Risk Diversification Benefits

of Multiple-Stock Portfolios
Holding between one and one hundred stocks.
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Vladimir de Vassal

isk diversification is important to all equity

R investors. Private investors with large con-

centrated holdings in one or only a few stocks
are vulnerable to significant risk of under-
performing the overall stock market. During the past seven
years, major stock market indexes (including the DJIA,
the S&P 500, and the Russell 1000) have more than tripled
in value—but not everyone with equity holdings may have
profited from this extraordinary bull market.
My analysis should provide a useful framework for
explaining the value of equity diversification to clients,
including the return/risk benefits of adding stocks to a
portfolio. The analysis uses Monte Carlo techniques to
simulate total returns of equity portfolios with varying
numbers of holdings for the seven-year period ending
December 31, 1999. The universe is based on the orig-
inal constituents of the Russell 1000 as of December 31,
1992, adjusted for survivorship.
The results suggest that adding only a few stocks
to a non-diversified portfolio produces significant risk
reduction benefits. The appendix reviews the strong rel-
ative performance of non-surviving stocks versus sur-
viving stocks during this period.

METHODOLOGY

VLADIMIR DE VASSAL is To analyze the risk of portfolios with different lev-

director of quantitative research at els of holdings, we use the original constituents of the
The Glenmede Trust Company in Russell 1000 at year-end 1992 and their total return per-
Philadelphia (PA 19103). formance (capital appreciation plus dividend reinvestment)

32 RISK DIVERSIFICATION BENEFITS OF MULTIPLE-STOCK PORTFOLIOS WINTER 2001

 EXHIBIT 1
DISCRETE FREQUENCY DISTRIBUTION RUSSELL 1000 — INDIVIDUAL STOCK RETURNS

20%
Frequency of Occurrence
18.5%
17.2% 16.8%
15%
11.4% 11.0%
10%
8.2%
6.6% 7.0%
5%
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3.3%
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0%
<(50%) (50%)- 0%-50% 51%- 101%- 151%- 201%- 251%- >300%
0% 100% 150% 200% 250% 300%

Total Return Seven Years Ended December 31, 1999

Source: Glenmede Investment Research and FactSet.

through December 1999.1 For companies that did not sur-
vive for the entire period, we recognize the total return
from December 1992 until the last reported stock price.
In addition, we assume that proceeds from the retiring
stock would be reinvested into another stock, randomly
selected from the original constituents of the Russell 1000
index. The total returns for the original and reinvestment
stocks are then combined on a compounded basis to deter-
mine a total return for the full seven-year period. (The
appendix analyzes survivorship bias and discusses the ran-
dom selection techniques in more detail.)

WINTER 2001 THE JOURNAL OF PORTFOLIO MANAGEMENT 33

 EXHIBIT 2
CUMULATIVE FREQUENCY DISTRIBUTION RUSSELL 1000 — INDIVIDUAL STOCK RETURNS
100%

Frequency of Occurrence
78.2% 81.5%
80% 71.2%
63.0%
60% 52.0%

40% 35.2%

20% 18.0%
6.6%
0%
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<(50%) <0% <50% <100% <150% <200% <250% <300%

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Total Return Seven Years Ended December 31, 1999

Source: Glenmede Investment Research and FactSet.

