After nine years of a bull market that has been aided by the most aggressive and sustained period of monetary stimulus in history (you didn’t forget about that did you?) index-based investing has become the go-to strategy for many investors. Year-to-date, EPFR estimates that globally, investors have dumped $436.5 billion into index funds. Actively managed funds have experienced net outflows of over $150 billion in the U.S. alone.
Jack Bogle would likely be proud, but does index-based investing still make sense when a majority of the money being invested in funds is flowing to vehicles that don’t discriminate based on value or risk?
Here the WSJ points out the growing peril of an index-based investment strategy. Technology, the sector with the greatest proportion of companies that experience catastrophic loss has the largest weighting in the S&P 500 as well as the MSCI Emerging Markets index (we pointed this out here).
Technology now accounts for almost 24% of the S&P 500 and 28% of the MSCI Emerging Markets index.
The WSJ has more.
“It’s sort of an inherent flaw of index funds,” said Kyle Moore, founder of Quarry Hill Advisors in St. Paul, Minn., referring to the way surging stocks have a bigger share of indexes that are market-value weighted, like the S&P 500.
Noting that some tech stocks have gained nearly 50% this year, Mr. Moore said a typical investor response would be to trim exposure to those stocks and take profits. When that happens in an index fund, nothing happens automatically, he said…
Some investment advisers say they are telling clients to reduce their tech exposure by selling individual stocks or shifting into other funds where tech has a lesser influence.
With a fund that tracks the S&P 500 now, “it’s almost like you’re getting a bit of a technology momentum fund,” said Tom Haggerty, portfolio manager at Retirement Strategies, which manages about $350 million in Jacksonville, Fla.
Mr. Haggerty said he has talked to a few clients with large technology holdings, including those who own specialized exchange-traded funds such as the PowerShares QQQ that tracks Nasdaq-listed stocks. “We have pushed hard to have them pull back on those positions, especially if they hold those stocks in a large-cap fund,” he said.
Gary Sagui, a retired commodity trader who splits his time between Florida and Wisconsin, said he recently became concerned about the increased weighting of large companies with high price-to-earnings ratios in his index funds. That includes so-called FANG stocks—shorthand for Facebook, Amazon, Netflix and Google ’s parent Alphabet.
Read more here.
Jeremy Jones, CFA
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