Strategy

Gimme Shelter

William Heathcoat Amory

Kepler

Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.

Sometimes it feels safer to run with the herd. Like it or not, you will likely be doing exactly this with your investment portfolio. On a global basis, it has been such a feature of equity markets that the biggest have got significantly bigger, increasingly driving overall performance, and at the same time becoming a greater and greater proportion of market-cap-weighted indices. In fact, this has mainly been a feature in US equity markets, the effect of which has spilled over into global indices, because of the sheer size of the US’s biggest companies which means they make up a huge part of global benchmarks.

According to statistics from JPMorgan, within the S&P 500, the market-cap share of the largest ten stocks relative to the broader market—is at the 86th percentile relative to history and stands at 29.4%. As we show below, this has led to a significantly divergent performance of the weighted vs the unweighted version of the index. According to JPMorgan the “Magnificent Seven” (of which more below) delivered returns of 101% over 2023, whilst the equal-weight index delivered a return of 2.5%. In other words, if you were a stock picker or aimed to have a vaguely diversified portfolio, it was an impossible year in which to deliver outperformance.

Whilst this isn’t necessarily of concern to investors, it will be of concern to active fund managers, who need these sorts of market phenomena like a hole in the head. With pressures on fees and the rise of cheap passives, looking at the graph below it is hard to argue that investing in an S&P 500 tracker hasn’t been the right thing to do.

WEIGHTED VS UNWEIGHTED

Investing in a market-weighted US or Global ETF during 2023 would have resulted in the outperformance of active managers at a low cost. On the other hand, indices are not “intelligent” capital allocators as such, but they are allocating capital for you—not based on anything other than what other people are investing in. This is reassuring in some way. No one likes being out on a limb, particularly when the downside of doing so is acute. Imagine a swimmer noticing the previously bustling shoreline full of other swimmers who are now all standing on the beach. Is it possible to imagine them being able to continue to enjoy their swim? Of course not. Humans are (generally) programmed to ask—what have I missed? Why am I here on my own? What awful predator has everyone else seen, but I haven’t? Irrespective of the very remote likelihood of being shark food, 99.9% of swimmers will get out of the water—sharpish!

Investors in an ETF of either the MSCI World or the S&P500 will find that, after many years of startling returns, a material part of these holdings is now represented by the seven stocks we show in the table below. More and more people are now standing on the same patch of beach!

£1,000 INVESTED TODAY IN AN ETF

STOCK	ISHARES MSCI WORLD ETF (£)	ISHARES S&P 500 ETF (£)
Microsoft	45.60	71.10
Apple	44.90	62.20
Nvidia	30.60	45.40
Amazon	25.60	37.10
Meta	16.90	25.10
Alphabet (Class A and C)	25.40	36.80
Tesla	8.60	12.40
£ Total	197.60	290.10

Source: iShares, as at 23/02/2024
Past performance is not a reliable indicator of future results

It takes a brave investor to peel away from these darlings of global stock markets and get back in the water. However, in our view, it makes absolute sense from a risk management perspective, to rebalance, take profits, and reallocate elsewhere. 2022 provides a good illustration (see below) of what can happen when the tide goes out. All of these companies underperformed world indices by a considerable margin, and it is hard to argue that the same could not happen again should sentiment turn.

2022: NOT SO MAGNIFICENT

Source: Morningstar
Past performance is not a reliable indicator of future results

Find me shelter!

Swimming against the tide is hard when you are investing. It takes tenacity, self-confidence and a willingness to be wrong until you are (eventually) proved right. As such, turning away from the Magnificent Seven will take a certain level of fortitude. But we all know that nothing lasts forever.

Aside from mitigating stock-specific risks, which as we show are increasingly prevalent in indices, adding less correlated returns to a portfolio adds to risk-adjusted returns. That said, given the financialisation of everything, the level of connectedness amongst investors globally, and the globalisation of capital flows, it is likely that if the Magnificent Seven hit turbulence, then stocks everywhere will feel the effect from a sentiment perspective. However, after the initial shock, we think fundamentals will eventually re-assert themselves, and so in our view, it makes sense to look within equity markets for other areas of growth which potentially offer very different drivers to those of the biggest listed companies in the world. We therefore examine various complimentary growth opportunities, which might make sensible avenues to explore for re-investing those magnificent profits into.