Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 315

It’s the large stocks driving fund misery

The first six months of calendar 2019 have again superbly proved why this equities bull market has been dubbed “the most hated in history”. At face value, equity markets have rallied by up to 20% suggesting making money from asset price inflation via the share market has seldom been easier for investors. A closer look reveals nothing could be further from the truth.

Amazing highs and lows

Imagine an investment portfolio consisting of Adelaide Brighton, Bank of Queensland, Challenger, Caltex Australia, Domino’s Pizza, Flight Centre, Link Administration, Pendal Group (the old BT Investments), South32 and the old Westfield, now Unibail-Rodamco-Westfield.

An equal-weighted portfolio of these 10 household names in Australia generated a negative return of nearly -10% between 1 January and 30 June 2019. That’s ex-dividends, but the average yield from the portfolio cannot fully compensate for the erosion in capital values. Besides, the S&P/ASX200 Accumulation index was up nearly 20% over the same period.

And that’s assuming investors were not caught out by disasters such as Syrah Resources (-39%), Wagners (-42%) or Bionomics (-72%), and numerous others.

Many a self-managing investor has portfolio exposure to the big four banks, large resources and energy producers, as well as Telstra, Woolworths, and Wesfarmers-Coles. They don’t necessarily need to compare their performance with a benchmark, so they most likely are feeling happy with the Big Bounce post the Grand Sell-Off during the closing months of 2018. In particular, if they also managed to pick up some additional gains from smaller cap high flyers such as Afterpay Touch, Austal and Credit Corp.

Fund managers doing it tough and consolidating

For professional fund managers, however, the scenarios for share markets in 2018/2019 have made beating the index an extremely tough challenge at a time when ETF providers offer ever-cheaper alternatives and retail investors feel emboldened about their own talent and capabilities.

It should thus be no surprise that, with the notable exception of Magellan Financial (MFG), most listed asset managers have been relegated to underperformers on the ASX, with shares in Janus Henderson (JHG), Platinum Asset Management (PTM), Elanor Investors Group (ENN), K2 Asset Management (KAM), Pinnacle Investment Management (PNI), and others overwhelmingly in the doghouse at a time when most investors feel like celebrating.

The industry of actively-managed investment funds is ripe for consolidation, or otherwise a shake-out. Locally, all major banks with exception of Westpac (WBC) have unveiled plans to divest their wealth management operations, while Magellan Financial acquiring Airlie Funds Management and Ellerston Capital acquiring Morphic Asset Management are but two early indications the industry locally is equally facing major transformation in the years ahead.

But why exactly is it that most active managers cannot beat their benchmark?

One narrative is that investor exuberance is largely to blame. With stocks like Afterpay Touch (APT), Appen (APX) and other smaller cap technology stocks up 100% and more, the narrative goes that institutional investors cannot justify owning these expensive stocks, making beating the index a near impossible task.

Sounds plausible, yes? Except that it doesn’t stand up to the test of deeper analysis.

The myth of the WAAAX

Financials make up more than 30% of the S&P/ASX200 (of which the Big Four banks more than 20%) while Materials and Energy adds another 23%. Combined, these sectors represent more than 50% of the index. Add a few extra-large cap names such as Macquarie Group, CSL, Telstra, Woolworths and Wesfarmers and the index representation rises above 66%.

In most years, underperforming or outperforming against the index is determined by how these large cap stocks perform versus exposure in investment portfolios.

The WAAAX stocks as a group, comprising of Wisetech Global, Afterpay Touch, Appen, Altium, and Xero, represented a total index weight of only 1.58% at 1 June 2019. The average gain from these five stocks is a smidgen over 80%. However, Fortescue Metals (FMG) alone weighs 1.35% and its shares went up by more than 117%. Plus, Fortescue pays a big dividend and the WAAAX stocks don’t.

In other words: Fortescue Metals shares have contributed more to the index gains than all of the WAAAX stocks combined. That’s one myth gone.

This example does, however, further highlight one of the key characteristics of the local share market in recent years: the internal polarisation is enormous. The gap between winners and losers is extremely wide and both baskets contain plenty of household names each. It makes outperforming the index not only a case of picking enough winners; it’s equally about avoiding the losers.

With most professional funds managers in Australia practicing a value-oriented approach, owning share market disappointments is pretty much par for the course, especially as corporate profit warnings came out in large numbers throughout May and June.

Making matters worse, most managers have been running their funds with larger-than-usual allocations to cash, and many have missed the large cap resource stocks. BHP Group (BHP) shares added 21%-plus ex-dividend, which is better than the index, while Rio Tinto (RIO) rallied 32% ex-dividend and Fortescue more than doubled. In the Energy sector, Woodside Petroleum (WPL) narrowly underperformed the index including dividend, but Santos (STO) shares went up by 29%.

Most fund performance due to large cap investments

What these numbers show is that underperforming or outperforming the local index over the past six months has been determined by a few large cap stocks only. Woolworths and Wesfarmers did not keep up with the index. In their place, large cap names Amcor (AMC), Brambles (BXB) and Telstra (TLS) – probably best described as ‘come back stocks’- all posted stronger than average gains.

