Does your portfolio have the EX factor? EX20 – a diversified Australian equities portfolio without doubling down on the big banks and miners
Australian market is heavily biased towards large-cap stocks
|Mid-cap exposure offers potential for growth||
Potential to outperform an actively managed ex-20 or equal weight exposure
Most Australian investors are already heavily exposed to market giants, in particular the big four banks and miners.
|A diversified portfolio comprising companies outside the top 20 offers the potential for growth without increasing exposure to stocks most investors already hold.||
EX20 has outperformed an actively managed ex-20 exposure and an equal weight Australian shares ETF over the last three years*.
Australia’s mega-cap stocks – especially in the financial and resources sector – face challenging times.
Facing slowing credit growth and growing regulatory burdens, the major banks have been a drag on sharemarket performance in recent years. In the recent earnings reporting season, several major banks revealed falling profits, dividend cuts and capital raisings. There was also an increase in bad debts, and remediation costs in the hundreds of millions of dollars.
What’s more, today’s falling interest rate environment means bank net-interest margins are falling. The banks’ return on equity, which used to be well above global peers, has fallen back to the pack. Valuations, measured in terms of multiples of book value, however, remain well above global banks.
The resource sector, meanwhile, faces challenges of its own. After a surge in iron-ore prices earlier this year, due to both Chinese stimulus and supply disruptions in Brazil, prices have dropped sharply. As Brazilian iron-ore supply returns to market and China continues to grapple with a slowing economy, key export commodity prices could well fall further.
Most investors are heavily exposed to the market giants
The financials sector makes up around 30% of the Australian market, while the materials sector (including BHP and RIO) accounts for another 17%1. That sector, too, faces headwinds, given our heavy reliance on demand from China, and concerns around the ongoing U.S.-China trade conflict.
S&P/ASX 200 sector breakdown, 8 November 2019
Whether they own shares directly or indirectly, most Australian investors are heavily exposed to a small number of large cap stocks. For example, approximately half of the index weight of the benchmark S&P/ASX 200 Index is in financials and materials, and just under 60% of exposure is to the top 20 stocks (as of 31 October 2019)2.
If an investor holds shares directly, the bias may be even heavier, given the tendency of Australian investors to own only a handful of well-known blue-chip stocks.
At times, this concentrated exposure has served investors well, as the big banks had a lengthy period of outperforming the market, as did resource stocks during the mining boom.
However, with the current outlook for the market giants not so optimistic, a different approach may be called for.
A diversified exposure that reduces sector and stock-specific risk
The BetaShares Australian Ex-20 Portfolio Diversifier ETF provides diversified exposure to a portfolio of the 180 largest companies on the ASX outside the top 20.
It offers a solution to investors looking for diversified exposure to Australian equities, but who already have an exposure to some of the largest cap stocks that they do not want to increase. In the index EX20 aims to track, no industry sector can have a weight of more than 25%, and no single stock can have a weight of more than 6%.
EX20 returned 18.7% over the 12 months to 31 October 2019, and 13.6% p.a. over the three years to the same date3. Over the five years to 31 October 2019, the index that EX20 aims to track returned 12.9% p.a., compared to 8.5% from the S&P/ASX 200, and 6.2% p.a. from the S&P/ASX 204.
The chart below compares the performance of these three indices from inception in March 2001, to October 2019.
Relative index performance
Source: Bloomberg. Performance shown is of the index which EX20 aims to track (Nasdaq Australia Completion Cap Index). You cannot invest directly in an index. Performance excludes the impact of EX20 fees and costs. Past performance is not indicative of future performance of the index or EX20. Index inception was March 2001.
As well as helping to reduce sector and stock-specific risk, we believe EX20 offers the potential to outperform a fund that tracks the broad market, due in part to the size of the companies in the portfolio.
EX20 companies may enjoy something of ‘sweet spot’ in terms of the typical growth trajectory of listed companies. As they are larger than the average listed company, they’re more likely to have overcome the early growth hurdles small companies typically face. However, as they have not yet hit the top-20, EX20 companies tend not to be so large that most of their growth potential is already past.
EX20 vs. an actively managed exposure that excludes the large cap stocks
There are of course alternatives to a passive, index-tracking approach to these ex-20 stocks.
However, active funds that focus on ex-20 stocks face challenges – the first being to pick stocks outside the top 20 that will outperform, the second being to overcome the impediment of high fees that active managers typically charge.
The chart below compares the performance of EX20 with a competitor unlisted managed fund that provides exposure to an actively managed portfolio of Australian equities outside the top 20. It shows the growth of $100,000 invested in the two funds on the inception date of EX20, 5 October 2016.
Of course, it’s important to keep in mind that past performance isn’t necessarily indicative of future performance.
EX20’s management fee is 0.25% p.a., the actively managed fund’s fee is 0.98% p.a.
Cumulative growth in $100,00, EX20 vs. actively managed ex-20 fund, 5/10/2016 – 31/10 /2019
Source: Morningstar Direct. Past performance is not indicative of future performance. Returns do not reflect brokerage or the bid-ask spread that investors incur when buying and selling units on the ASX. Returns are after fund management costs, assume reinvestment of any distributions and do not take into account tax paid as an investor in the fund.
EX20’s return over the three years to 31 October 2019 was 13.6% p.a., compared to the active ex-20 fund’s return of 10.7%.
This superior return was achieved with lower volatility, with a 3-year standard deviation of 10.3% p.a. vs. the active fund’s 12% p.a.5
The chart below illustrates the smoother ride EX20 offered investors over this period – most notably in the market correction of Q4, 2018, when EX20 suffered a drawdown of 14.8%, significantly less than the active fund’s 22.5% fall6.
Source: Morningstar Direct. Past performance is not indicative of future performance.
EX20’s return has also exceeded the performance of an Australian ‘equal weight’ ETF currently available on the ASX, whose investment strategy means that the mega-caps are still held, albeit at a substantially lower weight. Over the last 3 and 5 years to end-October 2019, the index that EX20 aims to track has outperformed the equal weight product’s index by ~0.46% p.a. and ~1.5% p.a. respectively7.
For more information on the BetaShares Australian Ex-20 Portfolio Diversifier ETF, go to EX20.
There are risks associated with investing in the fund, including small-mid cap securities risk, market risk and liquidity risk. The value of an investment can go down as well as up. Before making an investment decision investors should consider the Product Disclosure Statement and their particular circumstances, including their tolerance for risk, and obtain financial advice.
*Past performance is not indicative of future performance.
2. Source: Bloomberg
3. Source: BetaShares
4. Source: BetaShares
5. Morningstar Direct
6. Morningstar Direct
7. Source: Bloomberg. The index which EX20 aims to track is the Nasdaq Australia Completion Cap Index. You cannot invest directly in an index. Performance excludes the impact of EX20 fees and costs. Past performance of the index is not indicative of future performance of the index or EX20.