October 8, 2024 • 42 mins
On this episode of "Financial Perspectives: Chats," Stephen Biggs, CFA, CAIA, CFP - Managing Director & Head of Alternative Investments for The Mather Group - sits down with Ben Inker - co-head of GMO's Asset Allocation Team - to dissect the realities of today's concentrated market. They delve into the intricacies of market concentration and investment strategies, offering a comprehensive analysis of today's market heavyweights, the "Magnificent Seven" (MAG7) stocks.
Additionally, the episode touches on the broader implications, including potential regulatory and geopolitical challenges, for these tech giants and how these factors might shape their future performance. Inker sheds light on the enduring principles of value investing amidst a market dominated by mega-cap growth stocks, emphasizing that the fundamental principles of value investing remain robust and that there will come a time when active management will once again look attractive against a cap-weighted benchmark.
Don't miss this engaging discussion that promises to enrich your understanding of market concentration and investment strategies.
If you'd like to learn more about the show, have a topic or speaker to suggest, or would like to leave us a comment, email podcast@cfa-sf.org.
This podcast is produced by CFA Society San Francisco, a not-for-profit professional association, providing professional learning and career resources to over 13,000 investment industry professionals worldwide. To learn more about CFA Society San Francisco, visit our website or connect with us on LinkedIn.
The information contained in this podcast does not constitute financial or investment advice. Please consult your own financial advisor for information concerning your specific situation.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Lindsey Helman (00:05):
Hello and welcome to this month's chat
segment of the FinancialPerspectives podcast.
Our chats episodes featuredynamic conversations between
industry experts from some ofour recent and most popular
webinar recordings.
This month you'll hear from BenInker, co-head of GMO's Asset
Allocation Team, and StephenBiggs, managing Director and
(00:27):
Head of Alternative Investmentsfor the Mather Group, as they
discuss market concentration andinvestment strategies through
an analysis of MAG7 stocks.
Stephen Biggs (00:40):
Good afternoon everyone.
Thank you for tuning in today.
I'm Steve Biggs from CFASociety San Francisco.
It's my pleasure to welcome youto our event today.
Mag7 versus active management.
We are joined by Ben InkerToday.
Mr Inker is co-head of GMO'sasset allocation team, and a,
member of the board of directors, a partner of the firm.
(01:01):
He joined GMO in 1992 followinghis bachelor's degree and has
held several roles in researchand analysis, portfolio
management and CIO of thequantitative equities.
Now I'd like to present MrInker and thank you for joining
us today.
Ben Inker (01:19):
Sure Thanks for having me, steve.
Stephen Biggs (01:21):
Well, sure, sure Now.
Ben, you've done a lot of workon stock market concentration
and this came from a piece thatyou published recently on you
know the bag seven and marketconcentration and how active
managers work in this kind ofenvironment.
You know how does today'sconcentration differ or similar
(01:43):
to prior periods?
I mean, we certainly saw thetech bubble in the late 90s.
That was in my career span andeveryone wanted to compare that
to the nifty-fifty.
Fortunately that was before mytime, but I'm sure you've looked
into both.
Ben Inker (01:57):
Yeah, in terms of the sheer amount of concentration.
So the size of the top seven orthe top 10 names as a percent
of the total S&P 500, we are alot higher than we were in 2000.
Actually looked pretty similarto what the world looked like in
the nifty 50.
(02:17):
But the thing about the nifty50, right, you had this group of
quality growth stocks that werein a bubble, but that actually
wasn't the peak of concentrationin the S&P 500.
Now, most of this doesn'treally matter because this all
sort of predates the kind of themodern period of active
(02:38):
management in the US,professional active management.
But the market in the 50s and60s was actually even more
concentrated than it is now.
The top 10 names were.
You know, if the top 10 namesright now are about 34% of the
S&P, they peaked out at about40% in the mid 60s.
(03:00):
Now those names were kind ofdifferent, right, the largest
stock in the world then was AT&T, and AT&T was legitimately a
gigantic company.
