2 things the best share portfolios have in common

There is a jungle of theories on investing in stocks. But it all boils down to just a couple of basic attributes.

A business woman sits in the lotus yoga position near her laptop, indicating a patient investment style

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

There are many competing theories about stock investing.

You can target growth shares, or you can concentrate on value stocks. Perhaps you can try to 'buy the dip', or you can practise dollar-cost averaging. You can be contrarian, or ride the momentum.

They are all successful at certain times and underperform during other periods. If there was one clear winning strategy, we'd all be doing it.

But among this dizzying array of options, there seem to be 2 base characteristics that the most successful portfolios have in common, according to Montaka Global Investments portfolio manager Chris Demasi.

"In 2016, Martijn Cremers and Ankur Pareek published a ground-breaking research report," he said on the company blog.

"It showed that only the most distinct and most patient funds go on to meaningfully outperform the stock market over very long periods."

So what exactly do the terms 'distinct' and 'patient' mean?

Avoid becoming a 'closet indexer'

The research suggested that the best-performing portfolios have 'high active share'.

The term 'active share' refers to the part of the stock portfolio that is invested differently from market sentiment at the time of purchase.

"Highly concentrated stock pickers, for example, have high active share of 90% or more typically," Demasi said.

"On the other hand, 'closet indexers' with diversified and undifferentiated portfolios that look like the market (often despite claims otherwise) have low active share of 60% or less."

After all, how are you going to outperform if you're doing the same thing as the rest?

Demasi said the typical stock picker that has an active share above 90% outperformed the market by almost 1% each year.

"This seemingly small yearly benefit becomes extraordinarily large when compounded over more than a quarter of a century, when the market appreciated at 9.4% per annum on average," he said.

"A portfolio of the highest active share funds would have beaten the market by more than 180%. A hypothetical investor with initial capital of $1 million would be almost $2 million wealthier."

The power of patience when investing

The most successful portfolios also display Buddha-like patience for each stock.

Demasi explained it in terms of 'fund duration', which is a term describing the average length of time each stock is held over a 5-year period.

"Managers with long fund duration hold stocks at least 2 years, while short fund duration managers usually sell stocks 8 months after purchasing them."

Those who went long showed obvious outperformance.

"The long-term investors that stick to their convictions longer than 2 years outperform, and by almost 2% per annum. Less patient managers underperformed regardless of how active and concentrated they were — and, in fact, the more they traded the worse they performed," said Demasi.

"Basically, patience paid off in spades."

That sample investor who earned an extra $2 million from a high active portfolio would be even richer if she exercised equanimity.

"By allocating the initial $1 million of capital to a portfolio of those most concentrated active managers that were also the most patient with their holdings, the earlier hypothetical investor would have outperformed the market by an additional 380% and be another $3.8 million richer."

Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on Investing Strategies

Man pointing an upward line on a bar graph symbolising a rising share price.
Dividend Investing

3 growing ASX dividend stocks to buy now

Analysts are expecting these stock to paying growing dividends.

Read more »

Two players on a field pump their fists in the air, indicating two of the best
Growth Shares

The ultimate ASX growth shares to buy with $5,000

Brokers are very bullish on these names. But why? Let's find out.

Read more »

Man holding out $50 and $100 notes in his hands, symbolising ex dividend.
Dividend Investing

Where I'd invest $5,000 into ASX dividend shares right now

These two stocks look irresistible to me.

Read more »

Two funeral workers with a laptop surrounded by cofins.
Defensive Shares

Down 24% this year, is this top ASX defensive share a top buy according to Macquarie?

Are investors missing a trick by avoiding this ASX share?

Read more »

Smiling business woman calculates tax at desk in office.
Dividend Investing

Turn tax return into passive income with these ASX dividend shares

These options can bring solid returns through passive income. 

Read more »

Hand holding Australian dollar (AUD) bills, symbolising ex dividend day. Passive income.
Dividend Investing

Forget term deposits, these ASX dividend shares offer ~5% to 11% yields

Analysts think these shares could be better than term deposits. Let's find out what yields they offer.

Read more »

Tax time written on wooden blocks next to a calculator and Australian dollar notes.
Tax

Tax time: Use this hack to keep the Australian Tax Office off your back

Buying dividend shares can save you paying taxes...

Read more »

Man smiling at a laptop because of a rising share price.
Dividend Investing

2 exciting high-yield ASX dividend shares I'd buy in June

These stocks have a lot to offer investors focused on income.

Read more »