The ‘Ex Factor’ for driving returns in Australian equities

There is a need for investors to refocus on where they look for returns in Australian equities, and that may not be in the usual places.

The typical Australian investor is overexposed to financial stocks and resources companies, so it may be time to re-think their exposure to traditional blue-chip shares, including the big four banks, Telstra and BHP Billiton, which dominate the index.

Australia’s oligopolies are under pressure

As technology continues to advance at a rapid pace, it is transforming the way companies conduct business. Traditional barriers to entry have reduced, and distribution of products through online channels has impacted supply chains.

Customer-transparency has also dramatically increased and this has resulted in a more informed consumer. Examples of such disruption can be seen in print media, TV, travel and retail.

While technology is threatening some businesses, it is also creating opportunities for others. Those companies who embrace technology often offer interesting growth profiles. Australian technology companies, including Technology One, Aconex and WiseTech, have all hit the billion dollar mark, and this emergence of local technology companies is only the beginning.

Another factor impacting Australian companies is the booming population – Australia’s population has grown by 25 per cent in the last 15 years and, unlike other developed countries, the continued growth outlook for the next 10 years is strong. This aspect has attracted many overseas companies to our shores and is most evident in the retail sector, with many new international entrants including Zara, H&M and Sephora. This competition is set to put increasing pressure on Australian oligopolies.

A third consideration impacting Australian companies is regulatory risk, and the potential for regulatory change to impact returns, particularly across the financial services industry. The government’s Financial System Inquiry, as an example, requires banks to hold more capital and has increased regulation around the sale of financial products.

As Australian banks are highly correlated with each other, this can create problems for investors when it comes to diversification and concentration risk in a portfolio.

Seeking diversification

With this challenging landscape, investors need to look outside the traditional, blue-chip, core Australian companies to find sustainable diversified growth companies for the next decade and beyond.

In fact, the top 10 shares by market cap represent almost 49 per cent of all direct Australian shareholdings in self-managed super funds.

The BlackRock Concentrated Industrial Share Fund offers diversification to investors by focusing on quality Australian industrial stocks with the exclusion of the top five stocks. We believe this approach leads to a more diversified portfolio that focuses on uncovering opportunities outside these major stocks.

As well as excluding the top five stocks, the BlackRock Australian Fundamental Equities team also excludes resources in its entirety. Resource stocks, including metals, mining and energy have produced lower returns with higher volatility than Australian industrial stocks over the last 30 years.

The investment ‘sweet spot’

Investors should consider seeking out businesses that are easily understood, with strong balance sheets, and most importantly, companies with management teams that are reinvesting capital wisely for the long term.

The Australian Fundamental Equities team consider the sweet spot for investing to be in the $300m to $20 billion mark. In this range lie organisations that are well-positioned to withstand or potentially thrive in an environment of consistent disruption.

Unlike most small cap managers, the BlackRock Concentrated Industrial Share Fund can continue to own high conviction, strongly performing stocks, as their market capitalisation grows.

The fund offers diversification to investors by focusing on quality Australian industrial stocks with the exclusion of the top five stocks.

The team believe this approach leads to a more diversified portfolio that focuses on uncovering opportunities outside the major stocks.

Charlie Lanchester, head of fundamental active equities Australia and senior portfolio manager, BlackRock Concentrated Industrial Share Fund