EXHIBIT 3
FREQUENCY DISTRIBUTION OF PORTFOLIO RETURNS
Total Return Number of Stocks in Simulated Portfolios
Range 1 2 3 4 5 6 7 8 9 10 12 15 20 25 30 40 50 75 100
(76%)-(100%) 2.9 0 .2 0 .0 0 .0 0.0 0 .0 0.0 0 .0 0 .0 0 .0 0.0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
(51%)-(75%) 3.7 1.0 0.2 0.1 0 .0 0 .0 0.0 0.0 0 .0 0 .0 0.0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
(26%)-(50%) 4.7 2.5 1.0 0.5 0.3 0 .0 0.0 0.0 0 .0 0 .0 0.0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
(0%)-(25%) 6.7 4.9 2.8 1.6 1.0 0 .5 0.3 0 .1 0 .1 0 .0 0.0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
0%-25% 7.7 7.3 5.9 4.2 3.1 2.0 1.5 0 .8 0 .9 0 .4 0 .1 0 .1 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
26%-50% 9.5 8.7 8.3 7.5 6.3 5.3 4.2 3.5 2.7 2.5 1.6 0 .8 0 .3 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
51%-75% 9.2 9.7 9.8 9.7 9.5 8.0 7.7 7.3 6.8 6.1 4.5 3.6 2.1 1.0 0 .5 0 .1 0 .0 0 .0 0 .0
76%-100% 7.6 8.7 9.9 10.0 10.6 11.2 10.5 10.7 10.8 10.2 8.9 8.6 5.8 4.6 3.6 2.0 1.1 0 .2 0 .0
101%-150% 11.0 15.5 17.9 19.3 20.6 21.8 22.6 23.3 24.9 24.7 26.0 24.6 26.3 25.1 24.2 21.4 19.6 14.1 10.3
151%-200% 8.2 11.1 12.7 14.3 15.1 16.7 17.5 18.7 18.8 19.8 21.9 24.0 26.0 28.4 29.8 33.6 35.4 40.5 43.1
201%-250% 7.0 7.7 8.4 9.6 10.4 11.0 11.8 12.4 12.0 13.3 13.9 15.3 16.4 18.0 19.4 22.3 24.5 28.5 32.8
251%-300% 3.3 5.2 6.0 6.6 6.3 6.8 7.4 7.4 7.4 7.9 7.8 7.8 9.0 10.4 10.8 11.3 12.0 12.2 11.2
301%-350% 3.6 3.5 3.8 4.1 4.8 4.3 4.6 4.5 4.7 4.3 4.7 5.5 5.5 5.7 5.7 5.5 4.8 3.5 2.1
351%-400% 2.9 2.4 3.0 2.8 2.9 3.2 2.7 2.9 2.7 2.6 3.2 3.4 3.5 3.3 3.0 2.3 1.6 0.9 0 .3
401%-450% 2.0 2.0 2.1 2.1 2.0 2.0 1.8 1.6 1.7 2.3 2.3 2.3 2.1 1.7 1.6 1.0 0.7 0 .1 0 .0
451%-500% 1.3 1.6 1.4 1.2 1.1 1.4 1.3 1.3 1.5 1.6 1.5 1.3 1.4 0.9 0 .8 0.3 0 .3 0 .0 0 .0
501%-600% 1.6 2.3 2.0 1.8 1.6 1.7 2.3 2.2 2.1 2.0 1.6 1.6 1.2 0.7 0 .5 0 .1 0 .1 0 .0 0 .0
601%-700% 1.6 1.3 1.1 1.0 1.1 1.5 1.5 1.2 1.3 0 .8 1.1 0.9 0 .3 0.2 0 .1 0 .0 0 .0 0 .0 0 .0
701%-800% 1.2 0.9 0.9 0 .8 0.9 0 .9 0.8 0 .7 0 .6 0 .7 0 .6 0 .3 0 .2 0 .1 0 .0 0 .0 0 .0 0 .0 0 .0
801%-900% 0.5 0.7 0.3 0 .7 0.6 0 .7 0.5 0 .4 0 .6 0 .6 0.2 0 .1 0 .0 0.0 0 .0 0 .0 0 .0 0 .0 0 .0
901%-1000% 0.6 0 .3 0.4 0.7 0.4 0 .3 0.2 0.5 0 .3 0 .2 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
>=1000% 3.2 2.3 2.1 1.6 1.4 0 .8 0.8 0.4 0 .3 0 .1 0 .1 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0

