Less is more. Is removing the largest 20 stocks EXactly what you’ve been looking for? | BetaShares

Less is more. Is removing the largest 20 stocks EXactly what you’ve been looking for?

BY Jeremy Benson | 25 September 2019
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ex20 - australian stocks

Reading time: 3 minutes

Statistically speaking, most active managers of broad-based Australian equity funds have failed to beat their benchmark. The table below, taken from the SPIVA report from S&P Dow Jones, illustrates that just under 80% of actively-managed Australian equity funds underperformed their benchmark over the last five years to end December 2018. In fact, over 1, 3, 10 and 15-year periods, over 80% of funds fell short.

Source: S&P Dow Jones Indices LLC, Morningstar. Date as of 31 December 2018. Past performance is no guarantee of future results. Table is provided for illustrative purposes.

Investors are increasingly aware that there are other, low-fee options designed to track index performance rather than take an active approach, with continued flows globally into passive strategies such as index funds and ETFs.

As a consequence, active managers face a dilemma. Do they take bold stock-picking decisions in an attempt to outperform their benchmark (and justify their fees), at the risk of underperforming? Or do they play it safer in an attempt not to underperform the market, in the process effectively giving up their reason for existing – to provide meaningful outperformance through active management skills?

Investors in actively-managed funds that take the more conservative approach would be justified in asking why they are paying around 1% in annual fees to hold a portfolio weighted similarly to the market.

BetaShares Australian Ex-20 Portfolio Diversifier ETF (ASX: EX20)

Some investors may wonder how they can get the potential for outperformance from Australian equities without having to pay active management fees, and without overweighting their portfolios to the largest companies on the ASX.

One option is the BetaShares Australian Ex-20 Portfolio Diversifier ETF (ASX: EX 20). EX20 is a passive, index-tracking ETF, and so is able to offer management costs of only 0.25% p.a. The fund excludes the largest 20 stocks, leaving you with stocks #21-200 by size. For investors who already have a direct exposure to the largest Aussie stocks, such as the big banks and miners, the fund can provide low-cost portfolio diversification via a single trade on the ASX.

The index the fund aims to track dates back to March 2001. The chart below shows the performance of EX20’s index against the S&P/ASX 20, the S&P/ASX 200 and the S&P/ASX Small Ordinaries Index to end June 2019.

Source: Bloomberg. Performance shown here is the Index which EX20 aims to track (Nasdaq Australia Completion Cap Index). You cannot invest directly in an index. Performance excludes the impact of of ETF fees and expenses. Past performance is not an indication of future performance of the Index or the ETF. Index inception was March 2001.

EX20’s index has outperformed the ASX200 by 3.7% p.a. over the last 5 years, and has also outperformed over 90% of the 100 largest Australian equity funds over the same timeframe1.

In today’s low-interest rate and low-growth environment, stocks that offer secular growth potential should command a greater premium than cyclical stocks such as financials, which we believe should benefit the Australian small and mid-cap sector to a greater extent than large caps. This is because secular growth is not tied to the growth environment in the same way cyclical growth is.

Mid and small-cap stocks currently also offer higher earnings growth potential than the top 20 Australian stocks. As of July 2019, the mid-cap part of the Australian market had an estimated forward EPS growth ~77% higher than the Top 20 – but traded on a P/E multiple only 5% higher2.

P/E Estimated EPS growth Div Yield
Top 20 15.9 4.96 4.83%
EX20 (Australia stocks 21 – 200 by market capitalisation 16.7 8.79 3.89%

 


1. Source: Morningstar. Comparison universe – Morningstar categories: Equity Australia Large Blend, Equity Australia Large Value, Equity Australia Large Growth, Equity Australia Mid/Small Blend, Equity Australia Mid/Small Value, Equity Australia Mid/Small Growth.  Past performance is not indicative of future performance.

2. Source: Bloomberg. ‘Estimated EPS growth’ is the estimated Compound Annual Growth Rate (CAGR) of the operating EPS over the company’s next full business cycle (typically 3 – 5 years). Past performance is not indicative of future performance.  Actual results may differ from estimates.

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