The market can be extremely complex and confusing. While investing seems pretty simple in hindsight, knowing what to do in the present moment is not so easy. It’s why so many amateur and professional investors fail to outperform the market over the long run.
According to a 2016 article in the Financial Times, almost all US, global and merging market funds have failed to outperform since 2006.
‘According to the analysis, 99 per cent of actively managed US equity funds sold in Europe have failed to beat the S&P 500 over the past 10 years, while only two in every 100 global equity funds have outperformed the S&P Global 1200 since 2006. Almost 97 per cent of emerging market funds have underperformed.’
Size Can Limit Potential Returns
But when you really drill down, institutional investors are actually fighting an uphill battle. Yes, they have expensive degrees and years of experience. However, their size and activity is limiting their returns.
Size limits your returns by limiting the universe of potential opportunities. For example, imagine a fund manager with $1 billion to invest. Not unusual.
With such a large pool of capital to deploy, he’s limited to many of the biggest, well-known, most watched stocks on the market. The truth is, there just isn’t as much value in the largest stocks on the index.
Even Warren Buffett accepts that his returns have taken a hit since building an empire. He explained in a 1999 Businessweek interview:
‘If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow.
‘You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.’
OK, but what about activity? How does that affect your returns? Take a look at the graphs below.
Source: Marotta on Money
Both charts show the relationship between turnover rates and returns for 407 mutual funds. The top chart is over a three year period and the bottom chart is over a five year period.
As you can see, funds with the lowest turnover rates performed far better than the rest. The reason why, in my mind, comes down to two factors.
First, holding undervalued stocks for longer periods should theoretically give them more time to appreciate. Second, fund managers who had lower turnover rates — those who traded less — likely made fewer mistakes.
This is all well and good, but what does it mean for an individual investor like you or I? Well, for starters we can limit our activity by only investing in company that we truly understand and believe to be seriously undervalued.
Global Trends to the Rescue
To help you find these stocks you might want to think about global trends which could benefit particular sectors or industries, and start from there.
For example, one trend that’s been in the limelight for a while is Asian’s growing middle income class.
According to McKinsey & Company, China in particular is lifting hundreds of millions of people out of poverty and into the middle class.
In 2000, just 4% of China’s urban population was considered middle class. That’s defined as earnings of between US$9,000 and US$34,000 a year. Fast forward to 2012, and that number had increased to 68% of China’s urban population. And by 2022, around 76% could move into the middle income class.
But what will they do with this extra income?
Already China’s growing middle class has done wonders for our agriculture, service and tourism industries. As reported by The Australian:
‘Australia agricultural sales to China up 143 per cent in five years; services sales up 45 per cent; spending by Chinese tourists in Australia up 133 per cent.’
A2, Bega & Qantas – Highest Returning Stocks
And in 2017, some of the highest returning stocks are profiting from this trend. Year-to-date, A2 Milk Company [ASX:A2M], Bega Cheese Ltd [ASX:BGA] and Qantas Airways Ltd [ASX:QAN] are the three highest returning stocks in the ASX 200.
All three are up 168.6%, 71.2% and 71.1% respectively.
If you want to read about more stocks profiting from global trends, check out these three small-cap stocks trading on the ASX right now.
Junior Analyst, Money Morning