From the editor

By Tony Featherstone, editor

Consider this: about 69 per cent of Australian retail equity funds failed to beat the S&P/ASX 200 Accumulation index over five years to June 30, 2012, according to the S&P SPIVA Australia Scorecard for mid-2012. Over one and three year, about 72 per cent of funds could not beat their index.

In other words, the majority of unlisted managed funds struggled to achieve a return higher than their relevant benchmark index (in this case, the ASX 200, against which they compare returns) over time. Add in fees, and investors might wonder why they pay professionals to achieve a return less than the market.

Yes, some large-cap Australian equity funds produce stellar returns over time. Others produce strong gains over short periods, and underperform over longer ones. But the inescapable conclusion is that consistently achieving a higher return than the ASX 200 index requires great skill.

Of course, many retail investors care only about absolute, not relative returns; whether they underperform or outperform a certain benchmark index is irrelevant, so long as the return is acceptable. If your share portfolio consistently achieves a lower return than the S&P ASX 200, it might be time to consider a low-cost ASX-listed exchange-traded fund (ETF) that replicates an index return.

The good news is that 80 per cent of Australian equity small-cap funds outperformed the S&P/ASX Small Ordinaries index over five years to June 30, 2012, the SPIVA report showed. This finding, consistent over several years, shows there is greater potential to achieve a higher result than the market return using small and mid-cap stocks.

The result makes sense: sharebroking firms typically devote fewer resources to cover small and mid-cap stocks, as does the financial media. There are more pricing inefficiencies in small and mid-cap stocks (stocks that are overvalued or undervalued) simply because fewer investors look at them, compared to ASX 200 companies.

That does not mean investors should rush into small and mid-cap stocks. As a general rule, smaller stocks have more risk than larger ones: small companies might rely on one product or market, be less established, need plenty of capital to grow, and have lower liquidity in their shares. Conservative investors might prefer to stick to household-name stocks or ETFs that invest in them.

Seek financial advice, or do further research of your own, about whether small and mid-cap stocks suit your investment goals and risk tolerance. If so, consider a portfolio approach that allocates a portion of funds to such stocks, either directly or through Listed Investment Companies or ETFs.

This ASX Investor Update has plenty of stories to help you start. The Top Feature, by Lincoln's Elio D'Amato, considers the financial health of the small and mid-cap universe and nominates stocks that meet the firm's investment criteria. The Barefoot Blueprint's Michael Kemp provides another excellent educational article to help readers understand the language of small-cap investing.

The Australian Technical Analysts Association's Gary Burton considers small and mid-cap investing from a charting perspective, and Contango's Boyd Peters outlines the features, benefits and risks of using a Listed Investment Company for small-cap exposure.

Elsewhere, Evans & Partners' Michael Saba outlines how Exchange-Traded Australian Government Bonds will work, and ASX's Head of Education, Tony Hunter, explains ASX online resources that can help you learn the basic about investing in bond or other interest rate securities.

As always, do not act on newsletter themes or ideas without doing further research or talking to your financial adviser.

About the author

Tony Featherstone is consulting editor of ASX Investor Update.