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How the investment landscape has changed
From Jeffries Equities White Paper, 2019 “When the Market Moves the Market”
The ever-changing landscape in the investment industry is news to no one. Here are some charts and tables reviewing some of the major shifts.
Over the last decade, the proportion of equity trading conducted by different types of market participants has changed considerably. Bank principal trading (in which a bank acts on its own account, taking risk), has cratered by 80% - from more than 12% of trading to about 2.5%. Different hedge fund strategies have traded places, with quant activity nearly doubling to more than 25% of activity.
Over the last 20 years, the number of public companies in the United States has dropped by nearly 50%. This has happened at exactly the same time as a new form of equity-linked security has exploded: the ETF. So, while single name stocks have cratered, the number of ways to express broader investment views has increased.
Fidelity notes that ETFs now account for more than 18% of US equity trading volume. 43 ETF trading can exceed 2 billion shares per day.
The decline in the number of individual publicly traded companies and the explosive growth and use of passive products have resulted in investors’ ability to make broader, cheaper, more thematic bets, but have decreased the potential universe of single names in their portfolios. With nearly 400 sector and other narrowly based ETFs, active managers have more tools at their disposal for expressing their views, and for expressing them more cheaply than ever before.
The Price of Admission
Would you miss out on some of the upsides if it means you can avoid the downturn? Here is an experiment.
Imagine that there is a market “genie” who approaches you every December 31st and only tells you what the maximum intra-year decline will be for the upcoming year. This genie doesn’t tell you what next year’s return will be or anything else.
How much would the market have to decline at its worst point in the next year for you to forgo investing in stocks (S&P 500) to invest in bonds (5-Year U.S. Treasuries)?
Would it be a decline of 5%, 10% or maybe 20%? Since 1950, the average maximum intra-year drawdown for the S&P 500 has been 13.5%.
Let’s say you tell the Genie that you will avoid stocks in any year when there was a drawdown of 5% or more. Here is how you did since 1950 vs a Buy & Hold investor.
By 2018 you would have 90% less money than Buy & Hold investor. This is simply because you would be out of the market to often – this strategy would be invested in Treasuries in all but 6 years since 1950 or 91% of the time.
The ‘Avoid Drawdowns’ strategy doesn’t start to outperform until you can avoid drawdowns greater than 10%. Avoiding any year with 10% declines or more will mean you are invested only 46% of the years.
Nobody has a magic genie that will tell them when to avoid declines in the stock market. You have to experience some downside to earn your upside. This is the price of admission. As Charlie Munger once said, “If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get”
From Jeffries Equities White Paper, 2019 “When the Market Moves the Market”
The ever-changing landscape in the investment industry is news to no one. Here are some charts and tables reviewing some of the major shifts.
Over the last decade, the proportion of equity trading conducted by different types of market participants has changed considerably. Bank principal trading (in which a bank acts on its own account, taking risk), has cratered by 80% - from more than 12% of trading to about 2.5%. Different hedge fund strategies have traded places, with quant activity nearly doubling to more than 25% of activity.
Over the last 20 years, the number of public companies in the United States has dropped by nearly 50%. This has happened at exactly the same time as a new form of equity-linked security has exploded: the ETF. So, while single name stocks have cratered, the number of ways to express broader investment views has increased.
Fidelity notes that ETFs now account for more than 18% of US equity trading volume. 43 ETF trading can exceed 2 billion shares per day.
The decline in the number of individual publicly traded companies and the explosive growth and use of passive products have resulted in investors’ ability to make broader, cheaper, more thematic bets, but have decreased the potential universe of single names in their portfolios. With nearly 400 sector and other narrowly based ETFs, active managers have more tools at their disposal for expressing their views, and for expressing them more cheaply than ever before.
The Price of Admission
Would you miss out on some of the upsides if it means you can avoid the downturn? Here is an experiment.
Imagine that there is a market “genie” who approaches you every December 31st and only tells you what the maximum intra-year decline will be for the upcoming year. This genie doesn’t tell you what next year’s return will be or anything else.
How much would the market have to decline at its worst point in the next year for you to forgo investing in stocks (S&P 500) to invest in bonds (5-Year U.S. Treasuries)?
Would it be a decline of 5%, 10% or maybe 20%? Since 1950, the average maximum intra-year drawdown for the S&P 500 has been 13.5%.
Let’s say you tell the Genie that you will avoid stocks in any year when there was a drawdown of 5% or more. Here is how you did since 1950 vs a Buy & Hold investor.
By 2018 you would have 90% less money than Buy & Hold investor. This is simply because you would be out of the market to often – this strategy would be invested in Treasuries in all but 6 years since 1950 or 91% of the time.
The ‘Avoid Drawdowns’ strategy doesn’t start to outperform until you can avoid drawdowns greater than 10%. Avoiding any year with 10% declines or more will mean you are invested only 46% of the years.
Nobody has a magic genie that will tell them when to avoid declines in the stock market. You have to experience some downside to earn your upside. This is the price of admission. As Charlie Munger once said, “If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get”
EdgePoint at a TFC game. It was a great night and our team won 3 -1!
