Did you miss out on your milk?
Last week there was a big surprise when a2 Milk’s share price jumped. The disappointment was that most investors in managed funds got very little return from this. There’s a simple way for these investors to improve their chances of getting a decent return the next time the share price of a stock outside the S&P/ASX top 10 does something like this.
When a2 Milk announced its results last week its share price shot up.
The return to A2M investors on 21 February was 29.7%. On that day though the S&P/ASX 200 only rose 0.11%. Managed funds that track that index or stay close to that index, which is most of them, got very little benefit from investing in a2 Milk.
In contrast, the VanEck Vectors Australian Equal Weight ETF (ASX code: MVW) went up 0.67% on that day, with most of that excess return attributable to A2M.
This is not because our team at VanEck knew that a2 Milk’s share price was going to do this. Nobody knew in advance. The advantage of MVW is the way that it spreads its investment across the portfolio equally. There are 81 stocks and on each review date each one is 1.23% of the portfolio.
In contrast, a fund that spreads its investment based on market capitalisation, following the S&P/ASX 200, would have only held 0.37% of its portfolio in A2 Milk. There is no point in investing such a small proportion of your portfolio in a company, when on the day of its most stellar share price performance, it will contribute almost nothing to your overall return.
In the financial literature this is called ‘skew’. Share price returns are not distributed evenly across all of the stocks in the index. The return on the portfolio is made up by most of the stocks having a small or a negative return and just a small number of stocks having a high return. The more of the high-return stocks you have a meaningful weighting to, the higher your overall return.
Because of skew, portfolios based on the S&P/ASX 200 are hoping that the high-returning stocks are within the dozen or so stocks to which those portfolios have a reasonable exposure. An evenly spread portfolio like MVW is fishing with a much bigger net. There are currently 81 different stocks where the weighting is high enough that a rocketing share price won’t be lost as a rounding error.
A market capitalisation fund can have 200 stocks out of which only 12 matter. MVW has 81 stocks and all 81 of them have a chance of being the star performer.
No-one knows which stock’s share price will be the next headline grabber but it is better to hold 81 raffle tickets than just 12.
The effect of this can be seen in the historic performance of MVW against the S&P/ASX 200 Index.
When people ask you why this has happened, suggest that they research the effect of skew on portfolio returns.
This information is issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’) as responsible entity of the VanEck Vectors Australian Equal Weight ETF (MVW) (‘Fund’). This is general information only and not financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Before making an investment decision in relation to the Fund, you should read the PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at www.vaneck.com.au or by calling 1300 68 38 37. The Fund is subject to investment risk, including possible loss of capital invested. Past performance is not a reliable indicator of future performance. No member of the VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance or any particular rate of return from the Fund.