You might have seen the headline in the AFR the other day:
"The fund on track to beat 98pc of its peers"
Yeah, that got my attention, too.
Turns out the fund in question is the Van Eck Equal Weight fund.
According to The Fin:
"The exchange traded fund with a simple investment strategy of investing equally in Australia's largest companies, is now tracking ahead of 98 per cent of its Australian equity fund peers over five years."
Now, you need to be careful extrapolating anything from fund (or investor) performance. Sometimes, outperformance is a flash in the pan; the result of luck, rather than skill. Sometimes, it falls victim to 'mean reversion', where outlying success (or failure) ends up returning to average. But sometimes, it's the result of a stock picker's skill, or the superiority of the investment strategy.
So let's have a look, and start by breaking down the strategy itself.
First, let's define our terms. An "equal weight" strategy does what it says on the tin. In this case Van Eck buys shares in the top 85 companies in equal proportions. Essentially, for every $100 in funds it takes in, the manager purchases $1.18 worth of each company.
That's different to "market weight", where each company's size dictates how much you'd own. So, in a traditional ASX 200 index ETF, for example, if CBA's market cap is equal to 7% of the combined market caps of the companies in that index, $7 from every $100 is invested in CBA (and, say, around 10c in Domain).
(For the record, the ASX 200 index itself is market-cap weighted. So when you see the market quotes on the news each night, CBA's share price movement has 70 times the impact of Domain's when it comes to the change in the ASX 200.)
It stands to reason, then, that an Equal Weight ETF would outperform when the smaller companies do better than the big guys. It would underperform when the big guys do well.
If you have $7 of CBA in one scenario and $1.18 in another, you can see how that'd happen!
So Van Eck has done well because the smaller end of its investment universe has outperformed the larger end. Being 'overweight' in smaller companies was a very significant tailwind.
In a different market environment — say one where the banks and miners were in the relative ascendancy — that would have been a huge headwind for Van Eck. When it comes to mechanical strategies, you live and die by the same sword.
Now, while Van Eck's strategy is mechanical, we're not surprised it's done well. At The Motley Fool, we've been wary of miners (they're price-takers, and that's a tough way to make a quid, long term), and banks (they're meaningfully leveraged and the conditions required for long term meaningful house price growth seem unlikely).
We're underweight those companies for qualitative reasons, while Van Eck has been for mechanical ones, but we've ended up in a similar place.
That explains some of it, but it's also important to remember the other side of the coin — they were sufficiently over-invested in the mid-cap companies to put them in the top 2% of funds in the country.
They're not short the banks or miners, so they get no benefit from not owning more of them. The benefit comes from owning (relatively) more of the companies that have contributed to the ASX's climb.
We should remember, of course, that there are two explanations:
Either the mid-cap companies they own are delivering strong fundamental business performance; growing sales and profits at an impressive rate…
… or investors are just paying increasing prices for those companies, and Van Eck's investors are benefiting.
So which is it?
Without wanting to sound like the one-handed economist (on one hand…), it's almost certainly a bit of Column A and a bit of Column B.
With bank profit growth hard to come by, it wouldn't be difficult for their smaller ASX brethren to beat them in the earnings stakes.
And, in the midst of one of the (if not the) longest bull runs in history, we shouldn't be surprised that increasing numbers of investors are loading up on 'growth' companies, and pushing prices higher.
The former is sustainable. The latter… well, it doesn't always end well.
Which isn't to say Van Eck's time in the sun — at least with this particular fund — is coming to an end. But it's important to remember that 'what got us here won't always get us there'.
No, we're not suddenly filling our boots with banks and mining company shares. But we're aware that, if prices are elevated in some spaces, it may be more important in the coming year (or more) to selectively separate the wheat from the chaff.
Oh, and the other reason? Van Eck is compared against other fund managers. And when its fees are only 0.35% of funds under management, well it's already got a handy head start against many other funds who charge two or three times that.
(Don't get me wrong: like high performing company CEOs, we're happy to see extra pay going toward the top performing funds. But if you're paying high fees to an underperforming fund… well, I think it's fair to say Van Eck was probably always likely to be in the top half or 25% just on that basis alone!)
The Van Eck fund's performance was an interesting topic of discussion among the investing team here at The Motley Fool. As always, we're keen to see what others are doing well (or poorly) and to learn from those examples.
The result: If I was a betting man, I'd say too much exposure to banks and miners is likely to be a long-term drag on your future performance, relative to the index, such is the weight of those companies, and my guess as to their likely future performance (sluggish, at best).
If I'm right, that probably augurs well for Van Eck… but I'd rather pick the eyes out of the rest and build a diversified portfolio of the best investment options I could find.
Yes, I would say that, wouldn't I. But it also makes a whole lot of sense, don't you think?
Fool on!
