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Investor Update for March 2024

Hedging the 7

Prevailing tailwinds

As we mentioned in our previous monthly, historically, an equal-weighted S&P 500 Index exposure has provided a material tailwind to equity returns when compared to the cap-weighted index. An equal-weighted index owns all of the same shares as the cap-weighted index, however as the name suggests, it’s just that the smaller stocks or stocks with lower valuations, are weighted the same as the much larger and much more expensive securities (potentially where a lot of the good news may already be in the price).

As a result, this exposure to the well-recognised Value and Size factors, plus the regular re-weighting process (essentially harvesting winners and buying losers), has helped deliver the outperformance outlined below.

However, just as there are short-term changes in wind direction, so too are there periods when cap-weighted indices will outperform equal-weighted.  This is precisely the situation we are currently experiencing due to extreme levels of market concentration where typically well diversified markets are driven by the prices of a few (let’s call it seven!) stocks.

In the past, high levels of market concentration were typically driven by periods of economic distress which sees investors rush to the relative safety of larger companies with usually stronger balance sheets, or alternatively, during bubble conditions where Fear Of Missing Out (FOMO) and momentum has driven share prices to unsustainable levels without regard for fundamentals.

Source: Bloomberg, Authors

Concentration not all bad

However, higher market concentration, in and of itself, shouldn’t always mean that a market correction is just around the corner. The local Australian market, for example, has historically been heavily concentrated by a handful of larger companies and industries for long periods, and there are other examples.

Strong balance sheets, high profitability levels, and supportive growth outlooks for the mega-cap technology names powering today’s market concentration have the backers saying “it’s different this time”. These are valid arguments and do make comparisons with the year 2000 technology bubble a little difficult.

Possibly, the risk to the markets current top performers may come in a different guise. Historically when companies have become so large and exercise monopolistic-like influence, the risk of either litigation or legislation becomes a far more elevated concern.

Whether this time is different or not, the case for increased diversification within portfolios becomes even more compelling when markets are driven by increasingly fewer stocks. Additionally, with inflation stubbornly high and potentially moving higher, investors must be aware of the shortfalls of using fixed income as a means of portfolio protection.

Rhyming not repeating

As we mentioned last month, we believe our Global Fund is exceptionally well positioned to take advantage of a concentration unwind were one to appear and is not reliant on correlation with fixed income or certain factors to provide defence. We have used the example below during the last major concentration unwind in year 2000, to provide a sense of the potential diversification the Fund could offer.

Firstly, being equal-weighted, like the Global Fund, outperformed S&P500 cap-weighted index by 27% in the 12 months following March 2000. This may seem an exceptionally large number for an Index that holds identical securities, but highlights the power of concentration unwind.

Secondly, when combined with a cap-weighted overlay, like the Global Fund, the example portfolio outperformed by a further 23% in the 12 months following March 2000… a total of 50% outperformance of the standard SP500 index! Of note, bonds albeit providing some level of diversification failed to provide meaningful protection.

These are large numbers, but worth bearing in mind that the S&P equal-weighted index has underperformed by -18% since December 2022 (The global equal-weighted quality index that the Global fund uses has underperformed by a similar amount). Historically, this underperformance has unwound rapidly once concentration reverses.

Source: Wheelhouse, Bloomberg. Returns are hypothetical and may not be representative of future returns.

Hedging with positive carry

In this environment, owning a differentiated hedge may play a valuable role within portfolios. From a hedging perspective, similar strategies (such as our Global Fund) continue to generate reasonable positive carry and return contribution, despite recent headwinds, which makes it far easier to hold should the market concentration continue to build.

Timing as always remains with the Gods, but crafting a well-diversified portfolio that isn’t bond correlation related, needs to start today.


Vale Wayne McGauley

We join Australia’s investment and broader communities in remembering and commemorating the life of our dear friend, colleague and partner, Wayne McGauley.

Wayne’s enthusiasm for life, for his family and his friends was infectious and he brought energy and joy to our lives and all those around him. He was a very talented and authentic person, as reflected by the many heart-felt comments added to John Rowley’s recent post announcing Wayne’s passing.

Our deepest condolences to his family and all who cherished him.

Watch Alastair’s latest ausbiz interview

Alastair recently joined Juliette Saly on ausbiz, talking about equal-weighted versus cap-weighted index exposures.

Wheelhouse Global Fund

 1 mo3 mo6 mo1 yr3 yrs (pa)5 yrs (pa)S/I (pa)
Total fund return1.0%2.5%7.2%4.5%5.1%5.9%6.4%
Risk (volatility)6.8%7.3%7.4%7.6%

* The Fund’s benchmark is RBA +2.5% and is used for all time periods shown. From the Fund’s inception to 31 August 2023 the Fund’s benchmark was MSCI World ex Australia Index (AUD). The change in benchmark does not impact any fees the manager may earn and the Fund’s investment objective has not changed.

Performance figures are net of fees and expenses. Inception date is 26 May 2017. Past fund performance is not indicative of future performance.

Wheelhouse Australian Fund

 1 mo3 mo6 mo1 yrS/I pa^
Total Return3.7%6.2%13.9%14.6%9.5%

Performance figures are net of fees and expenses. Since inception numbers include 30bps exit spread.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 09/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

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