Is appeal of Concentration due to Positive Skew?

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Is appeal of Concentration due to Positive Skew?

Post by Anon9001 »

One thing I have noticed is that Index Funds have negative skew while individual stocks have the opposite positive skew. What means is that when owning individual stocks you are losing small amounts of money most of the time while rarely having a huge gain while with owning Index Funds you are gaining small amounts of money most of the time while rarely having a huge loss. I assume that the more concentrated a portfolio is the more positive the skew is. Is the appeal of concentration mainly due to this positive skew?
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Re: Is appeal of Concentration due to Positive Skew?

Post by nisiprius »

Anon9001 wrote: Wed Jan 20, 2021 6:25 am One thing I have noticed is that Index Funds have negative skew while individual stocks have the opposite positive skew. What means is that when owning individual stocks you are losing small amounts of money most of the time while rarely having a huge gain while with owning Index Funds you are gaining small amounts of money most of the time while rarely having a huge loss. I assume that the more concentrated a portfolio is the more positive the skew is. Is the appeal of concentration mainly due to this positive skew?
Are you sure about those statements? Where are you seeing statistics for that skew? I thought skew varied systematically by stock subclass, i.e. small-cap growth has been said to have positive skew while small-cap value has been said to have negative skew. Not contradicting you, I don't know anything to the contrary, but where have you found this?

Dunno, but the appeal of concentration certainly is the lure of the possibility of a huge gain--a "ten-bagger," 10X gain, Peter Lynch called them--in an individual stock, which you can't get an index fund or even a broadly-diversified portfolio. Jim Cramer, for example, likes his followers to buy five or ten stocks and recommends against more than fifteen. People in this camp often talk about "not wanting to dilute your best idea" and "diworsification." I think that the "non-Bogleheadish" community, which is to say most retail investors, are dreaming of lottery-like wins. Certainly the people who are putting 5% into "fun money" speculative purchases (yeah, including cryptocurrency) are not thinking so much in terms of Sharpe ratios and correlation as the hope that that 5% will include something so spectacular that even a 5% allocation can lift the portfolio as a whole. 5% allocation to something that could go to zero or multiply twentyfold translates into a 5% loss or doubling the whole portfolio, and some part of our lizard brain likes that even if the 5% loss is near-certain and the 20X gain is... something you know has actually happened for someone else, so why not you?

When people say "you'll never get rich investing in index funds," the unstated part is "but there is a possibility you can get rich if you pick the right individual stock."
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Re: Is appeal of Concentration due to Positive Skew?

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nisiprius wrote: Wed Jan 20, 2021 6:44 am
For Index Funds very easy just look at PV (Make sure to click "Metrics" tab of PV). The skewness for VT is -0.74. Individual stocks it depends on what stock you are selecting but broadly I would suspect they have positive skew. I haven't checked myself.
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Re: Is appeal of Concentration due to Positive Skew?

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nisiprius wrote: Wed Jan 20, 2021 6:44 am Are you sure about those statements? Where are you seeing statistics for that skew? I thought skew varied systematically by stock subclass, i.e. small-cap growth has been said to have positive skew while small-cap value has been said to have negative skew. Not contradicting you, I don't know anything to the contrary, but where have you found this?
Actually I tested this also and it seems like this statement that SCV is negative skew and SCG has positive skew is in-correct. Both have negative skew although SCG has less negative skew and less Excess Kurtosis than SCV so still safer than SCV.Same for Ex-US. Make sure to click Metrics tab for PV and scroll down until you see "Excess Kurtosis" and "Skewness".
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Re: Is appeal of Concentration due to Positive Skew?

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30 years of 8% is a 10 bagger.
And, whoomp, there it is. :moneybag
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Re: Is appeal of Concentration due to Positive Skew?

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I don't believe concentrated stock picking has a "positive skew". It's certainly more volatile, can be less correlated with broad diversified portfolios, and if you do have better information to use in picking your selections it makes sense to be concentrating on the areas where you have an advantage.
But broadly speaking, most individual stocks under-perform so individual stock picking broadly (especially concentrated positions) has a negative skew. I believe people attempting to back-test strategies of individual stock picks frequently suffer survivorship bias and other hindsight bias.
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Re: Is appeal of Concentration due to Positive Skew?

Post by Anon9001 »

nisiprius wrote: Wed Jan 20, 2021 6:44 am
I finally got a source for this. Do Stocks outperform Treasury Bills? (Page 49)
Image
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Re: Is appeal of Concentration due to Positive Skew?

Post by Valueinvestor2 »

Anon9001 wrote: Wed Jan 20, 2021 6:25 am One thing I have noticed is that Index Funds have negative skew while individual stocks have the opposite positive skew. What means is that when owning individual stocks you are losing small amounts of money most of the time while rarely having a huge gain while with owning Index Funds you are gaining small amounts of money most of the time while rarely having a huge loss. I assume that the more concentrated a portfolio is the more positive the skew is. Is the appeal of concentration mainly due to this positive skew?
I’m not sure about skew but I can tell you why I concentrate my positions (I currently hold 2 stocks at 58% of my net worth, rest is cash that I use to sell puts).

