Drawdowns and small stocks for God-like performance
"If God is omnipotent, could he create a long-term active investment strategy fund that was so good that he could never get fired?," US-based quantitative investor and author Wesley Gray asked several years ago.
Gray's data indicated that God would likely get fired - if God focused on picking investments that would deliver top decile (top 10%) returns over five years. After picking the stocks with perfect foresight and heading out fishing for five years, Gray found God's celestial clients would have endured drawdowns of as much as 76% in the interim. How many clients would have had the stomach to endure that?
We semi-regularly take a look back at what the return distribution for ASX industrials has been like over a five year period. It is an exercise that provides data points and context when considering risk and return.
We ran the numbers for the five years through to the end of August 2021, and found that:
Source: Equitable Investors, Sentieo
Some of the names in the top decile are well known "growth" stocks like Hub24 (ASX: HUB) and Pro Medicus (ASX: PME).
But there are plenty of names you may not have heard of - like IT recruitment and labour player HiTech Group (ASX: HIT) and medical diagnostic developer Proteomics (ASX: PIQ).
For context, the annualised total returns for both the S&P/ASX 100 and the S&P/ASX Small Ordinaries benchmarks were both around 11% - substantially higher than the median stock in this review.
The median stock would underperform indices over five years, if not for any other reason than simply because those indices would be rebalanced through the period in favour of the stocks that are performing.
The distribution of returns in this period of review was similar to when we ran the same analysis back in May 2018, although in the latest numbers there is a slightly larger portion of stocks that have had negative outcomes (40% now versus 36% then).
These figures are also consistent with a US analysis of the total lifetime returns for individual stocks between 1993 and 2006, where Blackstar Funds found 39% of all stocks had a negative return and around 20% were "significant" winners returning 300% or more.
Source: Blackstar Funds
Key insights we take out of the data presented here are that:
Author: Martin Pretty
Funds operated by this manager:
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