WHAT DRIVES INVESTMENT PERFORMANCE?
We recently undertook an analysis to try to better understand the structure and behaviour of the equity market, with a view to identifying cause and effect relationships that drive investment performance. While the work is ongoing, some interesting early findings are emerging.
The way we approached the task was firstly to organise the equity market into industry clusters based on similarity of investment performance. This is similar in concept to GICS industry groupings (and in many cases, aligns well with GICS classifications), but instead of assigning stocks based on someone’s judgement of how a stock should behave, we classified them based on how they did behave. This threw up some interesting differences, some of which appear quite logical and reasonable (for example Seek, Carsales and REA Group all ending up in the same cluster), and some of which are not so intuitive. In addition, there were quite a few stocks that did not readily fit into any cluster. For our purposes it makes sense to exclude those ones
If you’re interested, a list of ASX clusters based on 5 years of data is set out at the end of the post.
Having identified these clusters, we can then consider how different external effects flow through into the investment performance of each. One topical example might be to ask how different clusters perform in an environment of rising short-term interest rates.
Unfortunately, there are some big challenges to properly doing this analysis. In particular, we need to look at several decades of historical data, and in the Australian equity market there aren’t a great many companies that have been listed and doing the same thing for that length of time. This is a problem we should be able to solve with further work, but for now we have supplemented the Australian analysis with an analysis of the US market, which provides a much more comprehensive data set.
Some of the early (and still preliminary) findings include the following:
You might expect that rising interest rates are bad for clusters with defensive/bond like characteristics, like utilities and staples, and you’d probably be right. Unfortunately, the market seems to get out of bed early on this one, and the performance impacts for those stocks are typically seen before the interest rate changes take effect. This is perhaps not surprising, as the market generally knows in advance which way interest rates are heading, and it is a simple mechanical exercise to adjust a valuation discount rate to adjust for this.
What is a little more surprising is that there does seem to be a lagged effect of interest rate changes for banks and for discretionary retailers: For example, where interest rates have risen in the past 12 months, the forward returns for those clusters appear to be depressed. While it may be obvious that rising interest rates should negatively impact demand for credit and for retail goods, it seems that the market may take some time to factor this in. This might be explained by the fact that it is not straightforward to forecast the ultimate impact on demand, particularly if interest rate rises occur in the context of strong economic growth.
This may be something to keep in mind if we see the RBA becoming increasingly worried about rising inflation.
Another surprising finding is that rising oil prices appear to predict future outperformance for energy companies. We would expect the market to pick up pretty quickly on this one, such that by the time you have noticed the rising oil price its too late to take advantage of it by buying energy companies, but the evidence suggests otherwise.
It’s possible that this is because producing a revised commodity price “deck” is a big exercise for investment bank economists, and so it takes some time for changes to flow through into updated price decks and then into the forecasts and valuations of the sector analysts. Nonetheless, this lag effect is a little surprising.
It’s also potentially interesting, given that oil prices have been on the rise in recent months. Energy companies generally don’t fit our quality-driven investment style, but for those with more of a trading orientation, this may be something to keep in mind.
We continue to sift through the data in search of gems of insight, but there seems to be one overarching conclusion emerging: if something is obvious to others in the equity market then it likely has no investment value – it should already be factored into prices. However, investment markets are not omnipotent; if something is difficult or time-consuming to assess, it is probably worth making the effort to understand it better than others.
Name | Sector | Industry |
BHP BILLITON LIMITED | Materials | Metals & Mining |
RIO TINTO LTD | Materials | Metals & Mining |
FORTESCUE METALS GROUP LTD | Materials | Metals & Mining |
ORICA LTD | Materials | Chemicals |
BLUESCOPE STEEL LTD | Materials | Metals & Mining |
ALUMINA LTD | Materials | Metals & Mining |
MINERAL RESOURCES LTD | Materials | Metals & Mining |
SIMS METAL MANAGEMENT LTD | Materials | Metals & Mining |
