Holding a concentrated stock position can be an inefficient way for investors to allocate their wealth for three main reason. (Shutterstock)

US stocks have started 2024 on a strong note, with the S&P 500 index up 4.8% and breaking through the 5,000 mark for the first time in history, on 9 February. The largest US tech stocks—the so-called “Magnificent 7”—have driven much of this performance, gaining 3% last week alone. And over the last five years, these AI-driven mega-cap stocks have outperformed the S&P 500 by a cumulative 408.5%.

Investors holding a substantial share in these stocks—10% or more of their total portfolio—may be feeling very pleased to have what is known as a “concentrated stock position.” Said another way, this is a position whose return, risk, or other characteristic is the dominant factor in determining overall portfolio performance and an investor’s ability to achieve their financial goals.

But holding a concentrated stock position can be an inefficient way for investors to allocate their wealth for three main reasons:

1. Concentrated stock positions generate less reliable returns.

Looking at daily rolling annual returns data for the S&P 500—the largest and most liquid stock market in the world—from 1990 to 2022, holding the whole index as opposed to a single stock would have led to more annual returns around the median 11.3% return. And crucially, holding the whole index historically led to fewer periods of negative annual returns versus holding a single stock (16% versus 37%, respectively).

2. Concentrated stock positions are less resilient to external shocks.

The same S&P 500 index data set showed 89% of US single stock positions experienced steeper drawdowns (peak-to-trough losses) than the overall S&P 500 index. Single stocks also typically require longer to recover from their maximum drawdown. Only 7% of constituent stocks in the S&P 500 recovered more rapidly from their troughs than the index over the last two decades that we have analyzed—and 26% of single stock positions never fully recovered from their drawdowns.

3. Concentrated stock positions may deliver less repeatable results.

Analysis of the US stock market also shows that outperformance typically does not persist. Over the last two decades, an average 46% of stocks have outperformed the S&P 500 in a given year. But the share of stocks that have outperformed the S&P 500 in two consecutive years falls to only 22% on average.

So, we see potential ways for investors better to manage the risks of their concentrated stock position in the near term and position portfolios for the longer term:

  • Rebalance risk exposure and diversify around the position

Owners of a stock that cannot readily be sold should consider how the stock position fits into their overall portfolio strategy, and then ensure they diversify around the position.

Diversifying into less volatile securities—and those with a low correlation to the investor’s concentrated position—may help to grow wealth through the power of compounding.

We have a neutral view on equities and US equities overall, but are most preferred on emerging market stocks, the wider US technology sector (including semiconductor and software names), and US small-cap stocks.

  • Replace the concentrated stock position

Investors may feel that the decision to “put their money where their mouth is” justifies holding a concentrated equity position.

But investors may consider reducing the concentration of a company holding if they want to lock in potential gains and reinvest elsewhere. If so, and the position is significant, it may be possible to reduce the position gradually by exploring tools such as open market sales, block sales, structured sales programs based on the volume-weighted average price (VWAP) between a pre-agreed trade and completion date, or private placements.

With thanks to Moritz Vontobel (UBS Chief Investment Office) for his contribution.