'Mum and dad' stocks are underperforming: CommSec's Craig James

EXPERT OBSERVATION

Mid-sized companies and international shares have out-performed ‘Mums and Dads’ stocks over the past five years.

It is useful for investors to understand how different asset classes are performing as it may highlight opportunities.

Smaller returns from major Australian companies

Many Australians got their start in the share market through privatisations and demutualisations. That is, companies like Telstra, AMP, Colonial, Commonwealth Bank, Suncorp, Qantas and state betting agencies like TAB (NSW). Some retail investors have held on to these stocks over time and perhaps added modestly to their holdings with positions in other domestic companies. For others, the initial investment may have sparked broader interest with investors adding to their portfolios with domestic and international investments and perhaps positions in options and futures.

In 1999, CommSec devised an index called the Mums and Dads index to highlight the performance of retail investors who got their start in the share market through demutualisations, privatisations or ‘household names’ like Woolworths. The current composition of the CommSec Mums and Dads index is Telstra, Commonwealth Bank, Woolworths, Qantas, AMP, Tabcorp, Suncorp, IAG and Wesfarmers.

Until around five years ago, total returns on the CommSec Mums & Dads index (share prices and dividends included) closely tracked total returns on the broader index – the All Ordinaries accumulation index. But over the past five years, the All Ords accumulation index has lifted around 82% while the CommSec Mums and Dads index has lifted by just 35%.

Mid-sized companies gain favour

One of the out-performing areas over the past five years has been the mid-tier companies. Since mid-2013 the MidCap50 accumulation index has doubled in value. As noted above, over the same period the All Ords accumulation index lifted by around 82% while returns on the CommSec Mums and Dads index rose by just 35%.

The MidCap50 includes a number of ‘new wave’ stocks as well as ‘disruptors’ – companies challenging those with far bigger market size or capitalisation – that is, the ‘big cap’ companies. Notable mid-tier companies include A2 Milk, Dominos, Flight Centre, JB Hi-Fi and Resmed.

On a shorter-term comparison, since the start of 2018 the All Ordinaries accumulation index has lifted by 6% (ASX 200 accumulation +5.9%) while the MidCap50 accumulation index has lifted by 6.6%. By comparison the CommSec Mums and Dads index has risen by just 1.6%.

However just as investors constantly need to track the performance of their domestic portfolios – especially the influence of new themes or paradigms – there is also the need to take a broader perspective. Considerations include the differing performance of domestic industries or sectors to those abroad.

Global shares have certainly performed strongly over recent years. The US Dow Jones and S&P 500 indexes have hit record highs in the past month. And the Japanese Nikkei 225 index hit 27-year highs yesterday.

Global shares

Five or 10 years ago it was more difficult for retail investors to invest in individual companies that were listed on overseas share markets. To gain overseas exposure, investors tended to favour managed funds.

Today, retail investors have much more flexibility to invest in individual companies on overseas exchanges, or via exchange traded funds (ETFs) and managed funds. Australia accounts for just 2% of world share market capitalisation, so there is a raft of opportunities outside our borders. One complication is the need to take into account currency fluctuations. Since the currency was floated, the Australian dollar has fluctuated on average by US14 cents a year against the greenback, although there has been less volatility in recent years

One way of measuring the performance of the ‘world share market’ is by reference to an index. And one of the best known indexes is that compiled by Morgan Stanley Capital International (MSCI).

The MSCI World Index, is described as: “A broad global equity index that represents large and mid-cap equity performance across 23 developed markets countries. It covers approximately 85% of the free float- adjusted market capitalisation in each country and MSCI World Index does not offer exposure to emerging markets.” 

The world MSCI can be tracked through finance websites on a daily basis as well as wire services and adjustments can be made for dividends and currency fluctuations.

Over the past five years the world MSCI in US dollar terms has risen by 41% with total returns (measured by the accumulation index) up by 56%. By comparison, in Australian dollar terms the MSCI Australian index rose by 17% and 42% respectively over the period.

But when you adjust the world MSCI for currency changes – convert the index to Australian dollar terms – the out- performance is enhanced even further. Over the past five years the world MSCI has lifted by 83% in Australian dollar terms with total returns up 101%.

Shorter-run returns

As always the time comparison chosen may affect the results obtained. And with international shares, changes in the value of the US dollar can significantly impact the results.

Looking back since the index was constituted in May 2000, and assessing returns in Australian dollar terms, returns on the ASX 200 have risen four-fold whereas returns on the world MSCI have doubled. So on a long-term basis the Australian share market has out-performed global shares.

However, looking over the past decade, Australian dollar returns for both the ASX 200 and the world MSCI tracked closely, especially up to 2014. But in the past four years the world MSCI broke away, lifting by 68% while the ASX 200 has risen by only 39%.

Further, since the start of 2018, the world MSCI accumulation index in Australian dollar terms has lifted by around 14%, well ahead of returns of around 6% for the Australian market.

The US out-performs

The Dow Jones index is probably the best known of the US equity indexes. Other indexes include the S&P 500, Nasdaq Composite and Russell 2000. And while the price index – the Dow Jones Industrial average (DJIA) – is commonly quoted, there is also a total return index for the Dow.

Up until the end of September the DJIA rose by 7% and total returns (includes dividends) lifted by 10% while returns on the index in Australian dollar terms have lifted by around 18%.

By comparison, in local currency terms the ASX 200 rose by 2.3%, the All Ords lifted 2.6% and total returns on Australian shares have increased by around 6%.

Certainly the US economy has performed strongly with annual economic growth sitting at 4.2%, unemployment near 18-year lows and inflation sitting at just 2%. However the old adage applies for the share market – past performance is no guarantee of future returns.

The US Dow Jones has made solid returns – especially over the past two years, averaging annual growth near 22% and well out-performing the Australian market.

While the US economy is performing strongly, the budget deficit remains high, the Federal Reserve is still in the process or ‘normalising’ interest rates and the US is engaged in trade disputes with a raft of economies such as China and the European Union.

In addition some would cite relatively expensive valuations for US shares with prices around 17.8 times forward earnings, well above the longer-term average of around 14.5 times earnings.

What are the implications for investors?

Global share markets have made solid gains in recent years reflecting economic recoveries after the global financial crisis. In this respect, the US has had one of the stand-out economies and share markets.

Australian investors can now embrace a broader range of opportunities than in the past, whether they are domestic companies and sectors or opportunities across global economies. While there may have been good reasons in the past for investors to stick with blue-chip ‘Mums and Dads’ investments, better performing investments locally and globally argue for a fresh look at portfolios.

Investments in international shares and small and mid-sized Australian companies provide scope for greater diversification in investor portfolios.

Craig James is the chief economist at CommSec.