It was kind of boring too.
So it just wasn't that volatile.
And if you looked at the verybiggest companies, one of the
things that makes todaydifferent is these very big
(03:24):
companies are also quiteidiosyncratically volatile.
So from the standpoint of astock investor who is concerned
about tracking error.
Right, it's a combination ofthe size and the volatility.
Right now we've got moreconcentration in terms of pure
size than we have seen in 50years, and even relative to that
(03:47):
world 50 years ago.
It's probably.
I don't have the data on handto prove this, but I would be
willing to bet the giant stockstoday are more idiosyncratically
volatile than they were backthen.
Stephen Biggs (04:03):
Which could lead to more general market
volatility and more volatilityfor funds that want to more
closely align with the benchmark.
Ben Inker (04:10):
Yeah, I mean, it certainly is a challenge to take
, you know.
The obvious one today is NVIDIA.
Nvidia is really big.
It is not the largest name inthe S&P yet, but it's a lot more
volatile than Apple andMicrosoft are.
So for the vast majority ofactive managers in US large cap
(04:32):
space, nvidia, whether they ownit or not, is their largest
single source of stock-specificrisk.
Stephen Biggs (04:39):
So you, also mentioned that since 1957, nine
out of the top 10 stocksunderperformed the following
year.
This year, I mean, it seems inthis mag seven or whatever.
We have going back to 2020,other than the period of 22,
where we had a sell off and alot of these really contracted
(04:59):
seems like this kind of momentumhas continued for several years
.
What do you think is drivingthe outperformance relative to
previous time periods?
Ben Inker (05:10):
You know it's a little bit tricky trying to pull
that apart Kind of on abackward looking basis.
It is almost always the casethat the companies that are very
large have outperformedhistorically, because that's
kind of how you get to be verylarge and it's the forward
looking returns that tend to bedicier.
(05:31):
If we look over the longhistory, the biggest problem for
these very large companies hasbeen a combination of the fact
they tend to be trading at apremium to the market and that
should not be a surprise becausewe're defining that size on
market capitalization, andvaluation is a piece of market
(05:51):
capitalization, right, it isyour earnings, to oversimplify,
times your PE.
The higher your PE is, thebigger your market
capitalization is.
If we're looking at the verylargest stocks, they are
normally trading at a premiumvaluation.
The other piece that to datehasn't been true of this
generation of giant companies,but was true of previous
(06:21):
generations of giant companies,was they used to seem to have
some trouble growing.
Again, all of these companies,to oversimplify, had done a very
good job of growing in the past.
That is how they got to begiants.
But once you are a giant,normally there are some
diseconomies of scale.
It is harder to run a giganticcompany.
There tend to be more costsinvolved.
(06:41):
It can be harder to grow if youalready dominate the businesses
you are in and then you kind ofhave to continually enter new
businesses and somehow win inthere as well.
So, historically, thesecompanies have tended to
underperform because they'vebeen expensive and they haven't
grown.
More recently, these guys, Imean the striking thing about
(07:04):
them is they have grown.
They have grown very nicely.
Obviously NVIDIA the mostextreme.
In the last couple of yearsNVIDIA has grown in a way that
no giant company has ever donebefore.
But even kind of a slightlyboring Microsoft or Alphabet has
done a very good job of growing, given their giant size, I
(07:29):
think that brings up a questionon just valuations.
Stephen Biggs (07:33):
So we think about these having stretched
valuations.
I mean, maybe the market doesas a whole, because if we're
looking at relative valuations,maybe they're less elevated,
with the S&P at 25 timesapproximately.
But if we go out here on theNVIDIA and Microsoft, it's kind
of roughly 35 times, which,given the growth rate.
I don't know if NVIDIA candouble revenue every year.
(07:56):
That seems like the law oflarge numbers should kick in at
some point.
But still, even with adecelerating growth rate, it's
pretty solid growth there.
Thinking back to the techbubble, see, not all of those
top companies had huge multiples, but Microsoft was up there
with about a 65 times multiple.
