In the landscape of investment, a significant transformation is underway as the shares of prominent US technology firms continue to propel stock market trends in 2023. The Financial Times reports that the focus on artificial intelligence has notably driven stock prices, particularly among major companies such as Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla. Collectively, these corporations constitute a substantial portion of the S&P 500 index, accounting for approximately half of its gains as of October.
This surge in performance from tech giants has led to a remarkable shift in portfolio management and investor strategies, as the concentration of these stocks within the index has resulted in tighter correlations across active funds. Active fund correlation measures how similarly funds perform, and the current environment indicates that many funds are mirroring one another, which raises concerns among fund managers.
James Thomson, manager of the equity-based Global Opportunities Fund at Rathbones Group, highlighted this trend as a potential source of anxiety, stating that "it’s a struggle for active funds to outperform in a concentrated market." He emphasised the challenges faced by fund managers when returns are predominantly coming from a handful of stocks that hold high index weightings.
According to Bank of America, the top 10 stocks in the S&P 500 now represent more than 35 per cent of the overall index—marking the most concentrated weighting seen in four decades. Such concentration was evidenced earlier this year, when the index experienced a 5 per cent decline when excluding these tech stocks, yet rebounded with a 7.6 per cent gain when they were included, as per data from JPMorgan.
The implications of this trend extend beyond the US market, with the seven major tech companies representing 12 per cent of the market value of the MSCI World Index, which encompasses about 1,397 stocks internationally.
The rise of these tech stocks has compounded the challenge for actively managed global equity funds, leading to results akin to index trackers. Fund managers now face increased pressure to differentiate their portfolios amidst growing similarities. This proximity in performance among funds exposes investors to the risk posed by a market correction, which could disproportionately affect those heavily weighted in the top tech stocks.
Joe Wiggins, investment research director for St James’s Place, noted that the concentrated nature of current stock markets limits the flexibility for fund managers to create diverse portfolios. The reduction in new listings and robust merger and acquisition activity has further compounded this concentration in equity markets, creating corporate behemoths while limiting the options available for distinct fund strategies.
Wiggins also raised the "zeitgeist" effect, referring to how certain market narratives—particularly the current enthusiasm around artificial intelligence—affect investment dynamics. This prevailing sentiment results in a significant influx of capital into select stocks, thus inflating their market capitalisations and perpetuating sector exposure.
Dan Brocklebank, head of UK at Orbis Investment, pointed out that this phenomenon may lead to powerful influences on portfolio management, where fund managers feel compelled to follow the popular trends rather than pursue a contrarian approach.
Communication between fund managers and investors plays a crucial role in navigating these challenges. At Orbis, Brocklebank has indicated that maintaining a low correlation between their funds and popular stocks is a priority, and that transparent discussions with investors help reinforce this strategy.
Strategies to combat high correlation risks are also being explored. Chris Mellor, head of EMEA ETF equity product management at Invesco, has suggested an equal-weighted approach to investments, ensuring that each holding represents the same percentage within a portfolio. This approach could help mitigate the risks associated with high concentration while still allowing for exposure to market leaders.
Alternatively, Brocklebank proposed the concept of “top-slicing” profits from major tech stocks and reallocating the proceeds into a broader range of equity opportunities, thus reducing exposure to the concentrated tech market.
As investors and fund managers grapple with these significant trends in AI and stock market dynamics, the underlying structure of corporate incentives and management practices will be essential in promoting genuine diversity within portfolios and ultimately achieving long-term success.
Source: Noah Wire Services