Institutional investors need no reminding of the importance of picking the right active equity manager, as they seek out stocks that can deliver alpha. But a research paper examining skewness in stock returns further drills down on this point, and even goes a step further, casting doubt on the assumption that most stocks will outperform bonds in the long term.
In fact, the paper written by Arizona State University professor Hendrik Bessembinder, "Do stocks outperform Treasury bills?" found that, among approximately 25,300 companies that issued stocks in the Center for Research in Security Prices database from 1926 to 2016, only five companies accounted for 10% of shareholder wealth creation.
"When focusing on stocks' full lifetimes (from the beginning of the sample in 1926, or first appearance in CRSP, through the 2016 end of the sample, or delisting from CRSP), just 42.6% of common stocks, slightly less than three out of seven, have a buy-and-hold return (inclusive of reinvested dividends) that exceeds the return to holding one-month Treasury bills over the matched horizon," the paper stated.
The thousands of companies Mr. Bessembinder analyzed were collectively responsible, as of December 2016, for nearly $35 trillion in lifetime shareholder wealth creation, defined in the paper as "the accumulation of market value in excess of the value that would have been obtained if the invested capital had earned one-month Treasury bill interest rates."
While five stocks — Exxon Mobil Corp., Apple Inc., Microsoft Corp., General Electric Co. and International Business Machines Corp. — accounted for 10% of total wealth creation, around 4% of the compa- nies analyzed, or 1,092 firms, accounted for all of the net wealth creation, according to the paper published in September in the Journal of Financial Economics. The remaining 96% of companies collectively generated lifetime dollar gains matching those of one-month Treasury bills, the paper stated.
The 90-year sample showed that, "while the overall U.S. stock market has handily outperformed Treasury bills in the long run, most individual common stocks have not," the paper said. In other words, the outperformance of stocks, in aggregate, over bonds was heavily reliant on the few companies that became "home run" stocks — outliers within the samples, according to the paper.
"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," the paper concluded.