COMMONWEALTH BANK OF AUSTRAL | Financials | Banks |
WESTPAC BANKING CORP | Financials | Banks |
AUST AND NZ BANKING GROUP | Financials | Banks |
NATIONAL AUSTRALIA BANK LTD | Financials | Banks |
WESFARMERS LTD | Consumer Staples | Food & Staples Retailing |
WOOLWORTHS GROUP LTD | Consumer Staples | Food & Staples Retailing |
TREASURY WINE ESTATES LTD | Consumer Staples | Beverages |
COCA-COLA AMATIL LTD | Consumer Staples | Beverages |
INVOCARE LTD | Consumer Discretionary | Diversified Consumer Services |
SUNCORP GROUP LTD | Financials | Insurance |
INSURANCE AUSTRALIA GROUP | Financials | Insurance |
AMP LTD | Financials | Diversified Financial Services |
NIB HOLDINGS LTD | Financials | Insurance |
CSL LTD | Health Care | Biotechnology |
AMCOR LIMITED | Materials | Containers & Packaging |
BRAMBLES LTD | Industrials | Commercial Services & Supplies |
RAMSAY HEALTH CARE LTD | Health Care | Health Care Providers & Servic |
ASX LTD | Financials | Capital Markets |
COCHLEAR LTD | Health Care | Health Care Equipment & Suppli |
ANSELL LTD | Health Care | Health Care Equipment & Suppli |
CORPORATE TRAVEL MANAGEMENT | Consumer Discretionary | Hotels, Restaurants & Leisure |
NAVITAS LTD | Consumer Discretionary | Diversified Consumer Services |
ARB CORP LTD | Consumer Discretionary | Auto Components |
SIRTEX MEDICAL LTD | Health Care | Biotechnology |
WOODSIDE PETROLEUM LTD | Energy | Oil, Gas & Consumable Fuels |
ORIGIN ENERGY LTD | Energy | Oil, Gas & Consumable Fuels |
OIL SEARCH LTD | Energy | Oil, Gas & Consumable Fuels |
SANTOS LTD | Energy | Oil, Gas & Consumable Fuels |
WORLEYPARSONS LTD | Energy | Energy Equipment & Services |
WHITEHAVEN COAL LTD | Energy | Oil, Gas & Consumable Fuels |
BEACH ENERGY LTD | Energy | Oil, Gas & Consumable Fuels |
CIMIC GROUP LTD | Industrials | Construction & Engineering |
SEVEN GROUP HOLDINGS LTD | Industrials | Trading Companies & Distributo |
DOWNER EDI LTD | Industrials | Commercial Services & Supplies |
ALS LTD | Industrials | Professional Services |
MONADELPHOUS GROUP LTD | Industrials | Construction & Engineering |
JAMES HARDIE INDUSTRIES-CDI | Materials | Construction Materials |
BORAL LTD | Materials | Construction Materials |
FLETCHER BUILDING LTD | Materials | Construction Materials |
ADELAIDE BRIGHTON LTD | Materials | Construction Materials |
CSR LTD | Materials | Construction Materials |
MACQUARIE GROUP LTD | Financials | Capital Markets |
QBE INSURANCE GROUP LTD | Financials | Insurance |
JANUS HENDERSON GROUP-CDI | Financials | Capital Markets |
COMPUTERSHARE LTD | Information Technology | IT Services |
BT INVESTMENT MANAGEMENT LTD | Financials | Capital Markets |
PERPETUAL LTD | Financials | Capital Markets |
REA GROUP LTD | Information Technology | Internet Software & Services |
SEEK LTD | Industrials | Professional Services |
DOMINO’S PIZZA ENTERPRISES L | Consumer Discretionary | Hotels, Restaurants & Leisure |
CARSALES.COM LTD | Information Technology | Internet Software & Services |
NEWCREST MINING LTD | Materials | Metals & Mining |
EVOLUTION MINING LTD | Materials | Metals & Mining |
NORTHERN STAR RESOURCES LTD | Materials | Metals & Mining |
REGIS RESOURCES LTD | Materials | Metals & Mining |
ST BARBARA LTD | Materials | Metals & Mining |
SARACEN MINERAL HOLDINGS LTD | Materials | Metals & Mining |
RESOLUTE MINING LTD | Materials | Metals & Mining |
HARVEY NORMAN HOLDINGS LTD | Consumer Discretionary | Multiline Retail |
JB HI-FI LTD | Consumer Discretionary | Specialty Retail |
SUPER RETAIL GROUP LTD | Consumer Discretionary | Specialty Retail |
MYER HOLDINGS LTD | Consumer Discretionary | Multiline Retail |
TELSTRA CORP LTD | Telecommunication Services | Diversified Telecommunication |
RESMED INC-CDI | Health Care | Health Care Equipment & Suppli |
ARISTOCRAT LEISURE LTD | Consumer Discretionary | Hotels, Restaurants & Leisure |
FISHER & PAYKEL HEALTHCARE C | Health Care | Health Care Equipment & Suppli |
SPARK NEW ZEALAND LTD | Telecommunication Services | Diversified Telecommunication |
TPG TELECOM LTD | Telecommunication Services | Diversified Telecommunication |
DULUXGROUP LTD | Materials | Chemicals |
SKYCITY ENTERTAINMENT GROUP | Consumer Discretionary | Hotels, Restaurants & Leisure |
TRADE ME GROUP LTD | Consumer Discretionary | Internet & Direct Marketing Re |
CHORUS LTD | Telecommunication Services | Diversified Telecommunication |
AUSTRALIAN PHARMA INDUS LTD | Health Care | Health Care Providers & Servic |
BLACKMORES LTD | Consumer Staples | Personal Products |
TECHNOLOGY ONE LTD | Information Technology | Software |
ALTIUM LTD | Information Technology | Software |
NEXTDC LTD | Information Technology | Internet Software & Services |
ILUKA RESOURCES LTD | Materials | Metals & Mining |
OZ MINERALS LTD | Materials | Metals & Mining |
INDEPENDENCE GROUP NL | Materials | Metals & Mining |
OROCOBRE LTD | Materials | Metals & Mining |
SYRAH RESOURCES LTD | Materials | Metals & Mining |
SANDFIRE RESOURCES NL | Materials | Metals & Mining |
WESTERN AREAS LTD | Materials | Metals & Mining |
The Montgomery Funds own shares in Seek and REA
The Montgomery Global Funds own shares in REA