There are certain terms and phenomena in the investment world that are often a source of controversy and confusion. One such term is the 'fat tail'. This term comes from the field of statistics and refers to rare but influential events that can significantly impact investment performance. Economist Nassim Taleb called these events black swans, which further emphasises their unusual nature.
Equities beating major assets over the long term?
As you explore the investment market, you will come across charts that compare the performance of different types of assets, such as stocks, bonds or gold. For many years, the S&P 500 Index (US500) has outperformed other assets, and this gap has grown as the investment period has lengthened. Nevertheless, it is worth noting that gold investment over this decade, despite not generating additional value such as dividends, has long outperformed the market average.
Source: Tradingview
Most investors perform worse than average
The problem is the correct interpretation of the term 'average'. Many investors try to outperform the average market performance. However, if we look at the performance of all hedge funds managed by outstanding professionals, we see that most of them underperform the 'average'. Over the past 15 years, it is estimated that less than 10% of actively managed funds have outperformed the market average. Why is this the case?
Source: https://www.spglobal.com/spdji/en/spiva/article/spiva-us/
If we look at the proportion of companies that have outperformed the S&P 500, we see that only 26% of companies have posted a higher return than the market average over the past year. This percentage does not exceed 35% for the last three years and decreases as the period gets longer. However, this is not the most worrying statistic.
Source: Conotoxia own analysis
'Fat tails' move the indices, not most of the market
Analysing the average annual return for the last year, we can see that only nine companies out of a total of 3,500 listed on the New York Stock Exchange (NYSE) had a significant impact on the growth of the S&P 500 index during this period. The question is, how many of the major fund managers were able to predict that these were the companies that would perform in such a way, especially since as many as 46% of the companies posted losses? The biggest contributors to the current rise of the S&P 500 index were the so-called FAANG technology giants, namely Meta Platforms (Facebook), Amazon, Apple, Nvidia, Alphabet (Google) and Tesla. Consequently, it is still difficult to speak of a new bull market when only a few companies are performing significantly above average. This is what we call the 'fat tails' phenomenon in statistics. More than half (51%) of companies have recorded losses over the past five years.
Source: Conotoxia own analysis
Does this mean that we should not invest in equities?
Of course not. However, we can use this knowledge to our advantage. It is worth understanding that, as individual investors, we are not confined to one asset class and we are not obliged to settle on a regular basis, as most hedge fund managers are. Nevertheless, let us remember that beating the 'average' that is the S&P 500 over the long term may be more difficult than it seems.
Source: Conotoxia MT5, US500, Weekly
Grzegorz Dróżdż, CAI MPW, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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