Simulated Multiple — Stock Portfolios

Total Returns — Cumulative Frequency Distributions
Seven Years Ended December 31, 1999
Total Return Number of Stocks in Simulated Portfolios
Range 1 2 3 4 5 6 7 8 9 10 12 15 20 25 30 40 50 75 100
<(75%) 2.9 0 .2 0 .0 0.0 0.0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
<(50%) 6.6 1.2 0 .2 0 .1 0.0 0 .0 0.0 0 .0 0.0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
<(25%) 11.3 3.7 1.2 0.5 0.3 0 .0 0 .0 0.0 0 .0 0 .0 0.0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
<0% 18.0 8.6 4.0 2.1 1.2 0 .5 0.3 0 .1 0 .1 0 .0 0.0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
<25% 25.7 15.8 9.9 6.3 4.3 2.5 1.8 1.0 0 .9 0 .4 0 .2 0 .1 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
<50% 35.2 24.5 18.2 13.8 10.6 7.8 6.0 4.5 3.6 3.0 1.7 0 .9 0 .3 0 .0 0 .0 0 .0 0 .0 0 .0 0 .0
<75% 44.4 34.3 28.0 23.5 20.1 15.8 13.7 11.9 10.4 9.1 6.2 4.4 2.4 1.0 0 .6 0 .1 0 .0 0 .0 0 .0
<100% 52.0 42.9 37.9 33.5 30.7 27.0 24.2 22.6 21.3 19.3 15.1 13.0 8.2 5.6 4.2 2.2 1.1 0 .2 0 .0
<150% 63.0 58.5 55.7 52.8 51.2 48.8 46.8 45.8 46.1 44.0 41.1 37.6 34.5 30.8 28.4 23.6 20.7 14.3 10.4
<200% 71.2 69.6 68.5 67.0 66.4 65.6 64.3 64.6 64.9 63.8 62.9 61.6 60.5 59.1 58.1 57.1 56.1 54.8 53.5
<250% 78.2 77.2 76.9 76.6 76.7 76.6 76.1 77.0 76.9 77.1 76.8 77.0 76.9 77.1 77.6 79.4 80.6 83.3 86.3
<300% 81.5 82.5 82.8 83.2 83.1 83.4 83.5 84.4 84.4 85.0 84.7 84.7 85.9 87.5 88.4 90.7 92.6 95.5 97.6
<350% 85.1 85.9 86.7 87.3 87.9 87.7 88.1 89.0 89.0 89.2 89.4 90.2 91.3 93.2 94.1 96.3 97.4 99.0 99.6
<400% 88.0 88.4 89.7 90.1 90.8 90.9 90.8 91.8 91.8 91.8 92.6 93.5 94.8 96.5 97.1 98.6 99.0 99.8 100.0
<450% 90.0 90.4 91.7 92.2 92.9 92.8 92.6 93.4 93.4 94.2 94.9 95.9 96.9 98.1 98.6 99.6 99.7 100.0 100.0
<500% 91.3 92.0 93.2 93.4 94.0 94.2 94.0 94.7 94.9 95.7 96.4 97.1 98.2 99.0 99.4 99.9 99.9 100.0 100.0
<600% 92.9 94.4 95.2 95.2 95.6 95.9 96.2 96.9 97.0 97.7 98.0 98.7 99.5 99.7 99.9 100.0 100.0 100.0 100.0
<700% 94.5 95.7 96.3 96.2 96.7 97.3 97.7 98.1 98.3 98.5 99.1 99.6 99.8 99.9 100.0 100.0 100.0 100.0 100.0
<800% 95.7 96.6 97.2 97.0 97.6 98.3 98.5 98.8 98.8 99.2 99.7 99.9 100.0 100.0 100.0 100.0 100.0 100.0 100.0
<900% 96.2 97.4 97.5 97.7 98.2 98.9 99.0 99.1 99.4 99.7 99.9 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
<1000% 96.8 97.7 97.9 98.4 98.6 99.2 99.2 99.6 99.7 99.9 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Source: Glenmede Investment Research and FactSet.

