Investing in a Rising Sharemarket | BetaShares

Investing in a Rising Sharemarket

BY betashares | 3 February 2014
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One of the issues a number of Australian investors are considering at the moment is how to efficiently and effectively invest in our share market at a time when many companies’ share prices are at near-record highs. For example, “income stocks” like CBA are highly sought after by investors both in Australia and offshore, as the lure of yield draws global attention to them. However, these high valuations give investors cause to question the efficacy of buying stocks at these levels – causing leading global stockbrokers like UBS to label CBA as the “most expensive large bank in world” last year (UBS Investment Research, Commonwealth Bank of Australia, 3Q13 Trading Update, May 2013). At times like these, then, investing based on fundamental analysis of the value of stocks rather than simply relying on how the market is valuing them is particularly important (after all, that’s what disciplined investors like Warren Buffett do all the time).Rising

What is fundamental analysis?

Instead of buying an investment because others are doing so at the same time (which can lead to asset price bubbles), fundamental analysis looks at the economic value of assets in order to identify good value. Fundamental analysis was first advocated in the 1930’s by Ben Graham and David Dodd (often described as the fathers of modern investing), in their seminal study entitled Security Analysis.

Accessing fundamental value via ETFs?

One of the drawbacks of traditional index funds, which typically use indices constructed using the “market capitalisation” method, is that they are forced buyers of stocks at whatever the prevailing price is at the time of the rebalance of the index (which often occurs quarterly). Such forms of passive investment can be a very effective alternative compared to typically more expensive, higher turnover, actively managed funds. But what if we introduced fundamental analysis into the way the fund invests? The chart below illustrates the gap between the price that a stock may trade at, versus its fundamental (or fair) value:

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In recent times, there have been a number of index methodologies developed which use factors other than market capitalisation to weight their constituents. One of the most popular and fastest growing of these has been developed by Research Affiliates, a globally renowned product development and research firm, whose methodologies underlie products with in excess of US$100bn under management. The Research Affiliates Fundamental Index® (RAFI) approach uses 4 fundamental factors to develop index weightings. These factors, namely, sales, cash flow, dividends and book value, are used to determine the ‘economic footprint’ of companies.

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The Four RAFI Fundamental Factors
The benefit to investors from using this method is that the selection and investment into companies (and their weightings) are based on their fundamental value. This seeks to reduce the performance drag from buying into stocks which may be trading at inflated prices. The methodology has a compelling track record when compared with traditional market-cap weighted indices (for example, over 5 years to 31 December 2013 the Australian Fundamental index outperformed the S&P/ASX 200 by over 3.2% p.a!). BetaShares is the issuer of the first Australian ETF to invest based on the “fundamental value” of Australian companies. This product aims to track the performance of the FTSE RAFI Australia 200 Index. This ETF is quoted on the ASX with the code ‘QOZ’. Using such a product, investors are not exposed to an index which simply tracks the market as they would with a traditional index, nor are they having to pay the additional costs of an actively managed fund.

So an ETF tracking a fundamental index like QOZ can be a good tool for investors to consider when they are looking to invest efficiently in a rising share market, where share prices have diverged from ‘fair’ or ‘fundamental’ value.

Past performance is not an indicator of future performance.

 

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