Concentration & Valuations

[Closet_Gamer]

Having just turned 50 and with FIRE getting close in the headlights, I'm doing a very structured review of my AA.

As many will know: I am a passionate indexer and AA...

...but the shocking concentration of Apple, MSFT, Google, AMZN and TSLA within the big indices has my attention.

I did my math a few days ago, so these things might have wiggled around, but I think are still on point. By my math, these five are companies are:

40% of the NASDAQ 100
24% of the S&P 500
~15% of a big Vanguard fund I have in my 401K
Apple + MSFT are 9% of the DJIA.

The concentration continues. Around 35% of the S&P is in 15 companies.

The PEs on these are huge, predicated on forward PEs that require amazingly strong/consistent growth. Other large, healthy companies with wide moats and strong balance sheets make up 0.5% or less of S&P 500.

If any of these huge companies gets the sniffles, the indices will all catch a severe cold.

As an indexer, I know colds come and go, but really?
Have the major indices ever been this concentrated?

I'm broadly diversified (Small caps, Intl, fixed income, REITs), and was surprised to find that these five companies represent 10% of all my holdings.

For the first time in a long time, I'm considering trying and step away from this concentration by specific adding in a value tilt:

VTV -- Vanguard Value ETF, PE of 14 & yield of 2.1%
None of these companies in the top 30+ holdings.

Curious:

Is anyone else thinking about this concentration issue?
Plan to do anything about it?

Thanks

 

[target2019]

You made me look. I didn't dive into each fund's details, but we have approximately 15% overall in funds which are anchored by the mega caps. If 25% of those funds is concentrated, then we are at 4% weighted.

EQ/Equity 500 Index 6.1% PEOPX
Vanguard Total Stock Market Index Adm 8.3% VTSAX
Vanguard STAR Fund 0.4% VGSTX

The other 35% of equity allocation is REIT, Completion index, small value, and value stocks in Wellesley and our brokerage.

 

[matjung]

I know what you mean.
The index does not represent the full economy anymore.
I joined stock markets in 1988 and was working for a company who computed stock and bond indices.
No stock goes from down left to up right for ever.
If the FAANG or MAMAA are having a bad decade, the index performance is having a problem.
Stocks that go up, get a bigger index weight.

Then more ETF will buy those stocks, leading to more index weight.

Yep, the concentration is worrying.
Some index vendors like Deutsche Börse (DAX) already changed the framework for computing its indices.

If FED increases interest rates, and people re-balance towards Bond and Value stocks some indices and Growth Stocks will be under severe pressure.
Sector Picking might be the best strategy for the next foreseeable future.
One could also think about contributing money into Hedge Funds.

 

[Montecfo]

I'm not an indexer so I do not have this issue. But one way to attack it is through a fund or CEF that equal-weights the S&P or other market participants. I have not looked in a while but I believe these exist.

Cap-weighted indices are essentially momentum based. When they turn, yes, there will be a reckoning.

 

[audreyh1]

Have the major indexes like S&P500 always been this concentrated? I think so yes. But which sectors and companies changes over time. In the past, energy has dominated, financial has dominated, etc.

I prefer to use the broader indexes. There is still some concentration and I have other index funds not dominated by US large cap growth.

 

[DawgMan]

Agree. You have to look under the hood to see how these tech sectors, more specifically certain stocks, dominate some of these indexes. Personally, I like Paul Merriman's analysis of ideal AA mix and try to rebalance according to a quasi version of his Ultimate Buy & Hold Strategy, partially for the concern you have raised. I'm sensitive to not creating unnecessary capital gains in my after tax accounts, but try and move as many of the chess pieces in my tax deferred accounts to get close when rebalancing.

 

[DrRoy]

Take a look at the Equal Weight S&P 500 ETF - RSP.

 

[Closet_Gamer]

Thanks for the replies and suggestions.

I did a little digging and it looks like we are pretty concentrated by historic standards...except for those fun few years before and after 2000.

https://www.morningstar.com/articles/992504/the-sp-500-grows-ever-more-concentrated

(I tried to just insert an image of the graph in the article, but can't figure out how to do that. Sorry.)

 

[OverThinkMuch]

As many will know: I am a passionate indexer and AA...

...but the shocking concentration of Apple, MSFT, Google, AMZN and TSLA within the big indices has my attention.
...
If any of these huge companies gets the sniffles, the indices will all catch a severe cold.

As an indexer, I know colds come and go, but really?
Have the major indices ever been this concentrated?
...
VTV -- Vanguard Value ETF, PE of 14 & yield of 2.1%
None of these companies in the top 30+ holdings.

I flipped to active investor a couple years ago, but if I was still only a passive investor, I would direct you to John Bogle's interview on value vs growth, small vs large cap.
https://www.morningstar.com/articles/772797/bogle-not-only-stay-the-course-stay-the-straight-course


But if you decide to tilt towards value stocks, you need to answer a second question: when will you switch back?

In 2020 I flipped from passive investor to active investor. At first, I screwed up: I sold before the big March 2020 crash... but switched to other assets that also took losses. I think it's normal for a passive investor trying to switch to active to make mistakes. That's a risk of trying an active strategy now, unless you've done similar AA changes before.