(08:16):
Obviously there are a lot oflower quality names that were
smaller stocks, but it does seema little bit different.
In that the, as you mentioned,they seem to seem to have the
growth and maybe the I don'tknow if the premium relative to
the rest of the market is ashigh as it was in at least 1999.
Ben Inker (08:38):
Yeah, it's definitely not as high as it was in 1999.
But it's worth recognizing that, yes, microsoft was trading at
65 times earnings, but Coca-Colawas trading at 50.
The whole damn market wastrading at 35 times earnings.
So it was a very expensive timeand today, as you say, the
overall market is expensiverelative to history.
(08:58):
So these guys aren't trading atan absolutely enormous premium
to that.
They are trading at a premiumto it.
If they continue to outgrow themarket, they're probably worth
that premium.
If they don't, they're not.
(09:19):
And I think one of the things weare starting to see right, the
Magnificent Seven as a name Idon't think existed before last
year.
Maybe I'm wrong, but I think itwas coined in 2023.
And today you wouldn't callTesla a member of the
Magnificent Seven.
They're no longer the one ofthe top seven names.
I don't even think they're inthe top 10 anymore.
And so the kind of the factthat they were all growing so
(09:45):
well, my guess is, if we look atfive years from now, maybe a
couple of them will have grownnicely over the next five years,
but maybe a bunch of them willnot have.
Stephen Biggs (09:58):
Well, it's interesting.
So, as this applies to how thisimpacts active management, we
say that markets are gettingmore efficient and you state
that the concentration has beenconflated with the markets
becoming more efficient.
I mean, it's to some extent, Iguess, for several stocks maybe
not Tesla, but Nvidia, you know.
(10:19):
Despite the huge valuations, itseems to be correct.
So what exactly are yourthoughts around this?
Ben Inker (10:26):
Well.
So I want to tear apart acouple of things.
There is, to my mind, aconflation of the rise of the
MAG-7 with market efficiency,because a thing that has
occurred quite strikingly overthe last 10 years is active
managers have really gottentrounced by the index, and there
is this assumption that, well,in an efficient market, active
(10:50):
managers should not be able tooutperform and therefore, if
they have been underperforming,that must be a sign that the
market has become efficient.
And what we are trying to do isargue against that particular
thing.
And that's because when themarket is getting more
concentrated and by that we meanwhen the very largest stocks
(11:13):
are outperforming, that isinherently a very bad situation
for active managers.
Active managers as a group arestructurally substantially
underweight, the very largestnames.
It is really hard for them notto be, and the way they were
generally trained they don'thave any none of the heuristics
(11:36):
they have built around buildingportfolios would push them in
any other way.
So they tend to be underweight,these very largest names when
these very largest names areoutperforming that bet has been
hurting them.
So we don't think that justbecause it's been a bad period
for active managers necessarilymeans the market has become more
efficient.
(11:57):
With regard to, hey, thecompanies have done
fundamentally really well.
Doesn't that mean the marketgot it right?
I mean, in a sense, the marketgot NVIDIA profoundly wrong.
Right, I mean, if NVIDIA is upI don't know threefold, fourfold
, however much it is up over thepast 12 months, that is a
profound sign that the marketwas wrong 12 months ago.
(12:19):
The market might be wrong today.
It is unlikely to be wrong byso much that it was right a year
ago.
But if it was right a year ago,it's be wrong today.
It is unlikely to be wrong byso much that it was right a year
ago, but if it was right a yearago, it's profoundly wrong
today.
If it's right today, it wasprofoundly wrong a year ago.
So you know, you might havethis magical moment in time
where these stocks are fairlypriced, but their past
(12:41):
performance means they haven'tbeen continuously fairly priced.
It may have been a period whereit was good to be a gigantic, in
particular a gigantic techcompany, and it is possible it
will continue to be a wonderfulperiod to be a gigantic tech
company.
I would say it's probablyunlikely to be as wonderful to
(13:04):
be a gigantic tech company.
