Why are “blue chips” delivering such poor returns?
Most investors have their equity portfolios heavily skewed to the largest ten companies. Is that you? Do you think yours is a “blue chip” portfolio? Or have you given up on active fund managers and believe that investing in an Australian index fund is smarter?
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
steven lock
:
Your comment suggests nevertheless you should have some investment in these blue chips;
Roger Montgomery
September 13, 2017 at 2:57 pm:
Hi Karl,
The big four banks represent 27% of the ASX200. We have 7.5% invested in the banks. Stating it differently, we are significantly underweight the banks – which reconciles with our view.
Max Zan
:
Roger, commonsense tells everyone the answer to your question is “NO”. Rising interest rates will affect every Asset class in some way and not just companies with no growth. Ten year aussie Bonds are at 2.8% and with the Reserve Bank setting a neutral cash rate target of 3.5% it’s possible the 10 year Bond rate will rise over time to be close to 4%. How that extra 1.2% affects Valuations and Asset prices remains to be seen . If everyone is aware that interest rates are heading higher then Asset prices will start to correct – you are starting to see that happening in some high geared sectors so it’s likely the market will go nowhere for sometime as Valuations adjust. I don’t think that’s a bad thing as most share prices rose too high and a pullback is justified to accommodate the changing interest rate environment. It’s time to build cash levels to take advantage of lower valuations “if” they arise and to protect against any capital loss that “may” occur.
Roger Montgomery
:
It does sound like you are aggreeing with me. I don’t think there’s much more I need to say.
John Boardman
:
I can see your point that investing in a ASX 200 index fund may not be a great investment, but most of the fund managers that invest in large Australian cap companies are not doing much better. Some are doing worse. So if large cap managers can’t outperform, are investors to focus on small caps instead?
The Australian small cap index has performed worse than the ASX 200 index over the last few years, although there are a small number of funds managers who do out perform in the small cap space by quite a margin. So if one is to look at performance over the past few years, investors haven’t done too bad investing in the ASX 200 index compared to the alternative Australian investments.
Roger Montgomery
:
Thanks John,
Yes the impact of high payout ratios and low growth amont the large caps is going to impact both the index, which is constructed from them, AND the fund managers who are restricted to investing in them. Of course looking at only the last two years, you are right, but as Ben Graham was famously quoted as saying (by W E Buffett); In the short run the market is a voting machine, but in the long-run it is a weighing machine.
Max Zan
:
Hi Roger
Agree that investing in stocks solely for the Dividend has it’s limitations. One thing that you fail to mention is franking credits that attach to dividends and the benefits they have as far as enhancing dividend yields. Take a SMSF that is in pension phase and pays no tax and you soon understand the benefits when franking credits are refunded . Franking credits have no value when retained by a Business but do when investors receive dividends – it’s an issue that is peculiar to Australia and possibly explains why a lot of Investors focus on Dividends and why Businesses accomodate with high payout ratios. In the short term it’s OK to do that as inflation is currently running at below 2% , but as you correctly point out capital growth is also required as your purchasing power will dwindle over time without capital growth.
There seems to be a sweet spot that balances dividend income, franking credits and capital gains at twice the rate of inflation. Take a Business that generates 20% ROE and pays out 70% of profits as a fully franked dividend of 4% ( 5.7% grossed up ) – It’s sustainable growth rate would be 6% and provided that growth rate could actually be achieved then you would end up with an annual return of 11.7% split roughly 50/50 between income and growth. To achieve that return you need to purchase the Shares at a PE multiple of about 17.5 or below and because low interest rates in recent years has lead to PE expansion it’s hard to come across them at a price that will generate that return.
They say the Australian market is good for Income and that an Investor should focus on Overseas for Growth but with patience the Australian market can provide both when shares trade at an attractive multiple.
Roger Montgomery
:
Max, very low interest rates for a very long time have certainly played their part too. When interest rates are higher, will companies with no growth and a fixed income stream be as attractive?