It’s very simple, if you know what a business is worth and the market is drastically underpricing it (which for both of these companies was the case mid 2020 Bc markets are irrational and inefficient) then you minimize your risk significantly. In order to concentrate so heavily you don’t have to be right about the upside but you better be right about the downside. I agree that once someone owns more than 10 or so stocks that it is not possible to keep up with the business and have a level or understanding that is required to protect the downside. Also, there are just not that many opportunities that arise that protect downside but also have decent probability of gains in the future.

So for me the appeal to concentration has to do with my ability to understand businesses with enough precision that I can sleep at night.

I know, BH hate concentration because it is “risky”. This is not true if you understand the businesses that invest in, have extreme patience, have self control over your emotions, etc. being concentrated does lead to significant volatility since markets are inefficient (yesterday was a beautiful example with the big dips that recovered by end of day).

If you play around with compound interest calculator and compare 15-20% returns with 7% you can easily see why one would want to concentrate vs hold the general market. Compounding is truly amazing.
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Re: Is appeal of Concentration due to Positive Skew?

Post by nisiprius »

Anon9001 wrote: Wed Feb 24, 2021 5:45 am
nisiprius wrote: Wed Jan 20, 2021 6:44 am
I finally got a source for this. Do Stocks outperform Treasury Bills? (Page 49)
Image
Nice.
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Re: Is appeal of Concentration due to Positive Skew?

Post by nisiprius »

Valueinvestor2 wrote: Wed Feb 24, 2021 6:11 am...I know, BH hate concentration because it is “risky”. This is not true if you understand the businesses that invest in, have extreme patience, have self control over your emotions, etc. being concentrated does lead to significant volatility since markets are inefficient (yesterday was a beautiful example with the big dips that recovered by end of day)...
There isn't any "right" answer. Everyone has their own preference for risk. There isn't any objectively correct amount of risk to take.

However, while I think it is a valid personal choice to accept risk, I think it is a grave mistake to do something risky and believe that it is not risky. "I accept the risk" is fine; "The stock market is risky for everyone else but not for me" is dangerous.
If you play around with compound interest calculator and compare 15-20% returns with 7% you can easily see why one would want to concentrate vs hold the general market. Compounding is truly amazing.
Certainly, but the questions are

a) Whether you are actually able to do it, or whether you are mistaking luck for skill--Bill Miller beat the S&P 500 in 1991, 1992, 1993, 1994, 1995, 1996, 1997, 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005 but in three years he managed to lose back all of the gains over the S&P 500; when he resigned, the return over his fund over the years he managed it was about equal to the S&P 500. The point is that when someone can't really do it, it sometimes takes a long time to find out.

b) How many investors are able to do what you are doing? Warren Buffett has said “I don’t think most people are in a position to pick single stocks. A few [are], maybe, but on balance, I think people are much better off buying a cross-section of America and just forgetting about it.”

c) How do I know if you are one of those "few?" Overconfidence is one of the commonest behavioral errors, and for years various gurus have been suggesting that anyone with gumption can become one of those few stock pickers just by relying on what they know and spending a few hours a week "researching." I, at least, know that I can't read a balance sheet, I can't judge a business, and I can't identify which are the fund manager who can.

My own contribution to "why would you want to" concentrate, try to pick stocks, or try to time the market is this market timing chart, and it speaks to your observation about "compounding."

Image

The red chart is the result of buying and holding the S&P-500-and-predecessors. The green line is the result of being in the market during every calendar year in which the market made money, and being in cash--literal cash, no interest--during every year in which it lost money. Since the stock market doesn't lose money most years, you have to look at the chart carefully for the scattering of years in which the green line is horizontal.

Yes, of course, successful stock-picking, concentration, and market timing would be incomparably more rewarding than dumb passive buy-and-hold indexing. I get that, and I think most Bogleheads do. Furthermore, I think most Bogleheads start out by feeling it is intuitively obvious that there must some easy way to get an edge. Even if you can't pick the winners, surely you can avoid the obvious dogs, etc.
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Re: Is appeal of Concentration due to Positive Skew?

Post by 6U7a9Zfym64CRBB8gY3v »

Valueinvestor2 wrote: Wed Feb 24, 2021 6:11 am If you play around with compound interest calculator and compare 15-20% returns with 7% you can easily see why one would want to concentrate vs hold the general market. Compounding is truly amazing.
Why stop at 15-20%? Have you ever tried 50%? 1000%? Now that will really show the power of compounding!!