34 RISK DIVERSIFICATION BENEFITS OF MULTIPLE-STOCK PORTFOLIOS WINTER 2001

 EXHIBIT 4
FREQUENCY OF LOSS FOR ALTERNATIVE STOCK HOLDINGS
SIMULATED MULTIPLE — STOCK PORTFOLIO RETURNS
20% 18.0%
Frequency of Occurrence
18%
16%
14%
12%
10% 8.6%
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8%
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6%
4%
2%
0%
1 2
Seven years ended December 31, 1999.
Source: Glenmede Investment Research and FactSet.
RESULTS
Exhibit 1 depicts the percentage of stocks with a
total return within a specific range. For example, 66 stocks
or 6.6% of the Russell 1000 universe reflected a nega-
tive return between (50%) and (100%). The average and
median returns for all the stocks in the Russell 1000 dur-
ing the seven-year period were 201% and 94%, respec-
tively. The great difference between the average and
median returns reflects the positive skewness of the dis-
tribution, with 18.5% of the stocks yielding a total return
of at least 300% over the last seven years.
A cumulative frequency distribution is shown in
Exhibit 2. Eighteen percent of the Russell 1000 stocks
reflected a negative return over the seven-year period.
These results would suggest that if an individual
investor had randomly bought one stock at the end of
1992, there was about a one-in-six chance that the equity
investment would have lost value by year-end 1999, while
the Russell 1000 index was more than tripling in value.
This example highlights the potential risk of investing
in only one stock.
Given the risk of owning only one stock, we next
test for the risk benefits of adding additional stocks to a
portfolio. We use a Monte Carlo simulation program to
randomly select multiple combinations of individual stocks
from the Russell 1000 as of year-end 1992.2 As a first step,
we assign a numerical value (1 to 1,000) to represent each
stock in the Russell 1000 universe. Next, for determin-
ing two-stock portfolios, we compute 10,000 pairs of ran-
WINTER 2001
4.0%
2.1%
1.2% 0.5% 0.3% 0.1% 0.1% 0.0% 0.0% 0.0% 0.0%
3 4 5 6 7 8 9 10 12 15 20
Number of Stocks in Portfolio
dom numbers (integers ranging from 1 to 1,000 with equal
probability). Each pair of random numbers would then
correspond to the preassigned numerical values of two
stocks in the original Russell 1000 index.
The historical returns of the two stocks for the
seven-year period are averaged together to create an
equal-weighted portfolio return. This procedure is used
to create larger equal-weighted stock portfolios, rang-
ing in size from 3 to 100 stocks.
After generating the multiple stock portfolios, we
create frequency distributions with the total return
results. The frequency distributions in Exhibit 3 reflect
the percentage of simulated portfolios (with the same
number of stocks) with returns within a specific range.
For example, 25.5% of the simulated five-stock portfo-
lios had a total return between 150% and 250% for the
seven-year period ending December 31, 1999. More
than three-quarters (75.9%) of the 100-stock portfolios,
however, reflected total returns between 150% and 250%.
This analysis supports the hypothesis that the dispersion
of portfolio returns is inversely related to the number
of stocks in a portfolio.
Frequency distributions are also a useful tool to
analyze downside risk. The cumulative frequency dis-
tribution depicts the percentage of portfolios in which
the returns fall below a specific level. For example, 30.7%
of the 5-stock portfolios reflected a total return below
100% for the seven-year period versus 4.2% of the 30-
stock portfolios.
THE JOURNAL OF PORTFOLIO MANAGEMENT 35
 EXHIBIT 5
FREQUENCY OF UNDERPERFORMING INFLATION

25% 23.4%

Frequency of Occurrence 20%

15% 13.7%

10% 8.0%
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5% 4.9%
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3.2%
1.7% 1.1%
0.7% 0.6% 0.2% 0.1% 0.0% 0.0%
0%
1 2 3 4 5 6 7 8 9 10 12 15 20
Number of Stocks in Portfolio

Seven years ended December 31, 1999.

Source: Glenmede Investment Research, FactSet, Ibbotson Associates (U.S. Inflation).

DOWNSIDE RISK ANALYSIS
After accumulating the simulation results, we ana-
lyze the downside risk for portfolios with different num-
bers of holdings. We analyze the frequency of negative
nominal and real portfolio returns, as well as underper-
formance of a benchmark index by different levels of return.
The first measure of downside risk analyzed is the frequency
of negative returns for the portfolios of different holdings.
In Exhibit 4, we illustrate the frequency of neg-
ative returns for different size portfolios. It is evident that
there is a significant reduction in downside risk with the
addition of only a few stocks to a portfolio. For exam-
ple, the 18% frequency of a negative return for a one-
stock portfolio decreases to about 2% for portfolios with
four stocks (equally weighted), and to less than 1% with
six stock holdings. The frequency of loss is 0% for sim-
ulated portfolios with ten or more stocks.
It should be noted that this frequency of loss is
relative to the bullish period for stocks over the last seven
years and should not be considered indicative of all his-
torical or future periods.

