Outperformance made easy

Equal weight investing in Australia is one year old. The Market Vectors Australian Equal Weight ETF (ASX code: MVW), the only equal weight ETF in Australia, outperformed the S&P/ASX 200 Accumulation Index by 3.60%, returning 18.16% in its first 12 months. Its success is remarkably easy to understand.

Source: FactSet, as at close of business 3 March 2015. MVW commenced on 4 March 2014. Results are calculated to the last business day of the month and assume immediate reinvestment of all dividends and include management costs but exclude brokerage costs associated with investing in the ETF. The above performance information is not a reliable indicator of current or future performance of the ETF, which may be lower or higher.

There are two key reasons that have been identified by researchers why equal weight investing outperforms market capitalisation benchmarks such as the S&P/ASX 200 Accumulation Index (S&P/ASX 200), namely, equal weighting has:

1. a trading strategy that is contrarian; and
2. higher exposure to smaller stocks rather than to bigger stocks.

Equal weighting inherently imposes a contrarian trading strategy. Each quarter MVW rebalances its holdings in line with its index so that all stocks are equally weighted. This process involves:

• selling stocks that have risen since the last rebalance; and
• buying stocks that have fallen since the last rebalance.

We demonstrated how this process adds value in Confessions of a Contrarian Investor.

Equal weighting also allocates higher exposure to smaller stocks, in contrast to a market capitalisation index, like the S&P/ASX 200, that assigns a greater weight to bigger stocks and less to smaller stocks. Weighting a fund according to market capitalisation can have a negative impact on performance. This is because when the market overvalues a stock its market capitalisation goes up. A fund tracking a traditional market capitalisation index buys more and more of the overpriced stock and loses money when the market corrects. Conversely, when the market undervalues a stock, the fund sells more and more of the underpriced stock, missing out on profit when the market corrects. An equal weight portfolio’s contrarian strategy and higher exposure to smaller stocks rather than bigger stocks avoids the negative impact of market cap based investing.

A problem in Australia with market capitalisation is concentration. Equal weighting means that rather than having over 50% of your investment in just 10 companies like a fund tracking the S&P/ASX 200, you have equally weighted exposure to all stocks of MVW’s index. Telstra was the best performing S&P/ASX 200 top 10 stock during MVW’s first year but ranked 54th out of 200. In MVW it finished 26th out of 74. In other words, over a quarter of the S&P/ASX 200 and over a third of MVW’s portfolio performed better than the best performing stock in the S&P/ASX 200 top 10. Because its holdings are equally weighted MVW’s portfolio had more exposure to these better performers so its investors benefitted from having a higher exposure to smaller stocks rather than bigger stocks.

Another example of how allocating more to smaller stocks rather than bigger stocks has benefited MVW is Toll Holdings. Prior to its recent takeover bid, Toll Holdings was around 0.30% of the S&P/ASX 200. It was around 1.35% of MVW. As a result of being four times more exposed to a stock the market had under-priced, Toll Holdings was one of the largest contributors to MVW's performance in its first twelve months.

The concentration in the Australian equities market is problematic for active fund managers. Below is the top 10 holdings of three active managers compared to the top 10 of the S&P/ASX 200. Each manager presented in the table has a different management style, classified by Morningstar as Large Value, Large Growth, or Large Blend.

Source: FactSet, Morningstar Direct as at 31 October 2014.

It is evident that not much diversity exists within Australian active managers irrespective of their style. Like market capitalisation indices, active managers hold the largest companies in bigger weights than smaller companies, even though their conviction in these stocks may not reflect the weight they are holding. This is one of the reasons S&P Dow Jones Indices’ SPIVA® Australia Scorecard found that 74.9% of Australian active fund managers underperform the S&P/ASX 200 over five years.

MVW is not inhibited by market capitalisation and its simple strategy has produced 3.60% outperformance.

Happy Birthday MVW! Many happy returns!

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 Australian Equal Weight ETF (‘Fund’). MVI is a wholly owned subsidiary of Van Eck Associates Corporation based in New York (‘Van Eck Global’).

This is general information only and not financial advice. It is intended for use by financial services professionals only. It does not take into account any person’s individual objectives, financial situation or 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.

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