State of the ASX20

by Olivia Engel, CFA, Head of Active Quantitative Equity, APAC

The members of the S&P/ASX20 Index make up almost 60% of the market capitalisation
of the broader S&P/ASX300 Index1

These market heavyweights have underperformed the rest of the market over the year-todate, over one year and over three years2

We are not willing to give up on them entirely and some of the names should still have a
place in your portfolio

We have often commented on the peculiar concentration risks within capitalisation-weighted

Australian equity indices. The constituents of the S&P/ASX20 Index make up almost 60%1 of the
market capitalisation of the broader S&P/ASX300 Index, which is commonly used as the benchmark
for active and indexed investors alike.
With such a heavy concentration in indices, underperformance by these heavyweights is likely to be
acutely felt by Australian equity investors and they have underperformed over the past three years
by 2.3% per annum2. In the calendar year to date, the S&P/ASX20 has underperformed the
S&P/ASX300 Index by 4.00% (a 0.24% fall for the S&P/ASX20 compared to a 3.76% rise in the
S&P/ASX300)2. Indeed in light of recent interest in ex-20 strategies, we wonder if investors are
giving up entirely on these names.

Cumulative Total Returns

40
30

20
10

S&P / ASX20 Index

Apr-2016

Feb-2016

Dec-2015

Oct-2015

Aug-2015

Jun-2015

Apr-2015

Feb-2015

Dec-2014

Oct-2014

Aug-2014

Jun-2014

Apr-2014

Feb-2014

Dec-2013

Oct-2013

Aug-2013

-10

Jun-2013

S&P/ASX 300 Index

Source: S&P/ASX, Bloomberg, SSGA as of 31 May 2016

It is not even as if these mega-cap stocks offer diversification across sectors. The S&P/ASX20 is even
more skewed than the broader market index, with 11 out of the 20 constituents being within the
Financials sector, making up 60% of the weight1.

Bloomberg, 31 May 2016

Bloomberg, 31 May 2016 as measured by the S&P/ASX 20 Index , compared with the S&P/ASX300 Index.

Financials only make up 25% of the weight of the S&P/ASX300 ex the 20 Leaders. In fact, excluding
the 20 Leaders creates a less concentrated, more varied index, with decent exposures to broader
swathes of the Australian economy than just banks and miners.

Sector weights in S&P/ASX Indices

70
60
50
40
30
20
10
0

ASX300

ASX20

ASX300 ex-20

Source: S&P/ASX, Bloomberg, SSGA, as of 31 May 2016

In terms of fundamentals, as well as performance, these largest names have been underperforming of
late. Earnings expectations for the S&P/ASX20 have been declining over the past year, and while the
rest of the market has seen an uplift of late, the megacaps have largely continued their downward
slide.

Earnings Expectations (rebased)

120

100
80
60

ASX20

ASX300

ASX300 ex-20

Source: S&P/ASX, Bloomberg, SSGA, as of 31 May 2016

ASX300 Financials

May-16

Mar-16

Jan-16

Nov-15

Sep-15

Jul-15

May-15

Mar-15

Jan-15

Nov-14

Sep-14

Jul-14

May-14

Mar-14

Jan-14

Nov-13

Sep-13

40

Before we all give up hope and limit ourselves to an ex-20 world, there are other considerations. A
glimmer of hope for the largest names is in terms of valuations; the S&P/ASX20 now looks cheaper in
terms of forward P/Es than the rest of the market.

12m forward p/E ratios

20

18
16

14
12

ASX20

ASX300

May-16

Mar-16

Jan-16

Nov-15

Sep-15

Jul-15

May-15

Mar-15

Jan-15

Nov-14

Sep-14

Jul-14

May-14

Mar-14

Jan-14

Sep-13

Nov-13

10

ASX300 ex-20

Source: S&P/ASX, Bloomberg, SSGA, as of 31 May 2016

In fact, valuation is just one component of our assessment of the relative opportunities in the local
market. As active investors, we look at both the overall expected return of a stock and the risk when
considering opportunities. If we compare these attributes for stocks within the S&P/ASX20, compared
to the market averages, a rather different picture emerges and on this basis, there are some very
attractive names within the top 20. There is a reason these stocks are so large in terms of
capitalisation, and some exhibit good quality, decent valuations, are stable cash-generative, mature
businesses with relatively low volatility. This doesnt sound too bad when they can be picked up at
reasonable valuations.

Expected Return vs Volatility - ASX20

stocks
SSGA Expected returns

2.0

1.0

Average ASX20
Average
ASX300 ex-20

0.0
0

10

20

30

-1.0
-2.0

Source: SSGA, Bloomberg, as at 31 May 2016

90d Volatility

40

50

60

The State Street Australian Equity Fund has a 20% weight across six stocks from the S&P/ASX20
names3. Among the stocks we currently hold are some Financials, such as CBA and Westpac;
Industrials such as Transurban and even a miner. At 20% combined weight, this is a meaningful
allocation and a far cry from the 60% weight the S&P/ASX300 ascribes to the top 20 names.
We believe that to build a portfolio to maximise risk-adjusted return, all stocks within the investable
universe should be considered and this includes the top 20 mega-caps. However, when constructing
the portfolio, we select only the stocks exhibiting the best risk and return profiles. The result may,
thankfully, look very different from the capitalisation-based index.

as at 31 May 2016

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