20 LESSONS from 20 YEARS of Quality and Value Investing
eBook - ePub

20 LESSONS from 20 YEARS of Quality and Value Investing

One of Australia's most established value fund managers shares its guidelines for successful sharemarket investing

Anton Tagliaferro, TBD

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eBook - ePub

20 LESSONS from 20 YEARS of Quality and Value Investing

One of Australia's most established value fund managers shares its guidelines for successful sharemarket investing

Anton Tagliaferro, TBD

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About This Book

“LESSONS FROM MASTER INVESTOR ANTON TAGLIAFERRO”

Many investors find navigating the sharemarket a daunting task as the market continues through its unpredictable cycles.

Each boom brings a new fad or theme that excites investors who are bombarded by hype in the media. During these times, some companies reach extreme valuations, as investors get caught up in the froth and bubble.

Inevitably, these often-irrational booms are followed by sharp corrections as reality catches up. High-quality stocks are not immune to market corrections but good-quality businesses, generating real earnings, tend to recover better over time and as calm is restored to markets.

Investors Mutual Limited’s (IML) quality and value investment philosophy is based on the premise that a company’s share price will reflect its underlying value over the long-term. IML employs an active research-driven approach to identify companies that meet IML’s quality criteria and then determine an appropriate valuation.

Following this approach since 1998, IML’s funds have experienced returns that are more consistent and less volatile than the Australian sharemarket.

The sharemarket will continue to evolve, and while this book is not meant to be a complete guide to investing in the sharemarket, hopefully, these lessons, which cover how IML has invested over the past 20 years, will be of value to investors over the next 20 years.

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Information

Year
2020
ISBN
9780648727910
INVESTING BASICS
#5 WHAT IS THE MOST RELEVANT BENCHMARK WHEN INVESTING IN THE STOCKMARKET?
In an industry which is very focused on performance, an investor who has read any fund manager report will often see references to the “benchmark” and how a certain fund has performed versus its relevant benchmark.
WHAT IS THE BENCHMARK?
Benchmarks are used in the investment industry as a point of reference to monitor how various portfolios are performing relative to their target over a set period of time.
The most commonly used benchmark in Australia is the ASX 300 index, which measures how the top 300 stocks perform. Other benchmarks used to monitor smaller companies’ portfolios include the Small Ordinaries Index, which measures how stocks outside the top 100 in Australia are performing.
These indices are market-weighted, i.e. the larger a company is, the higher its weighting in the index. Index managers, also known as passive managers, seek to exactly replicate the index’s performance by buying stocks precisely according to their weight in the index that they are looking to replicate. Active managers, such as Investors Mutual, seek to outperform the index over the long-term by selecting a portfolio of quality and value stocks after undertaking fairly exhaustive research that, in our view, will provide better risk-adjusted returns than the index over a market cycle.
While some investors and advisers have a preference for using passive managers, in our opinion many are unaware of the issues arising when a portfolio is constructed to strictly track an index as one’s benchmark in the sharemarket. Some of these issues are as follows.
MANY POPULAR MARKET INDICES ARE OFTEN OVERCONCENTRATED IN SOME SECTORS
“IML’s Smaller Companies Fund currently holds only 6% in the Small Resources sector as we believe the benchmark weight of 22% is not suitable for the prudent investors on whose behalf we invest.”
Simon Conn, Senior Portfolio Manager, February 2019
Looking at the Small Ordinaries Index at 31 January 2019, for example, the Small Resources sector made up just over 22% of the Small Ordinaries benchmark. Any investors or fund managers closely following the benchmark would thus have had over a fifth of their small-cap portfolio invested in small resources stocks. This sector is made up predominantly of very risky, speculative exploration companies, the vast majority of which are loss-making.
RESOURCES WEIGHT IN THE ASX SMALL ORDINARIES OVER TIME
Source: IRESS; January 2005 to January 2019
As the chart above shows, the Small Resources Index actually reached a peak of 45% of the Small Ordinaries Index in 2011. Resources stocks soared as the iron ore price rose to a record US$180 a tonne at the time. Any Smaller Company Fund tracking this index closely would have worn huge losses if they had 45% invested in the sector because the Small Resources Index tumbled by almost 80% when the iron ore price fell to levels closer to US$50 a tonne and small resources stocks were sold down heavily. At the time, the IML Smaller Companies Fund had around 10% in this sector at its peak, meaning that our Fund fared far better than most.
THE HIGHER A STOCK GOES IN PRICE, THE HIGHER ITS WEIGHT IN ITS INDEX AND THERE ARE NO QUALITATIVE FILTERS WHEN IT COMES TO WHAT IS INCLUDED IN AN INDEX
Tracking an index closely means that index managers will end up owning more of the stocks whose share prices have appreciated strongly. This can mean that if one follows an index too closely, one can end up having too large a weighting in popular but very low-quality companies or sectors which have gone up substantially.
During the tech boom of 2000–2001, News Corp’s share price soared after internet provider AOL used its inflated stock price to bid for media group Time Warner in the US. At its peak, News Corp represented 18% of the All Ordinaries Index. During this period, share prices of other technology, media and telecommunications (TMT) companies such as One.Tel, Solution 6, Sausage Software and ecorp also soared, and the sector as a whole became a large part of the ASX All Ordinaries Index. During this time, Investors Mutual’s portfolios held no News Corp shares, or those of any of the TMT companies mentioned, as we could not justify holding them due to their very poor quality and massive overvaluation.
Howev...

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