When reviewing your portfolio, do you take pride in shares that are up substantially? Do you fixate on the biggest laggards, weighing how much better your portfolio would be without them? In Fisher Investments UK’s experience, many investors do. But fixating on the very best or worst performers can obscure what our research shows matters more: Viewing your portfolio in its totality.
Perhaps the temptation to view only the highest fliers or biggest laggards is natural. After all, big returns (whether good or bad) are eye-catching and could easily trigger emotions. In our experience, this often leads investors to conclude they should take some sort of action—either to sell down shares or put more money into good performers.
We think there are several problems with this. For one, any decision made in this manner hinges on past performance—which may not predict future equity price movement. In our view, markets are what we call non-serially correlated. That means yesterday’s price action has no bearing on today’s or tomorrow’s. That a share has done well or poorly has no bearing on whether it will continue to do well or poorly. That will be determined by other factors, chiefly, in Fisher Investments UK’s view, how company, sector and country fundamentals compare to investors’ expectations.
But also, fixating on equities that perform best or worst has other issues. In Fisher Investments UK’s view, no single equity should be a sizable enough portion of your portfolio to materially sway returns. The single biggest firm by market capitalisation (a measure of a firm’s size calculated by multiplying its share price by the number of shares outstanding) is American Technology giant Apple at £1.58 trillion.[i] Yet even this amounts to only 4.3% of global developed world market capitalisation.[ii] We think it is fine to hold a little more than this if you are optimistic on its prospects, but going so far that it skews your portfolio’s overall returns is unwise.
In our view, an adequately diversified portfolio must own enough equities to spread your assets across most, if not all, of the world’s 11 equity sectors. Within larger sectors like Information Technology or Financials, we think it is sensible to own more than one company’s shares to reduce the risk something specific to that firm goes wrong.
The result, ideally, is a portfolio comprised of some high-flying shares, a bulk that are hovering around their sector or the global equity markets and some that are lagging. What matters most is, perhaps obviously, the bulk. Rather than look at the fringes, assess what the majority of your portfolio is doing. Ask:
- Are the majority of the shares you own performing similarly to the global markets?
- If not, is it because they tend to concentrate in certain sectors or industries? This can be a sign of risk and a call to action.
- Are their returns roughly mirroring their sector or industry? Most equities should, in our view.
This last point also applies when reviewing high or poor performers. If you own shares that are up massively when the rest of the firm’s sector is weak, we think it is beneficial to ask whether this company is really responding to the sector’s key drivers. If it isn’t, that is a red flag, in our view—even if the performance deviation is positive.
To us, long-term investing isn’t about finding the next company that is set to soar skyward. That is more akin to speculating. We think long-term investing is all about earning something like markets’ long-term results for enough time to let gains compound. To get that outcome, staying diversified is critical—no single company’s return should be make-or-break.
[i] Source: FactSet, as of 16/11/2020. Apple market capitalisation on 13/11/2020.
[ii] Ibid. Apple share of MSCI World Index market capitalisation on 13/11/2020.
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