EXHIBIT 6
FREQUENCY OF UNDERPERFORMING MARKET BENCHMARK BY MORE THAN 100%

60%
52.3%
50%
Underperformance
Frequency of

40%
31.4%
30%
20.0%
20%
13.5%
10% 8.7%
4.6% 2.4% 1.3% 0.2% 0.1%
0%
1 5 10 15 20 30 40 50 75 100
Number of Stocks in Portfolio

Seven years ended December 31, 1999.

Source: Glenmede Investment Research, FactSet, Ibbotson Associates (U.S. Inflation).

36 RISK DIVERSIFICATION BENEFITS OF MULTIPLE-STOCK PORTFOLIOS WINTER 2001

 EXHIBIT 7
FREQUENCY OF UNDERPERFORMING BY 50%, 25%, AND 10%

80% -50% -25% -10%

70%
Underperformance

70% 64%
62%
Frequency of

68%
60% 58% 57%
60% 53% 52% 51%
50% 56% 47% 46%
51% 49%
40% 45%
64% 42% 40%
30%
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52% 35%
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20% 45% 38% 32%

35%
29% 24%
10% 22%
15% 11%
0%
1 5 10 15 20 30 40 50 75 100
Number of Stocks in Portfolio

Seven years ended December 31, 1999.

Source: Glenmede Investment Research and FactSet.

Exhibit 5 reflects the percentage of time that the
different simulated portfolios underperformed inflation. We
use the Consumer Price Index (CPI) as a proxy for infla-
tion. The CPI increased 18.6% from year-end 1992 through
year-end 1999.3 The exhibit indicates that there is about
a 23% probability that a randomly chosen stock would have
underperformed inflation in the seven-year period. With
six-stock portfolios, the frequency of underperforming CPI
decreases to below 2%. As in Exhibit 4, the negative risk
is significantly reduced with more stocks in a portfolio.
Exhibit 6 reflects downside risk from a different
perspective: the risk of underperforming the overall stock
market. In this example, we take the average return
(201%) for all stocks in the Russell 1000 index as a mar-
ket benchmark for the historical seven-year period.
Exhibit 6 illustrates what proportion of the simulated
portfolios would have underperformed the market
benchmark by more than 100% (e.g., total return less than
101% for the seven-year period).
The probability of significant underperformance
is dramatically reduced for portfolios with more stocks.
About 9% of the simulated 20-stock portfolios reflect
total returns at least 100% below the average market
return. The probability of underperforming the mar-
ket by more than 100% decreases to about 1% for port-
folios with 50 stocks.
Exhibit 7 compares the percentage of portfolios
that underperformed the market benchmark return by
50%, 25%, and 10%. The more conservative, risk-averse
investor would generally favor a tighter downside con-
straint (e.g., 10% or 25% underperformance) and be
biased toward a larger number of stocks.
For example, a conservative investor who wants
no greater than a 40% probability of underperforming
the market by 25% should own a minimum of 50 stocks.
A less risk-averse investor may be satisfied with a lower
downside constraint of underperforming the market, pos-
sibly 50%. With a 40% probability limit, this investor’s
portfolio should include about 15 stocks (38% frequency
of underperformance). If the investor wants to limit the
probability of a –50% relative return to 30%, a minimum
portfolio of about 30 stocks would be appropriate. The
investor with a very low risk tolerance of underper-
forming the market would turn to an indexed or
enhanced index portfolio.
Natural extensions of this analytical approach
would be to include other factors to further reduce
downside risk. Examples are sector weight constraints,
risk factors, and beta limits in the formation of the mul-
tiple-stock portfolios. Or, the analysis could be expanded
to recognize the impact of capital gains and income taxes
for high net worth clients.
SUMMARY
This analysis should help to encourage a client
with few stock holdings to diversify across a greater array
of stocks. Increasing the number of stocks held can sig-

