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Why equities are skew-whiff when the big get bigger


Stock markets have always been a win-lose situation, but the odds are skewing even further towards a handful of successful companies, according to a new analysis by Australian-based global manager Hyperion Asset Management.

In bad news for value and passive investment styles, the study argues that, historically, only a small proportion of listed companies have delivered the total equity market returns with the elite group set to shrink again in the “globalised, internet and smart phone-enabled, world.”

Between 1990 and 2019 just 1.3 per cent of listed global companies “provided all the net wealth creation,” the analysis says, showing markets were driven by a ‘power law’ relationship rather than the standard ‘bell curve’ distribution of average returns.

“Averages or mean values do not accurately describe many real-world systems and complex relationships. Positive skews and compounding create averages from large values in the tail. Power law distributions rather than normal distributions are more reflective of real systems, particularly when humans are involved. This is often called the ‘80-20 rule’ where a few dominate. We would argue in a competitive, disruptive, and complex world its closer to a ‘90-10’ or even ‘95-5’ rule,” the Hyperion report says.

“The world continues to migrate to a winner-takes-all model where average and below-average companies continue to suffer from low industry demand growth and a structural decline in the relative strength of their value proposition to customers. We believe the return and performance profile of a select group of quality growth companies will persist.”

While share market indices have delivered overall returns above the risk-free rate, even that free lunch could be at risk as an ever-smaller cabal of companies hog the global economic pie. “We believe that most listed companies will not produce long-term ‘buy-and-hold’ returns above Treasury bills. This is unconventional thinking,” the Hyperion paper says. “The basis of conventional finance theory states that equity investments have higher risk relative to other asset classes such as fixed-interest or cash because stocks exhibit higher levels of volatility.”

But as well as dismissing the validity of the standard approach to analysing equity returns – the capital asset pricing model (CAPM) made famous by Nobel Prize-winners Gene Fama and Ken French – the study suggests the already down-in-the-dumps ‘value’ investing style will struggle further in a low-rate, low-return, hyper-polarised world.

“Value-style investing is predicated on successfully forecasting short-term share price movements. This is difficult to do successfully without strong underlying economic tailwinds and regular and pronounced economic cycles,” the paper says. “In fact, we have previously observed value style investing has consistently under-performed in periods where nominal GDP growth and aggregate profit growth have been low.”

The study was authored by Mark Arnold, Hyperion’s CIO, and Jason Orthman, the deputy CIO. In Australia, Hyperion found that the top 10 stocks (almost 47 per cent) generate about half of the country’s net wealth, but there was a slightly less concentrated figure for the largest 20 companies (about 58 per cent).

“Given that it is only a narrow group of stocks that produce most of the sustained wealth creation from equity markets, we believe successful investors need to identify and invest in the highest quality businesses – the structural winners,” the report concludes.

Founded in 1996, Hyperion has about $7 billion under management across its global and Australian equities strategies. Hyperion is part the ASX-listed Pinnacle distribution group.

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