I would say it's probablyunlikely to be as wonderful to
be a gigantic tech company.
If nothing else, the governmentis viewing you less favorably
than it used to.
In general, your customers areviewing you less favorably than
they used to Regulatorily in theUS and elsewhere.
There are issues.
There are some geopoliticalissues that may well bite you as
(13:26):
well.
So it's probably not going to beas smooth sailing for these
companies over the next 10 yearsas it was over the last 10
years.
That's not to say they'reabsolutely guaranteed to do
badly.
Stephen Biggs (13:42):
So is it even possible for active managers to
have that kind of concentration?
I know, at least in mutualfunds.
Obviously not all assets aremutual fund assets, but there's
restrictions on position sizesover 5%, so there's limits to
what you can do.
I mean, how would a managerwith a positive view on some of
these stocks actually expressthat?
And then the opposite side ofthat, if all the concentrations
(14:05):
in the top sectors, if you'renegative on a smaller stock I
think I looked the outside ofthe top 100, everything's less
than a 20 basis point positionon the S&P 500.
If you don't like something,you don't own it.
You're really not benefitingfrom that view because you're
just not short that much.
(14:25):
It's not that meaningful of aweight in the benchmark.
Ben Inker (14:28):
Yeah, that's exactly right.
You know the active shareconcept, which is a perfectly
reasonable way of looking atactive managers.
Basically, it says you own themarket and then you own a long
short portfolio on top of it.
The thing about that long shortportfolio you are owning on top
of the market is you have verysmall positions in any company.
(14:50):
That's a small percentage ofthe index and, as you point out,
the vast majority of companiesin the S&P 500 are a very small
piece of the index and therefore, if you hate them, you still
don't have much of a bet againstthem.
And therefore, if you hate them, you still don't have much of a
bet against them.
And by default, your biggestbet against a company will not
(15:11):
come from the stock you hate themost, but from the largest
stock that you don't like enoughto own a material amount of.
There are some regulatory issuesaround mutual funds.
I don't think that requires youto be underweight the MAG7.
(15:32):
The biggest issue there is, ifyou're going to own a market
weight of the Magnificent 7,that automatically pulls down
your active share.
It reduces the amount of yourportfolio that you can use to
make bets against the market totry to outperform the market and
(15:54):
that is annoying.
It makes life more difficult.
You know, once we get to thegrowth indices, then those
mutual fund restrictions reallydo start to bite Right.
The Magnificent Seven are or thetop seven names are more than
(16:15):
half of the Russell 1000 growthor the S&P growth or any any of
the growth indices you want tolook at.
And that's a problem given themutual fund restrictions.
But even where it isn't aregulatory problem, it does come
up against the way activemanagers tend to think about
(16:38):
their portfolios and how theywant to own stocks in their
portfolios that they like andhow they want to think about
their absolute risk versus theirtracking.
Error risk A lot, particularlyon the fundamental side.
If you're dealing with peoplewho kind of pick stocks the old
fashioned way they tend to thinkin terms of absolute risk.
(17:00):
I only want to have so much ofmy portfolio in my favorite
stock because I could be wrong.
And for a lot of those managersthe largest position they would
have might let's say it's 5%.
Well, if you've got a 5%position in Microsoft or NVIDIA
or Apple, you're betting againstit versus the benchmark.
Stephen Biggs (17:23):
That would be betting against it.
I mean there's been.
Versus 20 years ago, 30 yearsago, there's a lot more focus on
active share right.
So even if you try to staysomewhat neutral, to the larger
you like the names it makes ittough to, I guess, to provide
that much active share ortracking error.
Ben Inker (17:40):
Yeah, I will say I do think the myth of active share
has been a little bit overblown.
Right when the original paperabout active share came out, the
authors noted that the veryhigh active share managers had
systematically outperformed, Ithink like 1980 to 2003, in
(18:10):
which the equally weighted S&Phad beaten the cap weighted S&P
by about two points a year andthese highly concentrated
managers had beaten theirbenchmarks.