Add Aristocrat Leisure (ALL) up 43% ex-dividend, Goodman Group (GMG) up 37% ex-div, Transurban (TCL) up 25.5% ex-div, and Newcrest Mining (NCM) up 51% ex-div and it is clear most of the strong index gains this year occurred on the shoulders of no more than 10 large cap stocks in Australia.

The most outstanding themes have been iron ore, gold, lower interest rates and bond yields, and structural growth stories in the case of Aristocrat Leisure, Goodman Group and the WAAAX companies. At the same time, less confidence and more investor caution has swung the market pendulum heavily back in favour of the large caps.

The Small Ordinaries index barely scraped in a positive return for full financial year 2019, and if we include dividends, it delivered 1.9%. Over the past six months, the Small Ordinaries’ total return was 16.8%. The Top 20 gained 26.7% ex-dividends.

The negative performance for stocks including Scentre Group and UR-Westfield contrasts sharply with the market-beating performances for Goodman Group and Transurban. In prior times, all four would have been considered beneficiaries of lower bond yields. This time around, however, investors are excluding the structural challenges from online competition and household budgets under pressure.

After five years of notable neglect, value stocks have made a sharp come-back post the late 2018 sell-off, as witnessed by (some) bank stocks, and via selective names among media companies, consumer-oriented businesses and resources stocks. Meanwhile, the lure of disruptors and new technology-driven business models has not disappeared.

The latter remains equally one of the key characteristics of this hated bull market. Hated by the fund managers who are supposed to be the experts.

 

Rudi Filapek-Vandyck is an Editor at the FNArena newsletter. This article has been prepared for educational purposes and is not meant to be a substitute for tailored financial advice.

FNArena offers independent and unbiased tools and insights for self-researching investors. The service can be trialed at www.fnarena.com.

RELATED ARTICLES

Why August company reporting season was poor

Headwinds and tailwinds, a decade in review

How we have invested during COVID-19

banner

Most viewed in recent weeks

The risk-return tradeoff: What’s the right asset mix for a 5% return?

Conservative investors are forced to choose between protecting capital and accepting lower income while drawing down capital to maintain living standards or taking additional risk. How can you strike a balance?

How long will my retirement savings last?

Many self-funded retirees will outlive their savings as most men and women now aged 65 will survive at least another 20 years. Compare your spending with how much you earn to see how long your money will last.

Buffett's favourite indicator versus all-in equities

Peter Thornhill shows how his personal portfolio has thrived under an 'all-in equities' strategy, but Warren Buffett's favourite valuation indicator says stock markets are priced at their most extreme ever.

In fact, most people have no super when they die

Contrary to the popular belief supported by the 'fact base' of the Retirement Income Review, four in every five Australians aged 60 and over have no super in the period up to four years before their death.

Five timeless lessons from a life in investing

40 years of investing is distilled into five crucial lessons. An overall theme is to embrace uncertainty to make an impact on how much you earn, how much you spend, how much you save and how much risk you take.

Welcome to Firstlinks Edition 403

Most Australians hold their superannuation in a balanced fund, often 60% growth/40% defensive or 70%/30%. Lifecycle funds are also popular, where the amount in defensive assets increases with age. Employees who are not engaged with their super (and that's most people when they start full-time work) simply tick a box for the default fund selected on their behalf by their employer. Are these funds still appropriate?

  • 15 April 2021

Latest Updates

Property

Whoyagonnacall? 10 unspoken risks buying off-the-plan

All new apartment buildings have defects, and inexperienced owners assume someone else will fix them. But developers and builders will not volunteer to spend time and money unless someone fights them. Part 1

Superannuation

Super changes, the Budget and 2021 versus 2022

Josh Frydenberg's third budget contained changes to superannuation and other rules but their effective date is expected to be 1 July 2022. Take care not to confuse them with changes due on 1 July 2021.

Economy

Why don't higher prices translate into inflation? Blame hedonism

Why are prices rising but not the CPI? When we measure inflation, we aren’t measuring raw price changes, we’re measuring the pleasure-adjusted or utility-adjusted price changes, and we use it incorrectly.

Economy

Should investors brace for uncomfortably high inflation?

The global recession came quickly and deeply but it has given way to a strong rebound. What are the lessons for investors, how should a portfolio change and what role will inflation play?

Risk management

Revealed: Madoff so close to embezzling Australian investors

We are publishing this anonymously knowing it comes from an impeccable source. Bernie Madoff’s fund was almost distributed to retail Australian investors a year before the largest-ever hedge fund fraud was exposed.

Exchange traded products

How long can your LICs continue to pay dividends?

Some LICs have recently paid out more in dividends than their net profit as they have the ability to tap their retained profits and reserves. Others reduced dividends to ease the burden on cashflow and balance sheets.

SMSF strategies

How SMSF contribution reserving can use the higher caps

With the increase in the concessional cap to $27,500 on 1 July 2021, a contribution reserving strategy could allow a member to make and claim deductions for personal contributions of up to $52,500 this year.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.