WINTER 2001 THE JOURNAL OF PORTFOLIO MANAGEMENT 37

 EXHIBIT A-1
FREQUENCY DISTRIBUTION OF SURVIVORS/NON-SURVIVORS (NO REINVESTMENT)
Frequency of Occurrence
25% 22.1%
19.9%
20% 18.2% 17.8% 18.1%

15% 13.4%
11.2% 10.9% 11.7%
10% 8.3% 8.4% 8.3%
6.2% 6.1% 6.5% 5.8%
5% 4.0% 2.9%
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0%
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0%
)

%
%

%
%

%
%
%

50

00
50

-5

00
00

50

00
)-0

0%
<(

-1

-2

>3
-1

-2

-3
0%

1%

1%
%

1%

1%
(5

10

15
51

20

25
Total Return

Non-Survivors Survivors
Seven years ended December 31, 1999.
Source: Glenmede Investment Research and FactSet.

nificantly reduce the risk of underperforming inflation APPENDIX

and the stock market. The other advantage to holding ANALYZING SURVIVORSHIP BIAS
a multiple-stock portfolio relates to the positive skew- IN THE RUSSELL 1000
ness of stock returns. The maximum loss that a stock can
incur is negative 100% — but the maximum return on The constituents of the Russell 1000 index, like most other
a stock is not limited. For the seven-year period ending major stock indexes, are subject to change over time as companies
December 31, 1999, about one in six stocks reflected are delisted because of merger, acquisition, bankruptcy, or other cause.
total returns in excess of 300%. The likelihood of get- The impact of this turnover can have a significant effect on the cal-
culation of portfolio performance.
ting one of these super performers increases as you add
To analyze the survivorship bias in large-cap stocks over the
additional stocks.
last seven years, we divide the original Russell 1000 constituents (as

EXHIBIT A-2
FREQUENCY DISTRIBUTION OF SURVIVORS/NON-SURVIVORS (WITH REINVESTMENT)
Frequency of Occurence

25%
19.6%
20% 18.2% 17.8% 18.1%
14.5% 14.1%
15% 12.7% 11.7%
10.9% 10.1%
9.1%
10% 8.0% 6.1% 7.6% 8.4%
5.8%
4.3% 2.9%
5%
0%
0%
)

%
%

%
%

%
%
%

50

00
50

-5

00
50

00
00
)-0

-1

-2
0%
<(

>3
-2

-3
-1
0%

1%

1%

1%

1%
%
(5

10

15
51

20

25

Total Return

Non-Survivors (Adjusted) Survivors

Seven years ended December 31, 1999.
Source: Glenmede Investment Research and FactSet.

