Apple’s heady rise highlights perils of concentration

Date published: 10 January 2020

Richard Henderson

Stock markets set a curious record last year: Apple gained more in equity value than any other company in history. But rather than gawp at the rise, equity investors need to consider whether the size of the company, and that of its brethren among the top five in the US — Microsoft, Amazon, Facebook and Google’s parent Alphabet — presents a growing risk to their portfolios.

Apple’s stock surged 86 per cent in 2019, sending the iPhone maker’s market capitalisation to $1.3tn — a gain of $556bn. That in itself is bigger than all but the top four S&P 500 companies, and is roughly equal to adding the entire Spanish or Italian stock market.

The gains owe much to the peculiarities of the calendar. Shares in the Cupertino, California-based group faded toward the end of 2018 when it revealed weak sales forecasts in China, and slid further during a general December sell-off that year. So the rise came from a low base. Yet keep in mind that 2019 was no banner year for Apple product launches, and the market was not wild about the streaming service unveiled in March.

The problem is that giant stocks such as Apple make up a sizeable chunk of the market, but deliver gains beyond their weightings. This puts fund managers in a bind: many are loath to load up on these bulky stocks, fearing the subsequent concentration — too much risk spread over too few stocks — will erode the benefits of diversification. But in doing so, fund managers may miss the outsized returns that can skew to the larger names. Put simply, the challenge for fund managers is not owning too much of these megastocks, but not enough of them.

This is not a new development. Over the past decade US stocks that outperformed the broader market were mostly among mega-cap companies “which are difficult to overweight, given the amount of fund concentration required”, Savita Subramanian, a Bank of America analyst, said in a note this week. She estimates that only 32 per cent of the stocks in the S&P 500 managed to beat their own index, compared with almost half in the previous decade.

But last year’s market rally was undoubtedly narrow. Apple alone accounted for one-tenth of the 29 per cent rise of the S&P 500 last year, according to data from Bespoke Investment Group. The top five listed companies as a unit, meanwhile, were responsible for about a quarter of the market’s gain. “They’re obviously punching above their weight,” said George Pearkes, macro strategist for Bespoke.

To some analysts this level of concentration is worrying, as it has echoes of the dotcom bubble in 2000. Back then, the top five companies represented 19 per cent of the S&P 500 at the peak of the market. Today that share is 16 per cent.

“You saw a handful of companies dominating returns” 20 years ago, said Michael Mullaney, director of global market research for Boston Partners, a value fund manager. “Today this is eerily reminiscent of that time. If you didn’t have a market weight in Apple and Microsoft last year, how in God’s name could you beat the S&P 500?”

There are also technical factors that favour bigger stocks, which could make the next decade just as painful for active fund managers who struggle to know what to do with the mega-caps.

Passive investing, for example, now represents about half of US fund assets — up from just a fifth 10 years ago.

The money pumped into index funds benefits bigger companies disproportionately, because the benchmarks most of them track are weighted according to market capitalisation. For example, a decade ago about 15 cents of every dollar put into State Street’s $312bn exchange-traded fund known as SPDR, or the $520bn Vanguard 500 index fund, went into technology stocks. Today that share is about 25 cents, because of the heavier weighting for tech.

In other words, as long as flows into passive funds continue at the current torrential rate, and assuming no serious business setbacks for the likes of Apple, Amazon or Microsoft, the big are likely to get bigger.

That will make it harder for active fund managers to prove their stockpicking prowess.

Fund managers on the whole have a preference for cheaper, smaller stocks, and that is understandable given they are vulnerable to ridicule if they simply buy huge, well-known names. But the march of the mega-caps is playing havoc with their performance. Barely one in 10 large-cap fund managers was able to outpace benchmarks over the past decade, according to Bank of America data.

If value stocks enjoy a long-awaited renaissance, or mid- and small-sized companies make up ground, then the performance of active managers will probably improve as well. But if the last 10 years is any guide, the pain is set to continue.


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