It looks like the Fed is going to take a wrecking ball to high growth stocks. Not intentionally, but as part of raising rates and bond yields to keep pace with inflation. That inflation hurts growth stocks, which mostly have profit in the future. Divide that profit by high inflation over many years, and it doesn't look so good - and aggressive growth stocks get sold off.

On the contrary side, what will stop the big tech companies? Most value companies have competition. Facebook doesn't. Similarly, Amazon and Google have powerful positions in their areas - not quite monopolies, but not too far off. The big tech companies have huge advantages not found in most companies, which makes their positions look a bit entrenched. May not be great for consumers, but for stock holders, it's good to be the king.

 

[Closet_Gamer]

But if you decide to tilt towards value stocks, you need to answer a second question: when will you switch back?

Thanks for the link.

That is of course the salient question. I think the answers are:

1) When PEs for indices get drop closer to historic norms
2) When concentration drops closer to historic norms

Also, I'm definitely not abandoning my index'ing ways...just adding a tilt of 5-7% within my high cap allocation towards value.

The rest remains index'd as it currently is...both within high cap and across the other asset classes.

Its sinning...but sort of smoking under the bleachers, not doing lines of coke at a bar.

 

[pb4uski]

Thanks for the link.

That is of course the salient question. I think the answers are:

1) When PEs for indices get drop closer to historic norms
2) When concentration drops closer to historic norms

Also, I'm definitely not abandoning my index'ing ways...just adding a tilt of 5-7% within my high cap allocation towards value.

The rest remains index'd as it currently is...both within high cap and across the other asset classes.

Its sinning...but sort of smoking under the bleachers, not doing lines of coke at a bar.

WADR, you're planning to make a portfolio change based on a concentration risk concern but if you simply tilt 5-7% of your high-cap allocation towards value that doesn't seem to me to do much at all to address the concentration risk concern.... how does a minor 5-7% tilt impact concentration? How does the proposed tilt impact the amount of the total portfolio in Apple, MSFT, Google, AMZN and TSLA? Before and after percentages?

 

[Closet_Gamer]

WADR, you're planning to make a portfolio change based on a concentration risk concern but if you simply tilt 5-7% of your high-cap allocation towards value that doesn't seem to me to do much at all to address the concentration risk concern.... how does a minor 5-7% tilt impact concentration? How does the proposed tilt impact the amount of the total portfolio in Apple, MSFT, Google, AMZN and TSLA? Before and after percentages?

Fair question and I mis-stated my intent.

Its 5-7% of my overall AA, not just 5-7% within the Domestic Large Cap portion.

This is in the context of a wider AA re-visit which is freeing up money from other asset classes. As part of this, my Domestic large cap AA is increasing from 40% to 45% of my total portfolio.

From that perspective its "new" money within the large cap portion of my AA. I'm loathe to pile this new money into making that concentration worse.

I need to run through the math, but suspect it will take the concentration from 10% to 8% or so. Not exactly a revolution but does at least halt the tide a bit and perhaps creates a re-balancing opportunity within the Large cap component if/when these concentrations subside.

Still thinking on the wider AA as well, but as I'm only talking +/- 5% between different classes, I'm largely just painting in the edges.

 

[pb4uski]

I wonder what your 8-10% in Apple, MSFT, Google, AMZN and TSLA would be if instead you changed your domestic large cap AA to an equal weight S&P fund as Montecfo suggests and I was also thinking about.

 

[Closet_Gamer]

I wonder what your 8-10% in Apple, MSFT, Google, AMZN and TSLA would be if instead you changed your domestic large cap AA to an equal weight S&P fund as Montecfo suggests and I was also thinking about.

Do you mean put the "new" money into the equal weight fund or move some/all of the existing large cap money that I have in the S&P/NASDAQ/Dow?

If the former, I bet it would be similar to adding VTV as neither has much concentration of the big 5.

If moving existing investments into an equal weight fund, I think the very nature of an equal weight fund mean you could pretty well crush the concentration to nearly zero.

 

[FLSUnFIRE]

About 40% of my portfolio is in Small Cap Index and another 9% in International so the megas are not quite so significant to me. All my taxable is Total Market though. All but TSLA have huge motes (for now) so the higher PEs are not as scary as the underlying companies are sound and proven moneymakers.

 

[joesxm3]

One thing I saw a while ago said that only a few of the SP500 companies were near highs and a majority were way off their highs. The concentrated winner companies were holding the index up.

 

[pb4uski]

Do you mean put the "new" money into the equal weight fund or move some/all of the existing large cap money that I have in the S&P/NASDAQ/Dow?



If the former, I bet it would be similar to adding VTV as neither has much concentration of the big 5.



If moving existing investments into an equal weight fund, I think the very nature of an equal weight fund mean you could pretty well crush the concentration to nearly zero.

Yes, I was suggesting the latter... flipping some or all existing holdings that are cap-weighted to equal-weighted if you are seriously concerned about FANG concentration. While I'm not sure if it would be near zero it would probably be a lot lower.