The Motley Fool

Why it pays to be a stock picker

2017 hasn’t been the year it might have been for index trackers. I examine why, and the lessons investors can draw from it.

I always find it astonishing that just 20 stocks make up just under half of the entire Australian equity market. Five of those stocks – the big 4 banks plus BHP Billiton Limited (ASX: BHP) – make up 25% in their own right.

That feeds through directly into the major indices that funds benchmark themselves against – the ASX100, 200 and 300. Take the ASX100. In the last year it’s returned a reasonable 7.4%. But delve a little deeper and you’ll find that 64 stocks in the ASX100 have done better than that, including 20 stocks that are up 30% or more.

The lag factor ? The big 5. The performance of the banks has ranged from +1.8% for National Australia Bank Ltd (ASX: NAB) to -3.5% for Australia and New Zealand Banking Group (ASX: ANZ). For all the strong resources performers out there, BHP itself is only up 4.3%.

In other words this has been the year of the stock picker. If you had been in Northern Star Resources Ltd (ASX: NST) instead of index weighted to BHP, you would be up 64%. If you had bought financial stocks  like Challenger Ltd (ASX: CGF) or Macquarie Group Ltd (ASX: MQG), rather than being restricted to the big 4, you would have seen gains of 28% and 18%.

This raises an interesting point. Do you actually need the safety or liquidity of those 5 largest stocks ?

I would argue that for the typical private investor it’s simply not necessary. Challenger, for example, is capitalised at $8.5 billion. The business is solid enough for any investor to sleep soundly at night, and if the market did crash, you would have no trouble selling it if you needed to.

For an institution with a mandate to invest, say, in ASX 200 stocks, its main preoccupation is not going to be finding the multitude of gems that add the real value. It’s going to be deciding its weightings in the top 5. It simply can’t afford to diverge too far from its benchmark index. That’s why so many “active” funds are no more than closet index trackers.

For the engaged investor, there are potentially much better returns out there, as 2017 has shown.

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Motley Fool Australia contributor James Middleweek does not own shares in any of the companies mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.