The Cult of the Equity revisited after 10 years

Gordon Gekko said:
Re diversification, it's as much about buying companies which themselves deal all over the world (Nestle, Unilever, etc).
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That is my point entirely. I have shares in companies like CRH, DCC, Bayer, Siemens. Their industry might be concentrated,but their earnings come from a lot of different currencies.

Brendan
 
Hi Duke

It's an interesting issue why people don't diversify.

I assume that people buying funds are much more likely to diversify that someone buying shares directly. If I am putting €50,000 into Irish Life, there is no administration hassle in splitting into property, bond, Irish equity, Euro equity, North American and commodity funds.

Buying shares directly is more difficult for the small guy. Believing in international diversification I bought shares in a German company many years ago. It was for my pension fund. I found it extremely difficult to find out the tax treatment. Eventually I found that I was entitled to tax credits for taxes paid in Germany. But after months of hassle, I gave up trying to get the tax credit certificates and just wrote off the money. That put me off for some time.

I later realised that most of my Irish shares were heavily diversified anyway.

During the early stages of the euro crisis, I opened a bank account in Germany. Then I thought it might make more sense to buy German shares which I did. I just picked two big names from the DAX, Siemens and Bayer because they gave me industry diversification as well. The tax treatment is fairly easy to follow. I keep an eye on the share price and watch when the dividends are due. But I only discovered 6 months after it happened, that one of the companies had spun off a subsidiary and I now had shares in another company.

MPT equates risk with volatility. Which is just plain wrong. So maybe if you have 100 shares you will have less volatility than 10 shares. I am not sure that the real risk is much reduced.

The main risk is that there will be a long term sustained loss of value by all shares.

Brendan
 
Brendan

Is the point not that "the market" should do (say) 7% a year on average and that the more shares one has, the closer one should get to that?

Of course that's an advert for Buffett's strategy for Joe Public (i.e. buy a cheap MCSI World Index tracking ETF and keep 10% in cash).

Tax is an issue for Irish investors though - An ETF is subject to the horrible offshore rules (41% tax on income and gains, the 8 year deemed exit and no loss relief). For a nation with quite a few capital losses sloshing around, that's far from ideal. And at least with direct equities, one has control regarding when a gain is triggered and no tax on death.
 

Those articles and links are rehashed every six months or so.

The same guys were saying the same things a year ago and the market did 16-18%!
 
Marc said:
Lets wind the clock on from the last post of this thread and see how we would have done if we had bought into that particular narrative..
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Well, if you had invested in the S&P, in USD , the answer is you would have made a lot of money. While, as ringledman correctly points out in post # 3, “We are now around 15-20 times on the CAPE for the USA market which still signifies overvaluation.” investing in the S&P in Aug 2012 would have resulted in a gain of 51% to last Jan. In this period the Schiller CAPE moved from 21.41 to 26.96, both well above its historical average of 16.57.
I haven't been able to locate CAPE or any earnings related data for European stock markets, but if you had invested in the Eurostoxx50, in euro, in Aug 2012, which according to ringledman, was “ more tempting on around 10 times the CAPE”, you would have gained 24%, to last Jan. Not bad but not as spectacular as the gains the US investor would have had.
Two years is a rather short duration to reach firm conclusions on this issue, but, based on recent performance, there is little evidence here that equities are 'dead'. In this two year period, developed market equities (i.e. US, EU, and GB) protected you from declines in other asset classes (e.g. commodities, emerging market equities) or those that gave more modest returns (e.g. property), assuming you have a diversified portfolio.
Now these gains are counter intuitive, as investing in high priced assets is supposed to lead to lower returns in the long term than investing in more reasonably priced assets. But if ringledman did as he said “I am staying defensive. Boring value, large caps with decentish yield that are already on P/Es of below 10. Invest for income for a few more years and hold a large allocation in cash”, he would have gained as developed market indices are large cap indices, which increased in value, and holding cash would have maintained capital values that you would have lost if invested in commodities and emerging markets.
 
