Beating the stock market – and passive index funds – isn’t easy. Recently, a study showed that a whopping 90% of active US large-cap managers had underperformed the S&P 500 index over the last 15 years.
It is possible to beat the market and generate higher returns than on offer from tracker funds though. Here’s how.
Letting winners run
If your goal is to beat the market, the single best thing you can do is let your winners run. Most professional fund managers are not able to fully do this.
You see, most fund managers are forced to trim their winners for risk management/compliance reasons. Typically, their compliance departments will stop them holding more than 5% of their portfolios in specific individual companies.
This limits their gains and negatively impacts their overall performance. Because they can never really truly benefit from big winners like Nvidia, which is up 185-fold over the last 10 years.
The good news is that retail investors don’t face these restrictions meaning that they can let their winners run and run. All you need is a few big winners, and market outperformance is very achievable.
Taking a long-term view
Another important strategy is to take a long-term view. This is where the big gains are generated — just look at Nvidia’s 10-year gains.
Again though, most pros can’t really do this. This is because they’re judged on their monthly, quarterly, and annual performances and can get fired if their performance is lousy.
As a result, they tend to be focused on trying to find stocks that will outperform in the short term. Consistently identifying short-term winners is very hard, however.
This is where retail investors have a massive edge over the pros. We don’t need to worry about short-term performance and can focus on long-term stock market winners.
Owning small-caps
Finally, another powerful market-beating strategy is to own some small-cap stocks. Occasionally, these stocks produce huge gains meaning that they can really boost overall portfolio performance.
An example here is Applied Nutrition (LSE: APN), a UK-listed protein and supplements company. Its share price is up about 38% in a month and 135% in a year (versus 0% and 18% for the FTSE 100 index).
It’s rising like this because the company is growing at a spectacular rate. This financial year (ending 31 July), its sales are expected to amount to around £150m versus £107m last year.
It has also seen gains as a result of an upward valuation re-rating – a year ago it was trading quite cheaply despite its growth. You often see this kind of disconnect between fundamentals and valuations in this small cap space because these stocks are not researched to the same degree as large-cap stocks are.
Now, the vast majority of fund managers can’t touch this kind of stock. It’s just too small at a market cap of £745m. They would end up owning too much of the company if they deployed capital into it.
Retail investors can though. This stock could be added to an ISA or SIPP to sit alongside blue-chip stocks or funds.
Personally, I think it’s worth a closer look (I own some shares myself). There are risks around competition and growth rates but with the forward-looking price-to-earnings (P/E) ratio in the low 20s, I see potential for further gains.
Should you invest £5,000 in Applied Nutrition Plc right now?
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Edward Sheldon owns shares in Applied Nutrition and Nvidia
