- Most retail investors who pick stocks find themselves lagging the performance of S&P 500 trackers.
- In order to get a real edge on the market, you have to find unglamorous, but high-quality companies that most miss.
- Investing expert Jonathan Francis explains how funds he works with pick the small group of stocks they invest in.
Beating the index is not easy. The majority of retail investors who pick stocks find themselves lagging the performance of a simple S&P 500 tracker over long time frames.
Even professional fund managers often struggle to consistently beat market trackers, particularly when their fees are factored in.
If you are going to beat the index, you are going to need to stray off the most well-trodden path and identify some stock market gems that most people have missed.
This is easier said than done, particularly in the US market, which has such deep and wide ranging coverage from analysts and the media.
Jonathan Francis, head of investment research at advisory firm Harrington Cooper, explained to Insider how one of the mutual fund firms he works with goes about this tricky task. As shown in the chart below, the strategy has returned around 380% since launch in 2008 versus 320% for the S&P 500.
“The Snyder US All Cap Equity Fund’s managers aim to identify quality businesses that are misunderstood by the market for some reason, he said. “This tends to take them into less glamorous parts of the market.”
“So, rather than owning things like the FAANG stocks they’re looking in the industrials sector. They own waste management companies, ball bearings companies. These other areas aren’t quite so glamorous, but actually names within that have really generated the performance. They are looking for smaller, compounding companies.”
Another key aspect of beating the wider stock market is having what is known as a concentrated portfolio. In simple terms owning a relatively small number of stocks, rather than taking a scatter-gun approach across many names. Around 20 to 30 stocks would typically be considered a well concentrated portfolio.
Launched in 2008, the Snyder fund has significantly outperformed the S&P 500 by taking this approach. It is important to keep in mind that while you need to differ significantly from the main market to outperform it, you also run the risk of underperforming it if you pick the wrong stocks.
“Over time the fund has done a lot better protecting on the downside and it tends to do better when there’s a focus back on fundamentals and valuations,” Francis said. “They’ve got very low turnover approach and they’re really looking to hold most of these businesses forever if they can.”
Francis said investors seeking to achieve this kind of success should try and find companies set up for long term success due to operating in industries or sectors with very high barriers to entry. This means it is difficult for a new company to set up shop doing the same thing, and compete with the incumbents.
He also pointed to “defensible economic moats’, a term that means existing potential competitors find it hard to take customers away because of the specific features of the product offering, and that the company is well shielded from downturns in the economy.
“Next, you’re looking for management teams who are very good stewards of capital and are investing in projects or new business lines where they are going to be able to compound returns and increase free cash flow,” he continued.
The Snyder fund is also targeting stocks which can perform well in a rising interest rate environment, as is expected to be the case for the rest of the year and into 2023.
In terms of specific examples, Francis pointed to some of the top holdings in the Snyder All-Cap fund, and a couple of recent additions.
The fund recently added KBR. It was an oil field services business, but the company has been exiting its legacy oil business and is now building new services targeting technology around green fuel and the Snyder managers believe the market has not priced this in yet.
Another recent addition to the fund came in the shape of Catalent, a firm that designs manufacturing processes for pharmaceutical drugs and treatments. It is exposed to a number of high growth areas, such as the delivery of personalized therapy.
Waste Connections is the fund’s largest holding, and as the name implies is a waste management business. It certainly fits the “unglamorous” billing but is a great business in other ways, Francis said. He noted industrials company FMC Corp is another business that Snyder believes is undervalued by the market.
For similar reasons, the fund holds utilities company UGI Corp, advanced materials company Entegris, semiconductor maker Analog Devices, another waste firm; Clean Harbors, fiberoptic cabling company Amphenol Corp and biotech firm Halozyme Therapeutics.