More of the same – which is good but not good enough short term
Can we call almost keeping pace with a benchmark a victory for the month? Given the continued strength and dominance of large-capitalization growth stocks we will take it. MSCI’s All Country World Index (“ACWI”) benchmark was up 5.36% in July versus our average Equity allocation being up roughly 4.25%. Year to date, given our (albeit relatively small) allocations to Value and Small Cap Equities, our average Equity allocation is down roughly 11.75% and ACWI is down 1.17%, a significant underperformance. At the same time, the S&P 500 is up 2.52% and the NASDAQ 100 is up 25.49%. So once again, it all comes back to that dominance of large-cap growth, particularly in the US.
We can talk about how the COVID-19 Pandemic exacerbated, or maybe just accelerated, the trend for this dominance. But the dominance has been extreme – and we are in fine company with other traditional Factor-based investors with much ink (and maybe some blood) spilled trying to explain why. Much of that explanation speaks to the risk of having concentrated exposures in Equities, i.e. that you need to maintain diversification, that market dominance rotates over time, and that new competitors emerge to challenge even the most dominant companies.
Looking at the numbers always helps (and thanks to one of our clients for initiating this detailed analysis). The Equities that comprise the NASDAQ 100, or the QQQ Exchange Traded Fund, have a gross market capitalization of roughly $13.5 Trillion. That is over 38% of the total market capitalization of all US Equities, with the five largest companies making up over half of that 38%. Our portfolios have overall exposure to QQQ constituents of roughly 25%, but not at the market cap weightings of the QQQ index. For Apple, Amazon, and Microsoft, we have roughly 42% of their US market-capitalization weighting, but with Alphabet (Google’s parent company) we have less than 26% and Facebook less than 8%. The other components of QQQ have not delivered returns like these leaders, so while we do have exposure to these drivers of return today we are underweight them relative to the overall markets and this has resulted in the drag on our returns.
When this dominance relative to the rest of the markets ends is anyone’s guess at this point. But at some point, we are confident it will end. To quote the late economist Herbert Stein, "If something cannot go on forever, it will stop." We do know that nothing goes on forever, even if that thing goes on for longer than most of us expect.
For balanced accounts, your Fixed Income allocation was up about 1.4% for the month, with all allocations contributing to performance. With interest rates at historically low levels, we believe that it is more important than ever to manage Fixed Income exposures with a focus on the risk taken for the expected return earned. You can read the full commentary on this in our month-end note for July on our Multisector Fixed Income strategy, which many of you own in the FWDB ETF.
Source: Morningstar
