Drawdowns and small stocks for God-like performance

Martin Pretty

Equitable Investors

“If God is omnipotent, could he create a long-term active investment strategy fund that was so good that he could never get fired?,” US-based quantitative investor and author Wesley Gray asked several years ago. 

Gray’s data indicated that God would likely get fired - if God focused on picking investments that would deliver top decile (top 10%) returns over five years. After picking the stocks with perfect foresight and heading out fishing for five years, Gray found God’s celestial clients would have endured drawdowns of as much as 76% in the interim. How many clients would have had the stomach to endure that?

We semi-regularly take a look back at what the return distribution for ASX industrials has been like over a five year period. It is an exercise that provides data points and context when considering risk and return.

We ran the numbers for the five years through to the end of August 2021, and found that:

  • 17% of stocks returned more than 200% over the five years

  • 40% of stocks disappointed with negative returns

  • Share prices of the top decile averaged a 48% drawdown (looking at pricing every three months)

  • Over 90% of the top decile had market caps of less than $1 billion

  • The median total return was just over 29% for five years or 5.25% a year

Source: Equitable Investors, Sentieo

Some of the names in the top decile are well known "growth" stocks like Hub24 (ASX: HUB) and Pro Medicus (ASX: PME).

But there are plenty of names you may not have heard of - like IT recruitment and labour player HiTech Group (ASX: HIT) and medical diagnostic developer Proteomics (ASX: PIQ).

For context, the annualised total returns for both the S&P/ASX 100 and the S&P/ASX Small Ordinaries benchmarks were both around 11% - substantially higher than the median stock in this review.

The median stock would underperform indices over five years, if not for any other reason than simply because those indices would be rebalanced through the period in favour of the stocks that are performing.

Consistent experience

The distribution of returns in this period of review was similar to when we ran the same analysis back in May 2018, although in the latest numbers there is a slightly larger portion of stocks that have had negative outcomes (40% now versus 36% then).

These figures are also consistent with a US analysis of the total lifetime returns for individual stocks between 1993 and 2006, where Blackstar Funds found 39% of all stocks had a negative return and around 20% were “significant” winners returning 300% or more. 

Source: Blackstar Funds


Key insights we take out of the data presented here are that:

  • There are great opportunities for active investors with longer term time horizons

  • Patience and discipline are all important as even the greatest opportunities have a habit of making investors question their conviction at times

  • We can't have the perfect foresight of a God but insight or an "edge" is required as the median stock has struggled to match index trackers.

  • God's investment portfolio, with a five-year time horizon and perfect foresight, would be dominated by smaller stocks!

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Nothing in this article constitutes investment advice. Neither the information, commentary or any opinion contained in this article constitutes a solicitation or offer by Equitable Investors Pty Ltd (EI) or its affiliates to buy or sell any securities or other financial instruments. Delivery of this article to a recipient should not be relied on as a representation that the information contained remains accurate or complete at any time after the preparation date. EI does not guarantee or make any representation or warranty as to the accuracy or completeness of the information in this article. To the extent permitted by law, EI disclaims all liability that may otherwise arise due to any information in this report being inaccurate or information being omitted.

Martin Pretty
Equitable Investors

Martin established Equitable Investors and the Dragonfly Fund in 2017 after serving as an investment manager with Thorney Investment Group. Equitable seeks out unique opportunities with intensive research and constructive corporate engagement

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