Academic Paper Finds Treasuries Outperform Many Equity Investments

Hendrik Bessembinder, a researcher with the Department of Finance at the W.P. Carey School of Business at the Arizona State University, recently published an analysis of long-term investment returns that is likely to surprise regular readers of PLANADVISER.

At a time when asset managers and retirement plan consultants are generally urging investors to be willing to take on equity risk to address muted long-term return forecasts, Bessembinder suggests many stock investments can be expected to underperform short-term Treasuries. 

In fact, according to his paper, “Do Stocks Outperform Treasury Bills,” most common stocks over the long-term fail to outperform one-month Treasury bills. Specifically, “slightly more than four out of every seven common stocks that have publicly traded since 1926 have lifetime buy-and-hold returns, inclusive of reinvested dividends, less than those on one-month Treasuries.”

Readers should note that the analysis is based on the Center for Research in Securities Prices (CRSP) monthly stock return database. According to Bessembinder: “Of all monthly common stock returns contained in the CRSP database from 1926 to 2016, only 47.8% are larger than the one-month Treasury rate. In fact, less than half of monthly CRSP common stock returns are positive. When focusing on stocks’ full lifetimes (from the beginning of sample or first appearance in CRSP through the end of sample or delisting from CRSP), just 42.6% of common stocks, slightly less than three out of seven, have a buy-and-hold return (inclusive of reinvested dividends) that exceeds the return to holding one-month Treasury Bills over the same horizon.”

Bessembinder goes on to explain how the analysis proceeded: “I assess the likelihood that a strategy that holds one stock selected at random during each month from 1926 to 2016 would have generated an accumulated 90-year return (ignoring any transaction costs) that exceeds various benchmarks. In light of the well-documented small-firm effect (whereby smaller firms earn higher average returns than large, as originally documented by Banz, 1980) it might be been anticipated that individual stocks would tend to outperform the value-weighted market. In fact, repeating the random selection process many times, I find that the single stock strategy underperformed the value-weighted market in 96% of the simulations, and underperformed the equal-weighed market in 99% of the simulations. The single-stock strategy outperformed the one-month Treasury bill over the 1926 to 2016 period in only 27% of the simulations.”

Bessembinder concludes the fact that the overall stock market generates long-term returns while the majority of individual stocks fail to even match Treasury bills can be attributed to the fact that the cross-sectional distribution of stock returns is positively skewed.

“Simply put, very large positive returns to a few stocks offset the modest or negative returns to more typical stocks,” he writes. “The importance of positive skewness in the cross-sectional return distribution increases for longer holding periods, due to the effects of compounding.”

Bessembinder goes on to note how, “at first glance, the finding that most stocks generate negative lifetime return premia (relative to Treasury Bills) is difficult to reconcile with models that presume investors to be risk averse, since those models imply a positive anticipated return premium.”

“We must note, however, that implications of standard asset pricing models are with regard to stocks’ mean excess return, while the fact that the majority of common stock returns are less than Treasury returns reveals that the median excess return is negative,” he states. “Thus, the results are not necessarily at odds with the implications of standard asset pricing models. However, the results challenge the notion that most individual stocks generate a positive return premium, and highlight the importance of skewness in the cross-sectional distribution of stock returns … These results complement recent time series evidence regarding the stock market risk premium.”

Access the full academic analysis here. 

* Please note, PLANADVISER originally reported that the paper questions the use of equity investments as a retirement strategy. However, Bessembinder followed up with a requested correction, stating that “for most investors the lesson is instead that the results reinforce the importance of portfolio diversification. I do not advocate the avoidance of stocks as an investment class.”