In our previous column of March 28th entitled “Prefer active management to passive management by choosing your stocks carefully”, we showed that management exclusively focused on so-called “growth” stocks made it possible to beat so-called index management invested in ETFs over the long term.
These initial reflections led us to pursue them by paying new attention to the functioning and composition of the CAC 40. This index is supervised by a Scientific Council. From this we understand that the Council is made up of scientists and not managers. This crucial distinction contains the seeds of conditions that are specific to beating the index.
The Scientific Council does not understand anything about the Stock Exchange
This is our chance. You should know that the sole mission of the Council is to provide institutional investors with a “large” index composed of the largest capitalizations on the market, with a large float and offering a large trading volume. This satisfies the interests of large investors including ETF issuers.
It is up to us to understand that The star index of the Paris Stock Exchange is in the hands of people who in reality understand nothing about the Stock Exchange in the sense that a manager understands it.
The Scientific Council does not select the most beautiful values with the best business models but the biggest ones. The Council, being focused on quantity, is in opposition to quality-conscious managers. And It is thanks to this divergence in the criteria for selecting values that we have a card to play.
The flaw to exploit
The composition of the CAC 40 suffers from two main flaws: the confusion of styles and the priority given to large values.
The index plays all styles at once, growth stocks, cyclical stocks and “values” (discount). As a result, one of the styles is constantly dragging down the overall performance.
In the same index, Hermès and Renault rub shoulders, EssilorLuxottica et Orangecertainly not with the same weightings but that does not detract from our reasoning.
A revealing fact: since the presence of values results solely from the weight of their capitalizations, Teleperformance which capitalizes 5 billion euros is still included in the index while this title lost 70% of its capitalization between 2022 and June 2024.
Another trap
This trap is similar to a kind ofoptical illusion produced by the view of the composition of the CAC 40. We see an amalgam of various values and styles, sending the manager the feeling that his fund must also be in the image of this panel, as if it were a model to follow, hence a drift towards “benchmarked” management (stuck to the index), implicit or explicit.
The recognition of this illusion then acts as an encouragement to detach ourselves from the purely quantitative composition of the index.
If, moreover, we are convinced of the long-term superiority of “growth” management, then The counterproductive mix of styles imposed on the CAC 40 gives us a real chance of beating it.
There is one condition for this: resist the temptation to pick and choose a stock here and there that you think is close to an upward movement, holding on to it long enough to stock up on capital gains, then tiptoe back out, thanking heaven that everything went well and, worse, that you escaped the “value trap”.
Hermès does better than LVMH
An example: Among the forty values of the index, LVMH being the largest capitalization logically appears at the top of the list with a weighting of 10.69%, while Hermes only ranks ninth with a weighting of 3.99%.
However, their stock market performances argue for an inverse classification. Whether over ten years, five years, three years or one year, Hermès beats LVMH hands down. It is very likely that the same will be true for the next ten years, in any case, it is a risk worth taking.
This outperformance is explained by the profitability ratios structurally higher than those of LVMH. In 2023, Hermès’ margin (operating profit/turnover) was 46.4% while that of LVMH was only 31.3%.
Knowing how to reverse priorities
To take advantage of this aberration and boost our performance, we simply need to reverse the order of priorities. Where the Council gives priority to quantity, we give priority to quality.
This reversal of priorities would have allowed us, over the past ten years, and for these two values alone, to take a large lead over our flagship index, up only 71% without dividends. As for dry, it should not even be in the index and even less in our portfolio. The same goes for Sanofi, for the three banking stocks, for Orange, pour Stellantis et Renault, pour Carrefour, Arcelormittal and some others.
