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FT editor Rola Khalaf picks her favorite stories in this weekly newsletter.
The writer is a contributing editor to the FT
Current sale In the technology sector resulting from the progress of the company Deepseek in the company Deepseek, a reminder of the risks of the concentrated stock market. The 10 largest stocks account for nearly two-fifths of the S&P 500. Such concentration is unprecedented in the modern era. Increasingly, equal-weighted index products, which invest the same amount of money in each stock in the benchmark, are being touted as a way to avoid the risk of an ever more concentrated portfolio. Should investors heed these calls?
More concentrated stock markets make for passive portfolios less diversified. But this need not be a problem for returns or even risk-adjusted returns. Having a third of your portfolio in a handful of stocks that accumulate high double-digit returns has been great for passive investors in recent years, if less so for active managers who are short on big tech.
There are good reasons why the largest companies are highly valuable. Today's star companies capture global economies of scale. They create and control valuable intellectual property and have demonstrated the ability to commercialize it. Their profits were growing rapidly and constantly. Market prices tell us that investors believe this trend can continue.
But the most valuable companies today are rarely the most valuable companies 10 years ago. research Written by Bridgewater Associates, last year examined the performance of America's most valuable companies going back to 1900. By assembling a new group at the beginning of each decade and tracking their relative performance, the authors found that a market-weighted basket of the 10 largest stocks underperformed 22 percent of the time. During the next decade. Run the clock forward three decades, and this poor performance has extended to 53 percent.
This dynamic is healthy. Yesteryear's star tech companies like Eastman Kodak, Xerox, and Lucent have been replaced by Apple, Amazon, and Alphabet today. A combination of spirited market competition and effective antitrust machinery is the key to economic growth.
It is possible that today's megacaps are more successful than their predecessors at either reinventing and disrupting themselves to avoid competitors, or at stifling competition and seizing control of the government. But to believe that is to believe that this time will be different. And for long-term investors considering equal index products, this is the big call. Reversion to a less concentrated market requires poor performance by the largest companies. This is likely driven by outperformance by equally weighted index trackers.
No one can know if today's Tech MegaCap titans will maintain their market presence, or perhaps even grow. A year ago, the elastic range seemed extended. Since then, the so-called Magnificent Seven have delivered an average return of more than 60 percent in 2024. There is certainly no built-in quantitative model that predicts the future. Thus, like a lot of investing, it comes down to a judgment call.
Goldman Sachs published its call in October. In his judgment, today's index focus will rest, and the impact on long-term return estimates is profound. The bank's forecast team, led by David Kosten, estimates that the S&P 500 will return just 3 percent annually over the next 10 years. With no change in index concentration, their call was a return of 7 percent per year. As such, its base forecast is for stocks to underperform the US Treasury – a historical rarity.
One of the attractions of passive investing on a market-weighted basis is that it offers a free ride on markets made efficient by the analytical toil of active investors. Passive investors do not need to take a view on the prospects of any individual company. Investing in an equally weighted index fund, by contrast, is to reject the idea that the stock market is efficient.
Equal Weight Index products are a way to get exposure to US stocks without betting that this time will be different. They offer investors diversification, but they run the risk of losing it if the Fab Seven continue their upward march. As the late Charlie Munger noted, “Diversification is for the known investor.” His point was not that diversification was stupid, but rather that it diluted any insights professional investors might have. Theory dictates that a well-known Munger investor would do best by investing in a market-weighted index. For those who want to capitalize on the view that today's intense focus will return to mean that equally weighted index products may be more attractive.
