many investment and wealth planning strategies are designed to help investors manage a concentrated position.
These strategies seek to allow the investor to de-risk, access capital from and/or diversify the position. Investors often select a combination of customized strategies to optimize for their investment views, personal financial goals, the transaction costs or market impacts, tax circumstances, as well as legal and regulatory implications.
We dig into three approaches to managing concentrated positions: sell, monetize and hedge.
