Boston - Global equities have staged a remarkable rally since the March lows, with the MSCI ACWI and the S&P 500® Index gaining approximately 30% through May 31, 2020. The recovery and participation of stocks to date however has not been broad-based, as a handful of stocks and sectors have driven much of the heavy lifting.
Such narrow leadership has ushered in an era we call the Great Concentration, where just a few positions account for an outsized weight of the market's total capitalization — and thus many of the benchmark indexes that they constitute. This poses yet another "new normal" for the market and a potential risk for investors.
Anatomy of a cap-weighted index
The S&P 500 is widely regarded as the best single gauge of large-cap US equities. To be included, companies must have an unadjusted market cap of $8.2 billion or greater. Index provider S&P Global claims that over $9.9 trillion in assets are now indexed or benchmarked to the S&P 500, with indexed assets comprising approximately $3.4 trillion of this total.
Despite the name, the index actually includes 505 leading companies and covers approximately 80% of the available US market capitalization. According to Ned Davis Research (NDR) as of May 31, 2020, the top five positions in the S&P 500 account for 20.6% — the highest share since the early 1980s and 40% higher than the 48-year average.
Index rebalancing season
The S&P 500 Index is rebalanced on a quarterly basis. By contrast, the FTSE Russell family of indexes is rebalanced annually in late June. Over $8 trillion in assets are benchmarked to the Russell US indexes, according to FTSE Russell data as of December 31, 2018. The Russell 1000 Index includes approximately 1,000 of the largest securities based on their market caps and represents over 90% of the US total capitalization.
Style indexes such as Russell 1000 Growth and Russell 1000 Value provide for additional flavors of the US large-cap investable universe. Currently, the top five issuers represent 32% of the Russell 1000 Growth Index and are projected by Credit Suisse to increase to 36% after the upcoming rebalancing on June 26. That would be the highest share over the past 20 years and more than 85% higher than the 20-year average. Similarly, Credit Suisse expects the top 10 positions to increase from 40% to 45%.
Passive buyers beware
Many of the stocks in the top ranks of these indexes have "earned" their way there. The recent leadership could possibly remain, but nevertheless presents a concentration risk under the current circumstances — particularly for investors accessing their equity exposure passively.
As an example, every $1 passively invested in the S&P 500 Index allocates approximately $0.20 to just five companies, which on average already outperformed the S&P 500 by 20% year to date and trade at an 80% premium to the market and more than a 100% premium to the median company in the S&P 500 Index.
Bottom line: In the new normal we call the Great Concentration, we believe active stock selection and allocation might offer a better alternative.