Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 538

Preparing for next decade's market winners

The lesson from history is that passive exposure leads to concentrations in expensive areas just before those areas suffer. That is alarming if we consider how passive portfolios have evolved since the Global Financial Crisis.

In 2009, a passive investor in the MSCI World Index had a 50% exposure to the US, 1/3 of their portfolio in giant companies, and a 10% exposure to tech. Over the subsequent years, that portfolio has grown more American, more dominated by giants, and more tech heavy. Stockmarkets are now heavily concentrated in the US (70%), giant companies (2/3), and in technology shares (25%). The magnificent seven alone account for close to 20% of global passive portfolios.

Figure 1: Equity markets are concentrated in the US

Figure 2: Equity markets are concentrated in giant companies

Figure 3: Equity markets are concentrated in tech shares

A static investment strategy has not led to static exposures, but increased concentrations in the winners of the last decade. That has been rewarding for investors as momentum has persisted. But as 2022 showed, it carries risks. Each of those three areas is more richly valued than its opposite. The US market trades at 22 times earnings, versus 14 times for shares elsewhere. Giant stocks trade at 20 times earnings, while the median global stocks trades at 17 times. Tech shares are valued at 30 times expected earnings, while other industries are valued at just 16 times in aggregate. Passive exposure to global stockmarkets has led to heavy concentrations in the most richly valued parts of the market.

Investors are concentrated in recent winning styles

That would be alarming enough, as close to 70% of the assets in Australia’s 10 biggest retail global equity funds are in passive strategies. But investors have also actively allocated to styles best suited to the day that is now approaching dusk. If we look just at the 10 biggest active retail global equity funds in Australia, Figure 4 shows that 66% of active assets are in growth strategies— those that generally pay higher prices for companies expected to grow more quickly. Only 10% of assets are in value strategies. Concentration in growth has worked fantastically well over the past 15 years. The largest active fund which has a growth style, trounced the broader market and a blend of the three biggest active global equity funds, which all have a growth style, beat the broader market over the same period.

Figure 4: Investors are highly concentrated in growth funds

Figure 5: It has been a great environment for growth-style funds

That is not just down to luck. While we prefer to focus on valuations, managers with a sound growth philosophy and the structure to stick with it over the long term can deliver very healthy returns.

The trouble is what happens when that falls out of favour. If investors hold multiple active funds to get diversification, but those active funds invest in very similar things, investors can end up being diversified in name only. But as Figure 6 shows, being diversified  only in name is painful when trends change.

Figure 6: Holding similar funds is risky when that style falls from favour

In 2022 the broader global equity market fell around 16%, and after a bit of a recovery this year, it is still down around 4%. The largest active retail global equity fund, which has a growth style, fell slightly more with a decline of 18%. Attempting to diversify by holding the two other largest active retail global equity funds did not help at all because they also have a growth style. Investors in that mix of funds saw declines of 21%, and are still underwater today.

Yet investors remain concentrated, with the bulk of their active assets in growth-style funds, and their passive assets concentrated in giant US technology shares. With valuations where they are today, that worries us. If they do not adjust their portfolios, they will need to adjust their expectations.

Value stocks are still attractive

Value has suffered a long, dark night. Having thrived for nearly a century, value has lagged since the Global Financial Crisis, suffering the deepest and longest drawdown in its history. That underperformance has left value stocks trading at exceptionally attractive prices, even after a good year in 2022. In a still-expensive market that has grown ever-more concentrated in richly priced US, mega-cap, and tech shares, value stocks offer both a refuge and a source of opportunity.

But as fundamental, long-term, contrarian investors, we look at companies like business  owners, and as business owners, the single most important metric is free cash flow. If you own a business outright, free cash flow is your money—to reinvest in profitable projects, buy a competitor, pay down debt, pay out dividends, or buy out your partners. It is the single measure that best captures the true worth of a business. And if we look at the free cash flow valuations of the most neglected companies, we see reasons for excitement.

That is not true for the market as a whole, as Figure 7 shows. On a price-to-free-cashflow basis, we see the same pattern as for the other measures. In the years since the global financial crisis, markets in aggregate have got more expensive, and are currently near their richest levels since the original Tech bubble in 2000.

Figures 7-8: Free cash flow

The pullback of 2022 barely made a dent. The typical global stock trades at over 25 times free cash flow. If you owned it outright, it would take 25 years of current cash flow to get your money back. Investors are hoping for rapid growth. In fact, the market’s valuation is so stretched that the multiple of the neglected shares is barely discernible.

We can change that by inverting the ratio, and looking at free cash flow yield, or free cash flow divided by price. This reveals a more promising picture.

While the overall market is expensive, the most neglected quarter of shares offer free cash flow yields of 17%. If you bought one of these businesses outright, and assuming cash flows stay flat, you would reap an ongoing return of 17% per year. You could get your entire investment back in about six years—and could still own a profitable business at the end of that period.

This excites us, as it suggests a wider opportunity. Cash flow is underappreciated at a time when investors desperately need the diversifying benefits of value stocks.

 

Rob Perrone, Shane Woldendorp and Eric Marais are Investment Specialists at Orbis Investments, a sponsor of Firstlinks. This article contains general information at a point in time and not personal financial or investment advice. It should not be used as a guide to invest or trade and does not take into account the specific investment objectives or financial situation of any particular person. The Orbis Funds may take a different view depending on facts and circumstances.

For more articles and papers from Orbis, please click here.

 

RELATED ARTICLES

Is there still value in high dividend-yielding companies?

Two companies with clear competitive advantages.

Reece Birtles on selecting stocks for income in retirement

banner

Most viewed in recent weeks

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Supercharging the ‘4% rule’ to ensure a richer retirement

The creator of the 4% rule for retirement withdrawals, Bill Bengen, has written a new book outlining fresh strategies to outlive your money, including holding fewer stocks in early retirement before increasing allocations.

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Latest Updates

Weekly Editorial

Welcome to Firstlinks Edition 628

Australian investors have been pouring money into US stocks this year, just as they start to underperform the rest of the world. Is this a sign of things to come? This looks at 50 years of data to see what happens next.

  • 11 September 2025
Exchange traded products

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Retirement

We need a better scheme to help superannuation victims

The Compensation Scheme of Last Resort fails families hit by First Guardian and Shield losses, as well as advisers who are being wrongly blamed for the saga. It’s time for a fair, faster, universal super levy solution.

Investment strategies

5 charts every retiree must see…

Retirement can be daunting for Australians facing financial uncertainty. Understand your goals, longevity challenges, inflation impacts, market risks, and components of retirement income with these crucial charts.

Economy

How bread vs rice moulded history

Does a country's staple crop decide elements of its destiny? The second order effects of being a wheat or rice growing country could explain big differences in culture, societal norms and economic development.

Investment strategies

Small caps are catching fire - for good reason

Small caps just crashed the party like John McClane did in the movie, Die Hard - August delivered explosive gains. With valuations at historic lows, long-term investors could be set for a sequel worth watching.

Defensive growth for an age of deglobalisation, debt and disorder

Today’s new world order appears likely to lead to a lower return, higher risk investment environment. But this asset class looks especially well placed to survive, thrive, and deliver attractive returns to investors.

Economy

Will we choose a four-day working week?

The allure of a four-day week reflects a yearning for more balance in our lives. Yet the reliability of studies touting a lift in productivity is questionable and society may not be ready for such a shift anyway.

Sponsors

Alliances

© 2025 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. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. 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.