Is the large cap party over?

Australian investors in low cost passive equity funds have enjoyed riding the ‘bull’ market since the depths of the GFC. Most of these passive investments track market capitalisation indices such as the S&P/ASX 200 Accumulation Index (S&P/ASX 200). As the name suggests, these indices are constructed using market capitalisation, so the larger companies with larger market capitalisations, represent a larger part of the index.

Australian investors in passive funds tracking market capitalisation indices, happy with past returns, are now in the awkward situation of being stuck with stocks which may be overpriced. This is a problem in a concentrated market like Australia in which the top 10 stocks make up over 50% of the market.

Additionally, the Australian market is not very diversified so if bubbles form in a particular sector, passive investors may be unintentionally exposed. Lack of diversification in Australia means sectors such as IT and healthcare are underrepresented in many passive Australian equity funds.

The recent correction in the price of Australian banks has highlighted the shortcomings of using market capitalisation as an investment strategy in a concentrated market like Australia. The Financials ex-A-REITs sector is over 40% of the S&P/ASX200 with the four banks making up over 30%. Investors in low cost funds tracking the S&P/ASX 200 have been allocating more and more to financials as their prices have risen, even though there may have been better opportunities for growth elsewhere. The problem now emerging by tracking a market capitalisation index is investors have been buying too much overpriced stocks. When the market corrected, having bought more of these stocks in the lead-up to the correction was not optimal.

The large cap party may be over.

An alternative exists for investors who want to retain the low costs of a passive portfolio but want a better diversified Australian fund - the Market Vectors Australian Equal Weight ETF (ASX code: MVW) . MVW tracks the Market Vectors Australia Equal Weight Index.

Last month Van Eck Global released research illustrating that an investment portfolio following an equal weight index would have produced significantly higher long-term returns and better diversification than one following a traditional market capitalisation weighted index.

Equal Weight Investing in Australia: Twelve months on

In summary the paper shows:

• Non-market capitalisation weighted indices have become the dominant theme in index innovation.
• Equal weight investing is not new. Equally weighted indices have demonstrable outperformance relative to their market capitalisation weighted counterparts.
• In its first full year MVW outperformed the S&P/ASX 200 by 3.60% returning 18.16%. Additionally it achieved top quartile performance in its peer group of Australian Equity Managers.
• MVW is three times better diversified than S&P/ASX 200.
• The long term performance of the Market Vectors Australia Equal Weight Index, which MVW tracks, demonstrates better risk characteristics than the market cap weighted equivalent. That is, the better performance is not the result of greater risk-taking. Equally weighting delivers better returns without excessive risk.
• Criticism of equal weight investing has concentrated on turnover and capacity. In practice neither is an issue with carefully developed index rules. In addition to being within acceptable ranges, the turnover at rebalance of the MVW is inherently contrarian and a source of outperformance for the portfolio.
• Researchers and academics from varied institutions such as The University of London’s Cass Business School, EDHEC Business School, Goethe University and Australia’s own Monash University, continue to demonstrate the long term outperformance of equal weight investing. These findings reinforce industry research by index companies S&P Dow Jones Indices and Market Vectors Index Solutions.

For more information on MVW click here or call 02 8038 3300.

IMPORTANT NOTICE:This information is issued by Market Vectors Investments Limited ABN 22 146 596 116 AFSL 416755 as responsible entity (‘MVI’) of the Market Vectors MSCI World ex Australia Quality ETF (‘Fund’). MVI is a wholly owned subsidiary of Van Eck Associates Corporation based in New York, United States (‘Van Eck Global’).

This is general information only and not financial advice. It does not take into account any person’s individual objectives, financial situation nor needs (‘circumstances’). Before making an investment decision in relation to the Fund, you should read the product disclosure statement (‘PDS’) and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at www.marketvectors.com.au or by calling 1300 MV ETFs (1300 68 3837).

The Fund is subject to investment risk, including possible delays in repayment and loss of capital invested. Past performance is not a reliable indicator of current or future performance. No member of the Van Eck Global group of companies guarantees the repayment of capital, the performance, or any particular rate of return from the Fund.

Market Vectors Australia Equal Weight Index (‘MV Index’) is the exclusive property of Market Vectors Index Solutions GmbH based in Frankfurt, Germany (‘MVIS’). MVIS makes no representation regarding the advisability of investing in the Fund. MVIS has contracted with Solactive AG (‘Solactive’) to maintain and calculate the MV Index. Solactive uses its best efforts to ensure that the MV Index is calculated correctly. Irrespective of its obligations towards MVIS, Solactive has no obligation to point out errors in the MV Index to third parties.

Market Vectors® and Van Eck® are registered trademarks of Van Eck Global.

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