This investment strategy has beaten the ASX by 10% over the last seven years

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Equity analysts from Credit Suisse have selected a basket of Australian stocks that typically outperform the market, based on the preferences of both stock brokers and their clients.

The latest research note from Hasan Tevfik and Peter Liu takes a look back at 2017 and the relative performance of broker recommendations against investor preferences.

And this year, brokers beat the buy-side — the third victory for brokers since 2011:

The pair’s analysis is based on the net long/short positions among both brokers and investors. In other words, the composite return from stocks they rate a buy and those they expect to fall in value.

They said brokers tend to perform better in a bull market, while investors prefer stocks which have less volatility and more earnings certainty.

“Going into 2018, we find the buy-side consensus is long mining service companies and is nervous on the Aussie consumer,” Tevfik and Liu said.

On the other hand: “The top three buys for brokers are CSL, Bluescope and Link Administration — all very different stocks.”

But while stock brokers and investors have different preferences, there are some stocks the two sides agree on — and those particular companies have a strong record of out-performance.

Stocks which generate consensus between the two sides form what Tevfik and Liu call the “Double Consensus Long” strategy (DCL).

Going into 2018, three companies fit the criteria: Asset manager Janus Henderson, healthcare company CSL, and Qantas.

“Our DCL strategy has generated returns of 18% per annum. over the last seven years,” the analysts said.

“By comparisons, the ASX100 has provided a total return of 8% p.a. In 2017, our DCLs included Caltex, Aristocrat, BlueScope and ResMed, which returned an average of 38%.”

To determine broker preferences, the two analysts simply chose stocks most commonly recommended to buy. While on the investor side, they highlighted the companies with the smallest number of outstanding short positions.

“The performance of DCL might surprise some fund managers as it contradicts one of their inherent beliefsā€”don’t follow the consensus. However, closer inspection reveals as to why this strategy performs well,” the analysts said.

They explained buy-side investors look for quality stocks with stable profits, while brokers are on the hunt for value — stocks which look cheap with the potential for future earnings growth.

“The DCL buys stocks that rank the highest on both. The message from DCL is clear — some of the most consistent returns are generated when the buy-side and brokers work together.”

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