Be disloyal: why blue chips may be costing your clients 

There is a phrase that has quietly shaped how generations of wealth clients think about the share market. Buy blue chips. Hold them forever. What could possibly go wrong?

According to Dion Hershan, executive chairman and head of Australian equities at Yarra Capital Management, quite a lot.

The risk of holding broken blue chips is more common than most investors realise. His research framework is built around a deceptively simple distinction: there are blue chips, and there are broken blue chips.

The evidence he marshals is uncomfortable. QBE had higher earnings in 2007 than it does today. Telstra’s earnings peaked more than a decade ago. Of the current ASX 20, around fourteen companies have lower earnings today than they did five years ago. “Just because a company is large,” Hershan says, “it doesn’t speak to their forward prospects.”

A market propped up by flows, not fundamentals

The ASX 20 has delivered price gains of around 35 per cent over three years, despite earnings contracting by roughly 2 per cent a year over the same period. Hershan’s explanation is structural.

The shift toward passive investing, quantitative strategies and high-frequency trading has pushed a weight of money into large-cap stocks regardless of underlying business performance. Valuations have now stretched to around 20 times forward earnings, a level he describes as almost without precedent.

The danger for advisers is confusing that price performance with health. “The outperformance doesn’t emanate from strong business performance,” Hershan says. “If anything, it probably speaks to a vulnerability around valuations.”

When broken blue chips change their stripes

For Hershan, the central research question is whether a company is changing in ways that erode its long-term earnings capacity. The signals he watches for are recognisable: poor capital allocation, ill-conceived acquisitions, weak leadership and shifts in industry structure.

Large companies, he argues, are often the least equipped to respond. Many pursue growth through M&A, and the evidence that most acquisitions destroy rather than create value has been accumulating for decades.

The broader environment makes this more acute. Technology disruption is accelerating and geopolitical shocks are becoming more economically consequential. The playbook that served a previous generation was written in a less volatile world. “We’re definitely in a period where technology disruption is going to be absolutely profound,” Hershan says.

“Be vigilant when you see businesses that change their stripes. When you see significantly better opportunities, don’t hesitate to rotate. That’s why we use the phrase: be disloyal.”

Where the real growth opportunity sits

The more interesting opportunity, in Hershan’s view, sits further down the capitalisation spectrum. Mid-cap companies occupy a sweet spot: proven businesses with sound balance sheets, but not yet mature enough to have exhausted their growth runway. Product expansion, cross-selling and entry into new geographies are paths they can pursue without the organisational inertia that slows larger peers.

Hershan points to ResMed and Carsales as illustrations. Both established dominant positions domestically before carefully extending their playbooks into international markets. They represent what he is looking for: proven models with room still to scale.

The macroeconomic backdrop reinforces the case. Australia faces prolonged low growth, falling productivity and rising debt levels. Banks and major miners, which dominate the ASX 20, are directly exposed to those headwinds. “We’re not looking to buy exposure to the Australian economy,” Hershan says. “We’re trying to find the outliers.”

The franking credits distraction

One reason concentration in large-cap stocks has proved so durable is franking credits. The tax advantage has been a powerful anchor, keeping investors in high-yielding names and reducing the incentive to look more broadly.

Hershan’s view is that this framing has been costly. Franking credits account for only around 10 to 15 per cent of the total long-term returns of the Australian market. Over the full cycle, roughly half of equity returns come from capital appreciation. A portfolio optimised for yield and franking is chasing a minority share of the available return.

The counterintuitive warning sign is a very high dividend yield, which tends to reflect past success rather than future earnings capacity. “Some of the worst leading indicators for a stock’s future performance is a very high dividend yield,” Hershan says. “It speaks to prior success, not actual future success.”

What disloyalty looks like in practice

For advisers, this argument requires shifting the client conversation away from the comfort of familiar names and toward the question of whether those names are still earning their place.

Hershan is clear that disloyalty is not a trading strategy. It is not about chasing momentum. It is about maintaining vigilance over whether portfolio holdings are strengthening or deteriorating and being willing to act when the evidence points in one direction. That may produce higher turnover. Hershan believes it should also produce materially better returns.

A market in which 62 per cent of the ASX 200 is concentrated in 20 companies, many with a decade or more of stagnant or declining earnings, does not reward passive acceptance of index composition. The more interesting opportunities may well sit in the 180 companies below.

“Those companies are not loyal to you in the sense of generating long-term returns,” Hershan says. “So be disloyal.”