Brendan ,

I think you need to be careful with statements to the effect that this strategy is performing "better than the vast majority of strategies, especially those who have stayed in cash"

True, a global portfolio of stocks like the MSCI World index (around 1200 stocks) is up by a little over 30% in Euro terms over the last 12 months. It is therefore relatively easy to infer that all investors in stocks will have done well over the last while. But this doesn't follow at all. Jp Morgan has just released data showing that since 1980 two thirds of US equities have underperformed the Russell 3000 index. The median stock returned 54% less than the market. Worse, 40% of stocks suffered declines of 70% or more. But the market increased 20 fold since 1980 the reason being that just 7% of stocks provided nearly all of the return of the index.

Similarly, I referenced several stocks that have lost value in the last year or so (BP, Tesco, GSK, IBM) these all meet with the "Large Cap dividend" category.

Precious metals also lost value over this period gold is down around 16% in Euro terms.

It is therefore perfectly possible if not highly probable that this "strategy" actually resulted in a capital loss in a period when equities generally performed well.

The real "cost" associated with failing to diversify broadly is measured by tracking error compared to a broad market index. This can be positive, like if someone had put all their money into Apple Inc, or it can be negative.

I accept that you might still claim a victory because you may have beaten cash by buying a portfolio of say European Value stocks. For example if you bought the top 30% of all UK and EU equites sorted by Book to market (around 160 stocks) then you would be up around 13% in the last year with all of this return earned in just the last 3 months.

But you took equity risk and therefore you "should" have earned more like 30%. The real cost over this period is the opportunity cost of the return forgone.

The real problem here is that the accepted measures of successful investment (sharpe ratios, standard deviation, and tracking error) are meaningless to most actual investors. As you put it, if you do better than cash you have done well. job done.

This perhaps explains why in the well publicised Dalbar studies in the US of a typical equity investor we see average returns well below the market and therefore well below the returns that were due to investors as compensation for the risks they took.
 
Marc said:
The real "cost" associated with failing to diversify broadly is measured by tracking error compared to a broad market index. This can be positive, like if someone had put all their money into Apple Inc, or it can be negative.
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I don't see the relevance of tracking "error" for investors. Say, a broad market index returns x%. If I invest in 10 shares within that index, I will get c. x% but not exactly x%. So what?


That is very interesting data.

Two thirds underperfoming is what one would expect. The maximum loss on any equity is 100% but the gain is unlimited.

Worse, 40% of stocks suffered declines of 70% or more. That surprises me and worries me. I would have guessed that the majority of shares - maybe 80% - increased in value with a few big losers and a few big winners. I had not realised that 7% are compensating for the 40% dogs.

If I have only 10 shares, there is around a 50% chance that I won't pick one of the good ones. With 40% dogs, I will definitely have a few of them. And I will have some of the 53% which do ok.

Have you a link for the JP Morgan data?
 
I've read that about 40% of stocks suffered declines of 70% or more myself actually somewhere. After lots of research last year I took the plunge with ETF's , I read articles all the time about equities been over valued and correction due etc etc , truth is nobody really knows everyones guessing just buy the total stock market and don't try beat it, my portfolio is up about 15-20% in less than a year of investing , if I had of listened to the doom and gloom I would of kept the money in the bank earning nothing , I continue to top up 10k a month and rarely check the performance of them but its so easy to be diversified I don't understand why one would opt for picking individual shares. MSCI world/europe/emerging markets just keep buying monthly , some months they will be up some they will be down over the next 7/8 years but the expected trend is for them to rise , its a gamble lifes a gamble , everyones guessing i'd rather take my own guess than pay an advisor
 
Yeah I agree the tax is the only problem, but it would cost me a fortune in stock brokers fees to get similar diversification by buying individual shares. It's an interesting discussion , I would say there is no right or wrong , whatever you buy and whenever you buy it once the market is liquid enough you are buying at fair market price , it is at this price because thats how the market values it. The least amount of companys you hold the more likely you are to see bigger swings this could be positive or negative again I don't see any right or wrong way. People want different things also , for me i'm investing a lot of my money I don't really want wild swings so am happy to for all world ETF's and hope that for not much volatility, whereas if i had say 10k i wanted to play around it with I would probably buy one or two stocks I liked and watch them keenly.
 
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