Far from middling performance: How the EX-20 Index has outshone small and large caps

BY David Bassanese | 22 November 2017
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Although the Australian sharemarket has delivered relatively sluggish performance in recent years, one standout area in terms of returns has been EX20 stocks, as broadly captured by the BetaShares Australian EX-20 Portfolio Diversifier ETF. Not only has this exposure outperformed the largest market-cap stocks in Australia, it has also outperformed smaller cap stocks.  This performance highlights how EX20 stocks can at times offer the potential to be the “sweet spot” of the market, i.e. big enough to have overcome the early growth hurdles typically faced by small companies, yet not too large that most of their growth potential is already past.

Large, mid and small cap stock indices

The BetaShares Australian Ex-20 Portfolio Diversifier ETF (ASX Code: EX20) aims to provide exposure to approximately 180 stocks listed on the Australian Securities Exchange, ranked from number 21 to number 200, based on their market capitalisation.  As such these stocks are neither the largest on the market, nor the smallest.  Indeed, the average market cap of stocks tracked by the EX20 ETF is around $4 billion, compared to an average of $46 billion among stocks in the large-cap S&P/ASX 20 Index.

The most commonly observed index of “small cap” stocks, by contrast, is the S&P/ASX Small Ordinaries Index, which covers around 200 stocks listed on the Australian Securities Exchange, ranked from number 101 to number 300, based on their market capitalisation.  The average market cap for stocks in this Index is a (still considerable) $1 billion.

The top-heavy nature of the Australian market is evident from the fact that although the S&P/ASX 20 Index accounts for only 6.7% (20/300) of the number of stocks in the S&P/ASX 300 Index, at end-October 2017 these stocks nonetheless accounted for 54% of the S&P/ASX 300’s market capitalisation.

Do small caps outperform large caps? Not necessarily

At face value, theory suggests (i.e. the Fama-French model) that small cap stocks should perform better over time than larger cap stocks, as they would seem to have greater upside growth potential and the market should reward their generally more volatile return profile.  Yet, as evident in the chart and table below, at least in terms of the overall index of small cap stocks in Australia, this has not been the case in recent years – especially since the global financial crisis.  In fact, the S&P/ASX Small Ordinaries Index has even under performed the large-cap S&P/ASX 20 Index.

Total Return Performance: March 2001 to October 2017

Source: Bloomberg.  Note you cannot invest directly in an indexPast performance is not an indication of future performance of the Index or the ETF.  EX20’s Index is the Nasdaq Australia Completion Cap Index. 

Meanwhile, the Index tracked by the EX20 ETF – which can be considered more of a “mid-cap” index – has done fairly well over the periods shown above to end-October 2017.

Why?  There appears to be a few factors at play.

For starters, the EX20’s Index has much less exposure to the financials sector compared to larger cap S&P/ASX 20 and S&P/ASX 200 Index.  Indeed, at end-October, EX20’s Index had a 12.6% exposure to financials, compared to a whopping 56% for the S&P/ASX 20 Index (37% for the broader S&P/ASX 200). As seen in the chart below, the lower exposure to financials means that EX20’s Index has tended to outperform the broader S&P/ASX 200 Index when financials have tended to under perform.

Relative Total Return Performance: Ratio of Index Performance Relative to the S&P/ASX 200 Index

Source: Bloomberg.  Note you cannot invest directly in an indexPast performance is not an indication of future performance of the Index or the ETF.  EX20’s Index is the Nasdaq Australia Completion Cap Index. 

That said, the S&P/ASX Small Ordinaries Index also tends to have lower exposure to financials yet has also notably under performed the large-cap S&P/ASX 200 and the EX20 Index in recent years.  Why?

Relative Total Return Performance: Ratio of Index Performance Relative to the S&P/ASX 200 Index

Source: Bloomberg.  Note you cannot invest directly in an indexPast performance is not an indication of future performance of the Index or the ETF.  EX20’s Index is the Nasdaq Australia Completion Cap Index. 

Note this period of significant small cap underperformance has also coincided with the the decline in commodity prices, suggesting part of the underperformance of small caps relative to the EX20 has reflected weakness in smaller mining explorers (even though both indices have similar exposure to the materials sector overall at just under 20%).

Another notable sector difference, moreover, is the fact that the S&P/ASX Small Ordinaries Index has a much larger exposure to consumer discretionary stocks (19% vs 10% for EX20’s Index as at end-October) and to some extent consumer staples (10% vs 5% as at end-October) suggesting the heavy toll that the internet and consumer spending weakness more generally has had on retailing and media stocks could also be a factor.

EX20 stocks – a growth sweet spot in times of much structural change?

The above analysis highlights a few issues that may continue to favour performance by indices such as that tracked by the EX20 ETF going forward.

In times of major structural change – such as when commodity prices are slumping and/or the internet is disrupting traditional business models in some sectors – the smallest cap stocks may well be less equipped to cope than their more established larger-cap counterparts.

At the same time, larger cap indices – such as the S&P/ASX 20 Index – may face challenges of their own given the growth potential of our large established financial and resource companies may be somewhat more limited.

In this regard, given the particular growth challenges faced by both large and small cap stocks, investors might consider a more mid-cap style exposure – such as provided by the EX20 ETF – as something of a potential “sweet spot” in terms of market-cap exposure.

 

2 Comments

  1. Ramon Vasquez  |  November 22, 2017

    Good morning ,

    could you let me know what is the range of stocks in the EX 20 , please ?

    Can the EX 20 be considered to be the Aussie equivalent to the FTSE 250 at all?

    Best wishes , Ramon .

    1. Alistair Mills  |  November 29, 2017

      Hi Ramon,

      Thanks for your enquiry.

      The BetaShares Ex-20 Portfolio Diversifier ETF aims to provide exposure to approximately 180 stocks listed on the ASX, ranked from number 21 to 200 based on their market capitalisation.

      You can find the full portfolio holdings in the Resources section on the EX20 fund webpage.

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