An article in a recent edition of the Financial Analysts Journal highlights risk of venturing away from the benchmark index weights of individual stocks
Most investors know that the worst possible outcome when you buy an individual stock is that it will go to zero and you will face a loss of 100 per cent. But we go ahead anyway because we know that the other side of that distribution is a potential gain of several hundred or even thousand per cent if we identify a winning stock.
An article in a recent edition of the Financial Analysts Journal suggests that positive skewness dominates market index returns and that it is extremely risky to venture away from the benchmark index weights of individual stocks unless you have some proprietary insights. Worldwide, 27 per cent of the stocks are located in the U.S., leaving 46,723 in other countries. Canada is represented with a sample of 2,001 stocks. All returns are converted to U.S. dollars for comparative purposes and the benchmark is the return on one-month U.S. Treasury bills.Their opening observation is an eye-opener: 55.2 per cent of U.S. stocks and 57.4 per cent of non-U.S. stocks underperform the one-month U.S. Treasury Bill Index over the full sample period.
Rather than computing the average return for individual stocks over different time periods, the authors instead compute the wealth creation for a buy-and-hold investor. This is defined as the increase in the end of period wealth to a shareholder as a result of investing in the stock rather than a one-month treasury bill.
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