Why I don't invest in the top 10 ASX stocks

Australia's 10 largest listed companies are:

1. Commonwealth Bank of Australia (ASX: CBA)
2. Westpac Banking Corp (ASX: WBC)
3. BHP Billiton Limited (ASX: BHP)
4. Australia and New Zealand Banking Group (ASX: ANZ)
5. National Australia Bank Ltd. (ASX: NAB)
6. Telstra Corporation Ltd (ASX: TLS)
7. CSL Ltd (ASX: CSL)
8. Wesfarmers Ltd (ASX: WES)
9. Woolworths Limited (ASX: WOW)
10. Macquarie Group Ltd (ASX: MQG)

For various general and specific reasons I do not invest in any of these companies.

General reasons

1. Competition between investors is fiercest at the large end of the market because these opportunities are available to all. As you go down the list, the number of investors competing for ideas reduces as those looking after large amounts of capital fall away. These larger funds also typically have greater resources than retail investors in terms of access to management and brainpower.
2. The top 10 companies represent less than 0.5% of total stocks on the ASX. Assuming the size of the company tells us nothing about its quality as an investment, it is unlikely that a portfolio of the best 20 stocks would include one of these names. This is not a reason to exclude the top 10 when looking for ideas, but perhaps suggests if your portfolio is dominated by these stocks then you are missing out on better opportunities elsewhere.
3. My previous point assumes that there is little correlation between company size and its suitability as an investment. Whilst I think that the proportion of quality companies diminishes as you move further down the list, business quality does not necessarily translate into superior returns. There is also price to consider and large caps are less likely to be trading at below fair value as per my first point. Furthermore, whilst most of the above companies dominate their respective industries and so could be considered high quality businesses, they typically also have limited growth prospects and this reduces potential returns.

Specific reasons

1. Half of the above companies are banks of one sort or another. Banking is a cyclical and heavily interconnected industry so these stocks are likely to get hit when economic conditions inevitably deteriorate. Perhaps collectively the banks will perform in line with Australia's economic growth through the cycle but prepare for a rough ride. For me, better returns can be found elsewhere.
2. The capital intensive and cyclical nature of the resources industry translates into poor returns for shareholders over the long term and BHP is no exception. You can make money on these stocks trading the upswing during the boom years but this is hard to do when everyone else is trying to do the same.
3. Wesfarmers, Woolworths and Telstra are strong defensive businesses. However, like most of the rest in the top 10 they have limited growth prospects due to a combination of their limited overseas operations and domestic dominance. Also, I wonder whether many years of market leadership has led to complacency opening the door to competitors? Having said that they obviously still enjoy significant distribution, brand and other scale advantages.

From my point of view the standout stock in this group is CSL and I would happily own it. The trouble is that others also clearly recognise the superiority of the business and so it looks fully priced to me.