In all honesty though you probably won’t beat the market. I do not know anything about you or your strategy, but the majority of speculators do not beat the market and I have no reason to believe you are any different.
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Re: Is appeal of Concentration due to Positive Skew?

Post by andrew99999 »

A quick video explaining skewness.

Note that the median is to the left of the mean for a positively skewed distribution, meaning that more than half the outcomes will be below the average.

This goes back to SPIVA reports that show that over 80% of active managers fail to perform even as well as the index over the long run. What is not mentioned is that the remaining sub-20% most likely have a larger magnitude of outperformance to the market than the magnitude of the underperformance of the 80%.

So the question becomes -
- do you want to be guaranteed the market returns, or
- do you want to have an 80% chance of underperforming and a 20% chance of outperforming by more than the magnitude of underperforming.

And of course, that is with an active manager who diversifies through dozens of stocks. If you are even less diversified, you will have a much higher chance of underperforming (90%+) and a larger magnitude of underperformance but an even smaller chance of outperforming although a larger degree of outperformance.

It very much is a lottery in this sense. I mean, why not go and buy an actual lottery ticket or options or bitcoin?

I've noticed that the majority of your posts are entirely grounded on confirmation bias - that is to say, you're not looking for the truth; you're looking for someone to agree with you so that you feel better about your decision regardless of whether it is a logical decision.

And by the way, I play the lottery. It's a minuscule amount of money that will have no material impact on my life to lose it, but I like the fact that there is some chance I could take part in some random luck. If you're keenly aware of the downside and you have the risk tolerance to recover and meet your financial goals (and if you don't have an addictive personality), I don't think gambling is particularly terrible. Just be aware that you are, in fact, gambling and don't kid yourself that you're investing.
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Re: Is appeal of Concentration due to Positive Skew?

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andrew99999 wrote: Wed Feb 24, 2021 6:58 am
I think you are replying to the wrong person. I am going to invest 100% of my money in Motilal Oswal Asset Allocation Passive Aggressive which is a passive fund. For more info:viewtopic.php?p=5836926#p5836926
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Re: Is appeal of Concentration due to Positive Skew?

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andrew99999 wrote: Wed Feb 24, 2021 6:58 am

I personally think active management in the large-cap space anywhere in the World except maybe China A shares is a losers game as the costs are much higher than Index at 1-2% so just to match the Index they have to have a alpha of 1-2% yearly. This is not realistic in large-caps where information on securities is easy to come by so they tend to under-perform Indexes. Also scalability is a problem. Sure you somehow identify the correct fund and you get massive outperformance but then lots of other bozos invest in the fund and make the AUM of the fund so high that the fund manager cannot take large positions on mid cap and small cap securities and they are now forced to hug the index due to large the fund is. If I wanted to beat the market I would prefer to do it myself instead of gambling on active manager to have a yearly alpha of greater than 1% if Expense Ratio is 1%/2% if Expense Ratio is 2%.
Last edited by Anon9001 on Wed Feb 24, 2021 8:53 am, edited 1 time in total.
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Re: Is appeal of Concentration due to Positive Skew?

Post by Valueinvestor2 »

andrew99999 wrote: Wed Feb 24, 2021 6:58 am A quick video explaining skewness.

Note that the median is to the left of the mean for a positively skewed distribution, meaning that more than half the outcomes will be below the average.

This goes back to SPIVA reports that show that over 80% of active managers fail to perform even as well as the index over the long run. What is not mentioned is that the remaining sub-20% most likely have a larger magnitude of outperformance to the market than the magnitude of the underperformance of the 80%.

So the question becomes -
- do you want to be guaranteed the market returns, or
- do you want to have an 80% chance of underperforming and a 20% chance of outperforming by more than the magnitude of underperforming.

And of course, that is with an active manager who diversifies through dozens of stocks. If you are even less diversified, you will have a much higher chance of underperforming (90%+) and a larger magnitude of underperformance but an even smaller chance of outperforming although a larger degree of outperformance.

It very much is a lottery in this sense. I mean, why not go and buy an actual lottery ticket or options or bitcoin?

I've noticed that the majority of your posts are entirely grounded on confirmation bias - that is to say, you're not looking for the truth; you're looking for someone to agree with you so that you feel better about your decision regardless of whether it is a logical decision.

And by the way, I play the lottery. It's a minuscule amount of money that will have no material impact on my life to lose it, but I like the fact that there is some chance I could take part in some random luck. If you're keenly aware of the downside and you have the risk tolerance to recover and meet your financial goals (and if you don't have an addictive personality), I don't think gambling is particularly terrible. Just be aware that you are, in fact, gambling and don't kid yourself that you're investing.
Your post is the reason I normally don’t post on this forum. I am not searching for confirmation from anyone. Ironically, the point of all my posts are that this entire forum suffers from confirmation bias and group think and it would benefit from understanding that there are actually different ways to invest. Thank you for highlighting this.