38 RISK DIVERSIFICATION BENEFITS OF MULTIPLE-STOCK PORTFOLIOS WINTER 2001

 of December 31, 1992) into two groups, survivors and non-survivors
(delisted stocks). We compare the total return performance of the
724 stocks that existed for the entire seven-year period and the 276
stocks that did not survive. In our first analysis, we compute the
respective total returns of the individual stocks of both groups, assum-
ing no reinvestment provision for the non-surviving stocks. The total
return is calculated from December 31, 1992, until the date of the
last closing price of the non-surviving stock.4
The frequency distributions of returns for the two stock
groups are presented in Exhibit A-1. The percentage of stocks that
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reflected a negative total return (below 0%) for the time period is
17.4% for the non-survivors versus 17.0% for the survivors. For large
losses, 6.2% of the non-survivors reflected a negative return in excess
of (50%), versus 6.1% for the surviving group.
The most significant variation in frequency is found in the
highest return category. Only 8.3% of the non-survivors had a total
return of more than 300% versus 18.1% for the survivors. A major
reason for this percentage difference is that many of the non-sur-
vivors did not participate in the bullish stock market for the entire
seven-year period, especially in the last four years.
It seems likely that the distributions of the two groups would
reflect less disparity if adjusted for this timing effect. To test this, we
assumed that the proceeds from a retiring stock would be reinvested
on the retirement date into an alternative Russell 1000 stock (uni-
verse as of December 31, 1992) for the remaining holding period
through December 31, 1999. We assume a 1% transaction cost for
each reinvestment.
To choose reinvestment stocks, we use a spreadsheet ran-
dom number generator.5 We assign each stock in the Russell 1000
index (as of December 31, 1992) an integer value from 1 to 1,000
with an equal-weighted probability. If a randomly selected rein-
vestment stock had already retired, an alternative stock was randomly
chosen. If a reinvestment stock would retire before December 31,
1999, its total return is recorded and another randomly selected stock
is chosen for the remaining period.
The total returns for the initial stock and reinvestment stocks
are combined on a compounded basis to create a total return for the
entire seven-year period. The total return results of non-survivors
with the reinvestment adjustment are displayed in Exhibit A-2.
The frequency distribution with reinvestment reflects some
differences versus the unadjusted non-survivor distribution (Exhibit
A-1). The frequency of large losses (over 50%) increases to about
8% versus 6% for the unadjusted non-survivors and survivors. The
frequency of a negative return is about 21%, somewhat higher than
the survivor frequency of 18%.
The most significant differences occur in the percentage of non-
survivors with total returns in excess of 200% (about 34% of the non-
survivors with reinvestment versus 27% for survivors). The non-survivors
with returns over 300% increase to a 19.6% frequency, versus 8.3% for
the unadjusted non-survivors and 18.1% for the survivors, respectively.
Overall, the adjusted non-survivor and survivor distributions
are relatively similar except for the slightly higher percentage of neg-
ative returns for the non-survivors, and the higher frequency of large
WINTER 2001
total returns (over 200%). The average and median price returns for
the adjusted non-survivors (reinvested) are 202% and 104%, respec-
tively. These returns are higher than those of the survivors (average
and median returns of 201% and 92%, respectively).
To help explain the higher return bias of the non-survivors
(delisted stocks), we researched the causes for company stock retire-
ments.6 We find that about 97% resulted from acquisitions or merg-
ers. Of the original Russell 1000 constituents as of year-end 1992,
only about 3% (eight companies) of the delisted companies were a
result of Chapter 7 or Chapter 11 proceedings (Bruno’s, CML Group,
Edison Bros. Stores, Geneva Steel, Harnischfeger, Mercury Financial,
Merry-Go-Round, and Service Merchandise).7
Initially, we were somewhat surprised by the results, par-
ticularly the relatively small number of non-survivors with negative
total returns. The bias for higher stock returns in non-survivors may
be explained by the price premiums that are usually paid for acquired
companies by surviving companies. This result seems consistent with
the data, given that most of the non-survivors were acquired, which
more than offsets the negative impact of the relatively few company
bankruptcies.
The analysis also assumes that delisted stocks were randomly
reinvested based on the original companies of the Russell 1000 as
of December 31, 1992. Given the rise and the price appreciation of
technology stocks in recent years, the performance of the non-sur-
vivors could have been significantly better if the reinvestment had
been based on the prevailing Russell 1000 universe as of the retire-
ment dates for delisted stocks.
In summary, the analysis suggests that a portfolio of non-
survivors (with reinvestment) would have outperformed the survivors
in the Russell 1000 index for the seven years ended December 31,
1999. These results were influenced by the relatively healthy period
of economic growth that the United States has experienced during
the last several years.
In addition, the original Russell 1000 represents the largest-
capitalization stocks, and bankruptcies may have been more common
among smaller-cap stocks. In preliminary analysis we find that at least
49 companies of the original Russell 2000 constituents have been sub-
ject to bankruptcy or liquidation. It should be worthwhile to perform
a similar survivor versus non-survivor return analysis on smaller-cap-
italization stocks and to test alternative economic periods.
ENDNOTES
1Data source: Russell Constituent Holding database avail-
able through FactSet.
2The program is Crystal Ball Pro (Decisioneering).
3Consumer Price Index data per Haver Analytics.
4Last closing price and total returns per FactSet.
5Microsoft Excel spreadsheet.
6Compustat’s Reason for Deletion Code available through
FactSet.
7Bloomberg.
THE JOURNAL OF PORTFOLIO MANAGEMENT 39