Top 20 rock solid

Published in Australian, December 2007 by Peter Switzer

How would you like a blue chip investment, with minimal risk, that could have some worrying moments but stands the test of time?

A few weeks back this investment had returned 130 per cent over a 10-year period or 13 per cent per annum.

But wait, it gets better, because this timeframe included the tech-wreck market dive that got a lot of superannuation fund managers on to many of their members' hate lists. 

On a five-year basis, the return was 104 per cent or close to 20 per cent per annum and for a three-year gap there was a nice 79 per cent result, or let's call it 26 per cent a year.

The one-year return was a stellar 29 per cent.

Not bad for a very blue-chip investment and it has to have many of you asking who was the genius fund manager who navigated his or her way through the financial challenges of the high-powered fund world?

The answer is no one in particular, just anyone who bought the top 20 stocks in the S&P/ASX 200.

A set-and-forget investor could have bought some of the nation's best-known companies and pocketed a nice return on investment, with minimal risk.

I should also add that these returns don't include any dividend income and tax credits that can come with holding your own shares.

The risk is nicely reduced by having 20 stocks, meaning you only have a 5 per cent exposure to any one company in case a prominent CEO has a brain explosion like some of the clowns who have been running the top banks and investment houses in the US.

The latest Fortune magazine has asked the question on its cover: "What Were They Smoking?'' in looking at the massive write-offs linked to the sub-prime loan debacle of Citigroup ($9.8 billion), Morgan Stanley ($3.7 billion) and Merrill Lynch ($7.9 billion).

And it makes you ponder how out of the loop a fund manager, and for that matter you too, can be with your investments.

Ask those who kissed tens and hundreds of thousands of dollars goodbye with Basis Capital if they understood where they were investing their money.

One well-known financial advising firm owned by a big institution had a policy to put at least 5 per cent of its clients' funds into this fund. 

Thank God they got that part of their planning right with only a 5 per cent exposure.

Sure there is always a degree of "keep your fingers crossed'' when you invest in companies, but wise investors and good advisers should try to minimise those unknowns, especially for investors not in the thrill seeker category.

The man who has campaigned loudly and has invested by the philosophy of "if you don't understand the business, then don't buy into it'', Warren Buffett, also has raised doubts about the value of fund managers.

Speaking recently on CNBC he gave a big thumbs up for cheap index funds for small investors who don't have a research team.

"The best way in my view is to just buy a low-cost index fund and keep buying it regularly over time, because you'll be buying into a wonderful industry, which in effect is all of American industry,'' he said.

"If you buy it over time, you won't buy at the bottom, but you won't buy it all at the top either.''

Even leaving out the calibre of the fund manager issue and all of the imponderables that go with new age investments, there is also a compelling cost argument.

Generally, index funds such as Vanguard's family of funds charge lower fees than actively managed funds.

"If you have 2 per cent a year of your funds being eaten up by fees you're going to have a hard time matching an index fund in my view,'' Mr Buffett said.

"People ought to sit back and relax and keep accumulating over time.''

Dale Gillham, of Melbourne company Wealth Within, wrote a book with a "big call'' title: How to Beat the Managed Funds by 20%. When I quizzed him on his claim, his argument was instructive.

Using either a self-managed super fund or a simple portfolio taking a blue-chip portfolio over time, you could do as well as the average fund manager. 

And let's say the average return is 10 per cent but you don't pay the 2 per cent that many fund managers take, then you are 20 per cent better off.

You could pick holes in the premise but I reckon a good point is made.

In his book Mr Gillham took the top 20 stocks and divided them up into two funds based on odds and evens and looked at their returns over five and six years from 1997.

The sixth year took in the tech wreck slide and the results were: Odds portfolio 1997-2002: 100.98 per cent. 1997-2003: 81.5 per cent. 

Evens portfolio 1997-2002: 114.8 per cent. 1997-2003: 80.5 per cent.

The annualised total, six-year returns of around 13 per cent look pretty attractive, especially knowing there are no fund managers dipping into your investments.

The case for your own portfolio or a self-managed super fund based on the top 20 stocks or simply an index fund that mirrors the overall stock market is compelling. However, what happens if the market head south?

Mr Gillham says we are overdue for a four-year low of the stock market, which could take the market down 20 per cent or more.

However, after that he believes the bull market will resume and march past current levels for possibly another two years.

He believes the China and India growth stories will fuel global growth and support higher share prices.

It would be nice to go very long on cash ahead of a big sell-off, if it happens, and then go back to blue-chip stocks for the next ride up.

However, that's a play fraught with the kinds of risks that makes monkeys out of professional fund managers.

The top 20 stocks in your fund or portfolio have a certain appeal as they make up 56 per cent of the S&P/ASX 200.

Furthermore, you get to own some of the best brand names in this country. Some years they will disappoint but most of the time they will deliver.

Back to Articles