People on this forum will do just fine buying and holding and returning 7% over a lifetime. That is a perfectly fine strategy. I apologize if I offended the Lord God Bogle and his disciples.
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Re: Is appeal of Concentration due to Positive Skew?

Post by andrew99999 »

Valueinvestor2 wrote: Wed Feb 24, 2021 8:52 am Your post is the reason I normally don’t post on this forum. I am not searching for confirmation from anyone. Ironically, the point of all my posts are that this entire forum suffers from confirmation bias and group think and it would benefit from understanding that there are actually different ways to invest. Thank you for highlighting this.

People on this forum will do just fine buying and holding and returning 7% over a lifetime. That is a perfectly fine strategy. I apologize if I offended the Lord God Bogle and his disciples.
I wasn't replying to your comment. Actually, I didn't even see it until just now.

If someone has the skill of valuing companies (I mean a professional level of skill in it), and they apply that to inefficient markets, I can see a case for investing in a concentrated portfolio. On the other hand, quoting positive skew is no different from saying, "yay, Bitcoin!, see, a concentrated portfolio can be better than indexing".
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Re: Is appeal of Concentration due to Positive Skew?

Post by Stork »

andrew99999 wrote: Wed Feb 24, 2021 6:58 am A quick video explaining skewness.

Note that the median is to the left of the mean for a positively skewed distribution, meaning that more than half the outcomes will be below the average.

This goes back to SPIVA reports that show that over 80% of active managers fail to perform even as well as the index over the long run. What is not mentioned is that the remaining sub-20% most likely have a larger magnitude of outperformance to the market than the magnitude of the underperformance of the 80%.

/snip
Is that not simply because a small selection of stocks are responsible for most of the gains of the indices, and the majority of stocks are underperforming them?
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Re: Is appeal of Concentration due to Positive Skew?

Post by jg12345 »

andrew99999 wrote: Wed Feb 24, 2021 6:58 am A quick video explaining skewness.

Note that the median is to the left of the mean for a positively skewed distribution, meaning that more than half the outcomes will be below the average.

This goes back to SPIVA reports that show that over 80% of active managers fail to perform even as well as the index over the long run. What is not mentioned is that the remaining sub-20% most likely have a larger magnitude of outperformance to the market than the magnitude of the underperformance of the 80%.

So the question becomes -
- do you want to be guaranteed the market returns, or
- do you want to have an 80% chance of underperforming and a 20% chance of outperforming by more than the magnitude of underperforming.

And of course, that is with an active manager who diversifies through dozens of stocks. If you are even less diversified, you will have a much higher chance of underperforming (90%+) and a larger magnitude of underperformance but an even smaller chance of outperforming although a larger degree of outperformance.

It very much is a lottery in this sense. I mean, why not go and buy an actual lottery ticket or options or bitcoin?

I've noticed that the majority of your posts are entirely grounded on confirmation bias - that is to say, you're not looking for the truth; you're looking for someone to agree with you so that you feel better about your decision regardless of whether it is a logical decision.

And by the way, I play the lottery. It's a minuscule amount of money that will have no material impact on my life to lose it, but I like the fact that there is some chance I could take part in some random luck. If you're keenly aware of the downside and you have the risk tolerance to recover and meet your financial goals (and if you don't have an addictive personality), I don't think gambling is particularly terrible. Just be aware that you are, in fact, gambling and don't kid yourself that you're investing.
Very good post, transferable to many other posts, and (at least to a certain extent) applicable to myself and many of us I believe.
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Re: Is appeal of Concentration due to Positive Skew?

Post by Anon9001 »

Valueinvestor2 wrote: Wed Feb 24, 2021 6:11 am So for me the appeal to concentration has to do with my ability to understand businesses with enough precision that I can sleep at night.

I know, BH hate concentration because it is “risky”. This is not true if you understand the businesses that invest in, have extreme patience, have self control over your emotions, etc. being concentrated does lead to significant volatility since markets are inefficient (yesterday was a beautiful example with the big dips that recovered by end of day).

If you play around with compound interest calculator and compare 15-20% returns with 7% you can easily see why one would want to concentrate vs hold the general market. Compounding is truly amazing.
Robert Hagstrom has produced a study in 1999 where he showed out of 3000 random 15 stock portfolios 808 beat the market and out of 3000 random 250 stock portfolios 63 beat the market so you want to beat the market having 2 stocks is certainly better idea than over-diversifying but you need to capable of handling high tracking error in relation to market if you are doing that approach as the best and worst return for 15 stock portfolios is 26.6% and 4.4% in comparison to 250 stock portfolio best return of 16% and worst return of 11%. I personally own active funds currently with low number of stocks due to this study by Robert Hagstrom. I also don't look at market every-day so I am not bothered by high tracking error. Source.
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