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.
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