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

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.

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.

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Are franking credits worth pursuing?

Are franking credits factored into share prices? The data suggests they're probably not, and there are certain types of stocks that offer higher franking credits as well as the prospect for higher returns.

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.

Latest Updates

A nation of landlords and fund managers

Super and housing dwarf every other asset class in Australia, and they’ve both become too big to fail. Can they continue to grow at current rates, and if so, what are the implications for the economy, work and markets?

Economy

The hidden property empire of Australia’s politicians

With rising home prices and falling affordability, political leaders preach reform. But asset disclosures show many are heavily invested in property - raising doubts about whose interests housing policy really protects.

Retirement

Retiring debt-free may not be the best strategy

Retiring with debt may have advantages. Maintaining a mortgage on the family home can provide a line of credit in retirement for flexibility, extra income, and a DIY reverse mortgage strategy.

Shares

Why the ASX is losing Its best companies

The ASX is shrinking not by accident, but by design. A governance model that rewards detachment over ownership is driving capital into private hands and weakening public markets.

Investment strategies

3 reasons the party in big tech stocks may be over

The AI boom has sparked investor euphoria, but under the surface, US big tech is showing cracks - slowing growth, surging capex, and fading dominance signal it's time to question conventional tech optimism.

Investment strategies

Resilience is the new alpha

Trade is now a strategic weapon, reshaping the investment landscape. In this environment, resilient companies - those capable of absorbing shocks and defending margins - are best positioned to outperform.

Shares

The DNA of long-term compounding machines

The next generation of wealth creation is likely to emerge from founder influenced firms that combine scalable models with long-term alignment. Four signs can alert investors to these companies before the crowds.

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.