One of the things that has always interested me about markets is the use or misuse of benchmarks such as the All Ordinaries Index or the S&P/ASX/200. I am always interested in how people measure the success of their portfolio against such tools – in part it makes sense but in part, various indices also convey a false sense of how the market is doing and in turn how a given portfolio should be doing. Granted if you are a professional money manager then there should be some way of accessing whether they bring any actual value to the investing process and this is done by comparison to a benchmark. However, for the majority of investors/traders, the index doesn’t really mean much but more importantly, it also means that in light of the performance of an index most stocks are duds.
Consider the long term chart below of the S&P/ASX20 versus the S&P/ASX200.
As you would expect they track together in terms of performance. However, I was interested in the performance post the COVD bounce and so generated the following chart.
In terms of raw performance, the larger index leads the way – in simple terms mass moves mass – it has more components from which to draw performance. But the important question for me is how much of the performance of the S&P/ASX200 is actually generated by the stocks in the S&P/ASX20. The answer can be found below.
At any given time in terms of the performance of the S&P/ASX200, the price movement of stocks in the S&P/ASX20 can account for between 94.5% and 100% of the movement. The extension of this is that the other 180 components of the S&P/ASX200 probably don’t do much. Outside of passing academic interest, what does this mean for the average investor? It means if you have a portfolio of stocks that is not heavily linked to the movement of any major index then using the index to tell you anything about the state of your portfolio is probably a silly idea.
I also think it has implications for the universe you choose to trade – if you are scanning an index such as the S&P/ASX/200 looking for the next big winner then you are probably looking in the wrong place.