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As market volatility rises, so does the risk of a concentrated stock position

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Yana S. Barton, CFACo-Director of Growth Equity, Eaton Vance Management and Carolina Concannon, CFASenior Portfolio Management Associate, Eaton Vance Management

      Boston - First in a series on the risks and opportunities of concentrated stock positions

      Equity prices have whipsawed over the past two weeks as fears of the coronavirus outbreak and unexpected outcomes in the US presidential primaries have rippled through the financial markets. As of March 4, the S&P 500 Index has corrected approximately 11% from February highs. But the average stock's drawdown has been 17%, underscoring the greater vulnerability of individual positions and concentrated sector, industry and stock exposures.

      A concentrated position refers to a portfolio holding that represents a disproportionate percentage of an investor's assets. While there is no precise threshold, typically an equity position representing more than 10% of the total portfolio value would be considered concentrated. Investors with concentrated stock positions potentially face the risk that the performance of a single entity could have an outsized influence on their portfolios, subsequently impacting their ability to meet long-term financial objectives.

      Market drawdowns are part and parcel of equity investing

      The period since the S&P 500's all-time high on February 19 has certainly been chaotic, with equities up significantly one day only to drop just as dramatically the next. Yet such market drawdowns, however distressing, aren't really that unusual.

      According to historical analysis by Ned Davis Research, based on 90 years of S&P 500 returns since 1928 through February 24, the market averaged three dips of at least 5% annually, with moderate corrections of 10% or more roughly once per year. Fewer than half of those worsened to severe corrections greater than 15%. And slightly more than half of those sold off by 20%, moving into bear market territory.

      As investors who are committed to the earnings growth and total return potential of equities over the long run, we think that's worth remembering, to help put the recent volatility in perspective.

      Investors tend to underestimate individual stock risk

      If a diversified index like the S&P 500 can experience such ups and downs, an individual stock is likely to be even more volatile, just as we've seen so far this year. But investors can be susceptible to a number of biases that can affect their judgment about the risks inherent in their portfolio holdings, especially the concentrated positions. We'll discuss these behavioral biases over the coming weeks.

      In the meantime, remember that old proverb about not putting all your eggs in one basket? We grouped all actively traded stocks on the major US exchanges from 1981 to 2019 into buckets by their annualized standard deviations, or volatility around the mean (see the blue bars in the chart below). This historical analysis revealed that nearly all of them had higher volatility than the S&P 500 at 15%, with the median stock volatility closer to 55%.


      All actively traded stocks listed on NYSE, Nasdaq and NYSE American (formerly AMEX), since 12/31/1981, excludes stocks with less than 24 months of returns to compute annualized standard deviation; 21,195 total stocks. Monthly return data, 1/31/1972 to 12/31/2019. Source: Ned Davis Research, Morningstar, Eaton Vance.

      Bottom line: With the markets continuing to oscillate, we believe it's even more important to recognize that no stock, no matter how strong or well-positioned it may seem, is immune from risk. For investors whose holdings are heavily concentrated in a single stock, now might be a good time to evaluate the options for diversification.