Episode 346 - Hendrik Bessembinder: Why It's So Hard to Beat the Market · The Rational Reminder Podcast summary

Key takeaways

A small number of stocks drive the majority of market gains, highlighting the impact of skewness on stock returns.
Approximately 42% of individual stocks outperform Treasury bills, but the majority do not outperform the overall market index.
Diversification is crucial for managing risk and enhancing long-term investment performance.
Most active managers struggle to outperform market index funds, but opportunities may exist for skilled managers.
Chasing past performance can negatively impact investment results, emphasizing the importance of a balanced strategy.
The concept of 'sustainable returns' shifts the focus from portfolio accumulation to the sustainability of cash flows for consumption.

Summary

The Impact of Skewness on Stock Returns

Hendrik Bessembinder discusses the concept of skewness in stock returns, explaining that a small number of stocks contribute to most market gains. This skewness means that the average return can be misleading, as the mean return is often pulled upwards by a few high-performing stocks, while most others fall short of outperforming Treasury bills.

Long-term Performance of Stocks versus Treasury Bills

The conversation delves into Bessembinder's notable research paper, 'Do Stocks Outperform Treasury Bills?' where he reveals that approximately 42% of stocks outperformed Treasury returns over the long haul, but the majority did not perform better than the market index. This finding emphasizes the importance of understanding individual stock performance and market trends.

The Role of Diversification

Bessembinder emphasizes the critical importance of diversification for long-term investors, stating that without it, investors face a significantly higher risk of underperformance. He explains that the average stock's performance is often worse than the average market return, advocating for broad diversification to mitigate risks associated with individual stock volatility.

The Challenge of Active Management

Despite evidence suggesting the difficulty in beating the market, the discussion includes a nuanced view of active management. Bessembinder highlights that although most active managers fail to outperform indexed strategies due to fees and market efficiency, there remains a possibility for skilled fund managers to add value,

Investor Behavior and Performance

The podcast touches on the behavior of investors, particularly the tendency to chase past returns. Bessembinder explains how this can be detrimental and lead to poor long-term outcomes, urging investors to focus on a more sustainable approach to portfolio management and wealth extraction.

Future Research Directions and Sustainable Returns

Bessembinder also introduces his latest research on 'sustainable returns,' which suggests that investors should consider the amount they can withdraw from their investments without depleting their portfolio. This framework shifts the focus from merely accumulating wealth to ensuring a sustainable financial inflow for future consumption.

Show notes

Did you know that just a handful of stocks drive nearly all of the stock market's long-term gains? In this episode, we sit down with Hendrik Bessembinder to discuss his groundbreaking research on why most stocks fail to outperform Treasury bills and how a small fraction of stocks generate the most long-term market returns. Hendrik is a Professor in the Department of Finance at Arizona State University whose research focuses on market design, trading, and long-term investment performance across stock, foreign exchange, fixed income, futures, and energy markets. In addition to his academic contributions, Professor Bessembinder has over 25 years of consulting experience, advising major firms, financial markets, and government agencies. In our conversation, we delve into the findings of his research and find out how a small fraction of stocks generate the majority of long-term returns. We explore why traditional investment strategies often overlook the impact of skewness, the impacts of broad diversification and passive investing, and why active fund managers struggle to beat the market. Discover why chasing past returns can lead to costly mistakes, his latest research on 'sustainable returns', what type of industries have the highest stock returns, common investing mistakes, and more. Join us to uncover the surprising realities of stock market returns and how you can build a portfolio that stands the test of time with Professor Hendrik Bessembinder.

Key Points From This Episode:

(0:03:54) Explore Hendrik's research on long-term stock returns and how most returns come from a small group of stocks.

(0:08:30) Learn how company size interacts with the skewness in stock returns and what it means for individual investors.

(0:11:39) Considering fundamentals in stock returns and the implications of skewness for measuring portfolio performance.

(0:15:42) Unpack how he used bootstrap simulations in his paper and the performance of stock returns versus Treasury bills.

(0:19:01) Find out the proportion of US firms responsible for dollar wealth creation and why diversification is essential for long-term stock returns.

(0:25:23) Navigating volatility in the market and why it is difficult to identify skilled managers in time to leverage the market.

(0:28:00) Compare the performance of US stocks versus global stocks and what is driving their performance.

(0:32:04) What the findings of his research means for financial planners and individual investors.

(0:35:35) Uncover which US firms generated the highest returns and what type of industries these companies are in.

(0:42:07) Hear about the long-term performance of US mutual funds and how investor behaviour contributes to it.

(0:49:54) How passive investing and index funds have reduced the contributions of actively managed mutual funds and the lessons for investors.

(0:55:48) Discover Professor Bessembinder's broader research interests and his definition of success.

Links From Today's Episode:

Meet with PWL Capital: https://calendly.com/d/3vm-t2j-h3p

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder Website — https://rationalreminder.ca/

Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/

Rational Reminder on X — https://x.com/RationalRemind
Rational Reminder on TikTok — www.tiktok.com/@rationalreminder

Rational Reminder on YouTube — https://www.youtube.com/channel/

Rational Reminder Email — info@rationalreminder.ca
Benjamin Felix — https://pwlcapital.com/our-team/

Benjamin on X — https://x.com/benjaminwfelix

Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/

Mark McGrath on LinkedIn — https://www.linkedin.com/in/markmcgrathcfp/
Mark McGrath on X — https://x.com/MarkMcGrathCFP

Professor Hendrik Bessembinder — https://search.asu.edu/profile/2717225

Arizona State University — https://www.asu.edu/

KRIS — https://www.kris-online.com/

Professor Hendrik Bessembinder papers on SSRN — https://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=667

SPIVA — https://www.spglobal.com/spdji/en/research-insights/spiva/

Episode 322: Professor Marco Sammon — https://rationalreminder.ca/podcast/322

Episode 124: Professor Lubos Pastor — https://rationalreminder.ca/podcast/124

Papers From Today's Episode:

'Do Stocks Outperform Treasury Bills?' — https://www.sciencedirect.com/science/article/abs/pii/S0304405X18301521

'Extending Portfolio Theory to Compound Returns' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3875870

'Luck versus Skill in the Cross-Section of Mutual Fund Returns' — https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.2010.01598.x

'Measuring Skill in the Mutual Fund Industry' — https://www.sciencedirect.com/science/article/abs/pii/S0304405X15000628

'Long-Term Shareholder Returns: Evidence from 64,000 Global Stocks' — https://www.tandfonline.com/doi/abs/10.1080/0015198X.2023.2188870

'Which U.S. Stocks Generated the Highest Long-Term Returns?' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4897069

'How Should Investors' Long-Term Returns Be Measured?' — https://www.tandfonline.com/doi/abs/10.1080/0015198X.2024.2401765

Editing and post-production work for this episode was provided by The Podcast Consultant (https://thepodcastconsultant.com)

Episode 346 - Hendrik Bessembinder: Why It's So Hard to Beat the Market