Hendrik Bessembinder - Do Stocks Outperform T-Bills? | #532

Episode Summary

Executive Summary: The episode centers on Henrik Bessembinder’s research showing that long-term stock market gains are driven by a small number of exceptional winners, while most stocks underperform Treasury bills or the market. He explains his shareholder-wealth-creation framework, the difficulty of predicting winners, why diversification matters, and how these ideas extend to mutual funds, rebalancing, and long-horizon performance measurement.

Main Topics: Stock returns are highly skewed (Priority: 5/5): Bessembinder argues that the equity premium is not generated by the average stock; a relatively small set of firms creates most long-run wealth, while many stocks lose money over time. Shareholder wealth creation vs. buy-and-hold (Priority: 5/5): He introduces a wealth-creation metric that measures outcomes in dollars, not percentages, and avoids assuming dividend reinvestment into the same stock, aiming to better reflect aggregate shareholder experience. Implications for active vs. passive investing (Priority: 4/5): The research adds support for diversification for most investors, while acknowledging that some investors with genuine comparative advantage can add value through active stock selection. Characteristics of big winners and prediction limits (Priority: 4/5): He finds that predicting future decade-long winners is extremely difficult; younger firms, higher prior asset growth, and prior R&D spending have some signal, but predictive power is very low. Drawdowns and the path to superstar stocks (Priority: 4/5): Top-performing stocks often endure severe interim declines, meaning investors need exceptional fortitude to hold winners through large drawdowns. Mutual funds, fees, and long-horizon alpha (Priority: 4/5): The conversation extends the same skewed-distribution logic to active funds, high fees, closet indexing, and the need for better long-horizon performance measures than standard monthly alpha. Rebalancing and diversification (Priority: 3/5): He argues rebalancing is not a free return enhancer; it is fundamentally a contrarian strategy whose main virtue is restoring diversification, not guaranteed wealth creation.

Key Arguments: Most long-run equity returns come from a small number of extraordinary stocks, not the typical stock. A shareholder-wealth-creation framework is more realistic than simple buy-and-hold compounding because shareholders do not collectively reinvest dividends into the same stock. For most investors, diversification remains the right default because stock-picking is usually not their comparative advantage. The data show that predicting decade-long winners is extremely hard; even with many variables, out-of-sample explanatory power is minimal. Big winners are often volatile and can suffer devastating drawdowns before becoming iconic companies. Tech stocks produce many of the biggest winners, but also many of the losers; the sector is not a simple shortcut to success. Mutual fund outcomes exhibit the same skewed structure as stocks, implying that high fees and closet indexing can materially reduce investor wealth. Standard alpha and average-return metrics can miss the economics of long-horizon investing, motivating better measurement frameworks. Rebalancing should not be sold as a guaranteed return booster; it works only insofar as it restores target weights and diversification. Investors should think carefully about what they are investing for: consumption, pensions, endowments, or other real-world objectives, rather than only terminal wealth.

Data Points: Cropland lost to urbanization: 4.8 acres per minute - Used in the farmland ad copy at the start of the episode, highlighting farmland scarcity. Farmland investment minimum: $15,000 - AcreTrader advertises passive access to farmland with this minimum investment. Sample period for wealth-creation research: Almost 100 years - Bessembinder discusses research spanning roughly a century of stock returns. Best compound buy-and-hold return mentioned: 240 million percent - Bessembinder says Altria Group had the highest compound return when he last checked through 2016. Largest wealth creators: Microsoft, Amazon, Apple - Examples of household-name firms near the top of the wealth-creation rankings. Drawdown for top performers: 51% average prior-decade drawdown - Top 200 firms in a given decade had, on average, suffered large drawdowns in the prior decade. Apple drawdown: 70%+ - Example of how even a massive future winner endured severe interim losses. Amazon drawdown: 91% - Example of the extreme volatility faced by a future superstar stock. Predictive variables tested: 20 variables - Bessembinder examined accounting and return-based variables for forecasting future decade winners. Predictive power: Less than 1% R-squared - Predictive regression for future decade winners had extremely low explanatory power. Statistically significant predictors: 3 out of 20 variables - Only three variables showed significance in predicting next-decade winners. Mutual fund wealth gap vs SPY: $1 trillion - Hypothetical difference if mutual fund investors had earned SPY returns instead of actual returns by end of sample. Dividends and long-run compounding effect: Up to 20x difference - Bessembinder argues that assuming dividend reinvestment can materially inflate long-run ending-wealth illustrations.

Pivotal Quotes: "The majority of stocks lost money, majority underperformed treasuries. Most of the gains in the market was attributable to a few firms." — Henrik Bessembinder: Summarizing his core finding about skewed stock-market wealth creation. "If you do have one of these big winners in your portfolio ... whether to let it ride or take your money off the table, I don't have an answer." — Henrik Bessembinder: Discussing the difficulty of managing concentrated winners and the lack of a one-size-fits-all answer. "If everybody's a passive investor, they certainly wouldn't be efficient." — Henrik Bessembinder: Explaining why active investors still matter for market functioning, even though most investors should diversify.

Implications: Investors should expect extreme skewness in returns, avoid overconfidence in stock-picking, and focus on diversification unless they truly have an edge. The episode also calls for better long-horizon performance metrics for stocks, funds, and portfolios.