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Investment Strategy

The Risks & Rewards of a Concentrated Stock Position: Latin America edition

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“While concentrated stock positions can create substantial wealth, there is also a high probability of dramatic losses that have the potential to derail the financial future you had envisioned for you and your family.”

From oil and mining to autos and manufacturing, Latin America’s industries have created great fortunes, but success sometimes comes at a cost. From behemoths like Mexico and Brazil, to cautionary tails like Venezuela, as industries evolve and change, and public policies and administrations come and go, some companies have adapted and thrived, while others have struggled to survive and disappear.

We examined stocks across 7 countries (Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela), and same rule applies for them all: whether these experiences have been positive or negative, consequences have been magnified by the level of concentration held by an investor.

Here are 3 key take aways from the paper:

1. While building a business or holding a concentrated stock position can lead to great wealth, not knowing when to fold can easily destroy it. Over 40% of the stocks that have ever been part of the Russell 3000 suffered some sort of “catastrophic loss”, defined as a 70% price drop from its historical peak with a recovery of less than 60% from the lows. In the UK, the statistic is similar when analyzing the FTSE All-Share Index ex. Investment Trusts from 1986 to 2022. In Asia, between 1992 and 2022, the number of “catastrophic losses” nearly doubles to 76% of stocks listed in both Hong Kong and Singapore. LatAm is the region with the least number of catastrophic losses at 30%, but the number does not account for Venezuela’s political demise nor for hyperinflation in Argentina. Economic realities and political uncertainties in our region raise the risk of holding a concentrated position.

Analysis of the MSCI EM LatAm Index, 1995-2023

Source: FactSet, Bloomberg Finance L.P., MSCI, J.P. Morgan Private Bank. Data as of April 2023.
This table shows an analysis of the MSCI EM LatAm Index between 1995-2023 . • Looking at all sectors, 30% had a catastrophic loss, 26% had negative absolute returns, 51% had Negative Excess Returns Vs Index • For Information Technology, 25% had a catastrophic loss,253% had negative absolute returns, 50% had Negative Excess Returns Vs Index • For Energy, 12% had a catastrophic loss, 6% had negative absolute returns, 29% had Negative Excess Returns Vs Index • For Consumer Discretionary, 53% had a catastrophic loss, 47% had negative absolute returns, 65% had Negative Excess Returns Vs Index • For Health Care, 50% had a catastrophic loss, 30% had negative absolute returns, 40% had Negative Excess Returns Vs Index • For Communication Services, 36% had a catastrophic loss, 30% had negative absolute returns, 68% had Negative Excess Returns Vs Index • For Real Estate, 0% had a catastrophic loss, 13% had negative absolute returns, 38% had Negative Excess Returns Vs Index • For Industrials, 39% had a catastrophic loss, 26% had negative absolute returns, 57% had Negative Excess Returns Vs Index • For Materials , 37% had a catastrophic loss, 22% had negative absolute returns, 52% had Negative Excess Returns Vs Index • For Financials , 21% had a catastrophic loss, 24% had negative absolute returns, 40% had Negative Excess Returns Vs Index • For Consumer Staples , 20% had a catastrophic loss, 22% had negative absolute returns, 47% had Negative Excess Returns Vs Index • For Utilities, 7% had a catastrophic loss, 14% had negative absolute returns, 45% had Negative Excess Returns Vs Index
Source: FactSet, Bloomberg Finance L.P., MSCI, J.P. Morgan Private Bank. Data as of April 2023.
This table shows an analysis of MSCI EM LatAm Index between 1995-2023 • Looking at all sectors, 30% had a catastrophic loss, 26% had negative absolute returns, 51% had Negative Excess Returns Vs Index • Looking at Brazil, 33% experienced catastrophic loss, 29% had negative absolute returns, 49% had negative excess returns vs the index • Looking at Mexico, 33% experienced catastrophic loss, 28% had negative absolute returns, 41% had negative excess returns vs the index • Looking at Argentina, 6% experienced catastrophic loss, 18% had negative absolute returns, 35% had negative excess returns vs the index • Looking at Peru, 39% experienced catastrophic loss, 13% had negative absolute returns, 659% had negative excess returns vs the index • Looking at Columbia, 43% experienced catastrophic loss, 29% had negative absolute returns, 61% had negative excess returns vs the index • Looking at Chile, 22% experienced catastrophic loss, 24% had negative absolute returns, 81% had negative excess returns vs the index • Looking at Venezuela, 22% experienced catastrophic loss, 11% had negative absolute returns, 17% had negative excess returns vs the index
Here’s another visualization. The winners have generated enormous excess returns, but the median stock has underperformed the FTSE All-Share ex-Investment Trusts Index.

Distribution of excess lifetime returns on individual stocks vs. MSCI EM LatAm Index, 1995-2023

Number of stocks

Source: FactSet, J.P. Morgan Private Bank. Data as of April 2023.
This bar chart shows the distribution of excess lifetime returns on individual stocks relative to MSCI EM LatAm Index between 1995 and 2023. The median excess lifetime returns came in at -0.3%, and registered the following frequencies within 10% ranges: • < -70% - 3, • (-70%, -60%) – 0, • (-60%, -50%) – 7 , • (-50%, -40%) – 7. • (-40%, -30%) – 5. • (-30%, -20%) – 22. • (-20%, -10%) – 55, • (-10%, 0%) – 124, • (0%, 10%) – 149, • (10%, 20%) – 38, • (20%, 30%) – 8, • (30%, 40%) – 5, • (40%, 50%) – 0, • (50%, 60%) – 0, • (60%, 70%) – 3, • > 70% - 8

2. Poor management is not always to blame. In fact, our findings show that across all regions, “exogenous” risks (aka situations out of the company’s management control) were the culprits of the sharp stock price decline. Businesses failure to adapt does explain, however, the failure to recover in most cases. In Latin America, we conclude that nearly 70% of the “catastrophic losses” identified were due to exogenous shocks such as politics, macro mistakes, sectoral shifts, regulatory changes or adverse commodity price moves. Corporate strategy, mostly related to over indebtedness, is to blame in a little over 20% of the cases.

 

3. Concentration can lead to massive wealth creation, but unforeseeable events can destroy it. Hence, diversification is key. There are many alternatives to just selling out of the position, with a focus on risk management.

Read the full report to find out more

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The MSCI Emerging Markets (EM) Latin America Index captures large and mid cap representation across 5 Emerging Markets (EM) countries in Latin America. With 88 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

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