A handful of giant technology companies now dominate the major stock market indices. That makes some investors nervous. A video on the Bloomsbury Wealth YouTube Channel.
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Transcript: Robin Powell & Ben Felix/ Portfolio manager & podcaster
Robin Powell: A handful of giant technology companies now dominate the major stock market indices. That makes some investors nervous. If just a few companies make up such a large slice of the market, what happens when one of them stumbles — or worse? It’s an understandable concern. But is market concentration really as dangerous as it feels? Ben Felix is a portfolio manager and a podcast presenter. He points to a remarkable episode from recent Canadian market history.
Ben Felix: “There’s this crazy story from Canada where leading up to the dotcom bust, Canada had one company called Nortel that made up about 36%. One company, 36% of the Canadian market. And Nortel did bust, not just because of the dot com bust, that was part of it, but there was a whole bunch of stuff that went wrong with their strategy and the business, and it legitimately went to zero, like it was a proper idiosyncratic risk showing up. The stock crashed. Over a number of years, the market did drop, not just because of Nortel, but because of the tech bust. But the crazy thing is that the Canadian market recovered and went on to outperform the US market by a meaningful amount over the next 10 years. The US market had a lost decade, and it was not as concentrated as the Canadian market at that time. And Canada went on to outperform. So it’s just an interesting little anecdote where even if that risk that people are worried about of that concentration showing up through idiosyncratic risk in that one company, it doesn’t necessarily mean that the market as a whole is going to perform poorly.”
RP: That’s a striking example. But is it a one-off, or part of a broader pattern? Ben Felix has studied the relationship between market concentration and future returns across multiple countries and decades of data. His conclusion is clear.
BF: “So you look at the starting level of market concentration and ask, is that related to returns over the next 10 years? In the US you find a very, very small and weak relationship. Statistically, zero, but there is a tiny, tiny, tiny negative relationship. But it’s, I would call it no relationship. It’s a tiny little slope. That’s the US market, going back to 1926 that I’ve looked at. So starting level of market concentration. Let’s look at the 10 year following returns. Look at that over a whole bunch of 10 year periods throughout US market history. Is there a relationship? No. And then the other thing that I’ve done, I don’t have as much historical data, but I looked at a whole bunch of non-US markets, ranked them by their starting level of market concentration, which is another interesting point actually. A lot of markets other than the US are much more concentrated than the US market. So everyone’s freaking out about US market concentration, but like a lot of other markets that have been and are currently more concentrated in their top stocks. But again, if we look at that relationship in international markets, does the level of market concentration 10 years ago predict the future 10 year returns? No. It does not. Again, so I really think this idea that market concentration is some predictor of a future bad outcome for the market as a whole, it just doesn’t have any basis in reality.”
RP: So concentration alone tells us nothing about where markets are heading next. Some investors respond to this anxiety by switching to equal-weight index funds, which give every company the same allocation regardless of size. But that approach brings its own problems, including higher costs and more volatility. For Ben Felix, the answer is far simpler.
BF: “Based on what I just said about there being very little relationship between future returns and market concentration, I don’t think people who are index investors need to do anything. However, you know, as you just noted, it can make sense to tilt toward smaller, lower priced, more profitable companies in any market conditions. Not just because the market is currently concentrated. And if you are doing that, like if you look at the level of concentration in the top holdings in a Dimensional fund or an Avantis fund, it’s gonna be a much lower level of concentration than the market as a whole. So, I mean, I wouldn’t say, you know, because the market’s concentrated, you should shift to this version of investing, but I would say that if you are investing that way, it’s a little bit less of a concern than it would be if you were not tilted away from the largest companies.’”
RP: Ben Felix mentioned two specific fund providers there, but they’re not the only options. An independent, evidence-based financial adviser can help you choose the approach that best fits your circumstances. The wider lesson, though, is worth holding on to. Market concentration feels alarming, but the urge to react to it is far more dangerous than the concentration itself.
Disclaimer — The information in this video does not constitute advice or a recommendation, and you should not make any investment decisions on the basis of it. If you do however require advice please do not hesitate to contact Bloomsbury Wealth.
