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What The 10-Year Challenge Teaches Us About Investing

15 February 2019Victor Mupunga – Research Analyst at Old Mutual Wealth Private Client Securities

Over the first few weeks of 2019, the ‘#10yearchallenge’ was the most popular social media phenomenon. This trend soon went viral with countless parodies and memes doing the rounds on social media platforms.

I decided to give this challenge an investment slant by looking at how local and global markets have changed over the last decade. The results highlight a few key lessons for investors.

Single stock concentration
Graph 1 is essentially the South African equity market’s “10yearchallenge”. The graph shows the ten largest shares at the end of 2008 alongside the ten largest shares a decade later. In the interest of simplicity, I have used the ten largest shares as a proxy of the market. Keen observers would have already noted that the aggregate weight contribution of the ten largest shares to the All Share Index (ALSI) has not changed significantly over the last decade, decreasing marginally from 59% to 55%. The Top40’s weight contribution has not changed much either, falling from 86% to 83%.

The obvious change that most investors will point to is the preeminent position Naspers now holds at an 18% weight in the index. Interestingly, when one looks back one decade, it is evident that at a 14% weighting, Billiton was not that far off from where Naspers is today. As far back as we can recall, our market seems to have always had a dominant company or sector that has driven most of the returns. Naspers has certainly done that over the last decade, contributing about 12% of the ALSI’s price return – impressive, when considering that a decade ago its weight in the ALSI was just 2%.

Graph 1: Ten largest JSE listed companies’ weight contribution to ALSI: 2008 vs 2018

Source: Old Mutual Wealth Private Client Securities

Picking the right Chinese exposure
Another glaring change over the last decade in our local market has been the reduction in resource contribution, from 35% of the Top10 in 2008 to 17% in 2018, particularly among single commodity producing miners. A decade ago, three of the five resource companies in the top ten were single stock commodity producers. Today, only Sasol remains on that list and even they are in a race to diversify their earnings from oil. The reduction in resource weighting over the decade can largely be explained by the end of the Chinese-fuelled commodity boom of the early 2000s. However, despite China not growing its commodity consumption at the same rate as it did a decade ago, its influence on our market has not waned. Both Naspers and Richemont, which make up a quarter of the local market cap, derive the majority of their profits from Chinese consumers. It turns out that the Chinese government’s drive to reconfigure their economy from investment led to consumption led has fully played out on our local market. With China soon to be the largest global economy, this is a trend I believe will continue to influence local market returns to a great extent.

The rise of technology
Looking at the US equity market - which makes up close to 70% of global equity market capitalisation - it is clear to see what the winning theme over the last decade has been: technology. Today, five of the ten largest S&P 500 companies are tech companies. Of interest to us is the fact that of the large tech companies, only Microsoft was in the top ten a decade ago. This best exemplifies how enduring Microsoft’s offering is or how deep its competitive advantage is. A lot of credit also needs to be given to Microsoft’s current management team who have steered the old ship (in technology years) and allowed the group to retain its foothold within enterprise software despite all the new entrants.

Interestingly, some of the largest technology companies today have barely been around for 20 years, which further highlights how quickly technology is evolving. This raises the interesting question of which of the current tech companies will still be dominant (or existent?) a decade from now?

Graph 2: Ten largest S&P 500 listed companies by market cap: 2008 vs 2018

Source: Old Mutual Wealth Private Client Securities

Too big to fail?
If anyone thinks it’s far-fetched to question the future existence of any of today’s large companies, then one need not look much further than General Electric (GE). At its peak, GE was the most iconic American company that was well diversified across multiple industries and geographies while employing in excess of 400 000 people. However, a series of management errors led to the company’s epic fall from grace. Consider this; the cumulative profit that GE has reported in the last seven years is less than what they reported in one financial year a decade ago. The key lessons are that free cash flow (while typically great) in the hands of a bad management team can quickly destroy value, and safety does not come from simply being the largest.

Defensive growth
Of the four global shares that have retained a spot in the top ten over the decade, Johnson & Johnson (J&J) is one that would surprise many people. Firstly, it is the only company that can be considered a ‘defensive‘ on the 2018 list – Pfizer, AT&T and Procter & Gamble have all fallen off the list over the decade. Secondly, J&J do not cater to a high growth industry like technology. And yet, the company has retained its position and generated respectable shareholder returns despite already being a behemoth a decade ago. In our view, some of the key reasons behind J&J’s endurance are good capital allocation around mergers and acquisitions and a portfolio that is exposed to important health trends. Most of J&J’s acquisitions tend to be smaller in size, reducing the risk of failure. Added to that, the group consistently spends over 10% of its revenue on research and development, ensuring that they have some of the leading drugs in the markets they operate in.

There are plenty more lessons that can be gleaned from how market constituents have changed over the last decade. This alone demonstrates how dynamic markets are over time and highlights the importance of understanding the bigger picture themes that play out over years, such as the reconfiguration of China’s economy and the rise of technology. At a time when short-termism and instant gratification prevails, looking at one’s investment portfolio, or the market, over the real long term certainly gives an interesting perspective and some important lessons to take into the next 10 years. #20yearchallenge.

 

 

 

 

 

 

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