It doesn't specify what theirbenchmarks are, but probably
mostly where the S&P orsomething similar, by 1.1 points
per year.
One thing you can say aboutvery high active share managers
is they don't own very muchthat's in the benchmark and
therefore are systemicallyunderweight the very largest
(18:32):
names.
They have to be right If you'vegot 95 percent active share,
you couldn't own more than fivepercent in the benchmark.
So I think part of the reasonwhy people got so enamored of
high active share managers wasthey're looking at this period
of time in which it was reallygood to look different from the
(18:52):
cap weighted benchmark.
It was a really good idea tolook much more like an equally
weighted portfolio which you'regoing to as a very high active
share portfolio.
So I do think it's in order tobe a good active manager.
You don't have to have 90%active share, but life gets
(19:14):
difficult if you are spendingmore of your portfolio just
getting up to the benchmark innames either that you don't have
a view on or you don't reallylike, but you don't want to have
a giant bet against.
Stephen Biggs (19:30):
And you touched on it.
Something we spoke up yesterdayand a question came up on this
from the audience is thedifference between an equal
weighted S&P index versus thecap weighted and difference in
performance.
Ben Inker (19:45):
Yeah, so over the long run, we've got decent data
on this, going back to 57.
The top 10 stocks hadunderperformed the equally
weighted S&P by about two and ahalf points a year since 1957.
And since 2014 or so they havebeaten the equally weighted S&P
(20:06):
500 by about five points a year.
So for most of history you werebetter off in the equally
weighted version of the S&P.
That's not again.
That's not shocking.
We know that the big guys havetended to underperform.
By being equally weighted, youdo get something of a value bias
(20:27):
to you, which for most ofhistory has helped.
But, as we were saying yesterday, there is a difference between
deciding whether you want tohire active managers and
deciding whether you simply wantto own the cap-weighted
benchmark, you could say well, Idon't really want to hire
(20:47):
active managers because they'reexpensive and most of them
underperform.
But I think in a concentratedworld the equally weighted
version of the index has anadvantage.
Stephen Biggs (20:58):
You can just buy that.
Ben Inker (20:59):
ETF cost a little bit more than the cap weighted ETF
and it's got a little bit moretrading to it, but it's not hard
and it's probably not a badidea.
Stephen Biggs (21:09):
Which kind of brings up.
I mean so if you equal weight,you have you're more value
biased and you're a smaller capbiased too.
So smaller cap, you knowconsidered factors.
There's a number offactor-based ETFs these days.
You know value, size, momentum,quality, dividends, cash flow,
everything.
What are your thoughts on thatversus active management in a
(21:33):
way to try and avoid some of thepotential traps with a market
cap weighted index that's goingto have a big concentration in
these large stocks?
Ben Inker (21:43):
Well, depending on how these portfolios are put
together, they may have similarconcentration.
If you were going to buy aquality biased portfolio which
was starting from the S&P 500and then owning the top third of
quality or something like that,you're going to have even more
(22:04):
concentration at the top end Nowyou own high quality companies.
You may say it's even moreconcentration at the top end,
now you own high qualitycompanies.
You may say it's okay to beconcentrated in high quality
companies, but you've got a lotof concentration risk there.
There are ways to build factorportfolios that are more biased
towards equally weighted orindeed are equally weighted, but
(22:27):
a lot of them.
In a world where the mega capsare just a lot bigger than other
companies, you still have a lotof that individual stock
concentration.
It's hard to get away from thatuntil and unless you are
willing to ignore thoseunderlying market capitalization
(22:49):
weights.
Stephen Biggs (22:50):
So we had another question come in on what would
it take for active management tobe able to generate returns
that would bring people back toactive management and I asked
the question yesterday.
You know is the point of activemanagement to control the
drawdown risk.
So we know that potentiallythese large stocks that make up
a large part of the index arehighly volatile relative to
(23:13):
previous periods.
So we would expect a majordrawdown if we had something
happen to tech, say a systemicproblem like Taiwan, a massive
drawdown.
Is that what we're trying to doin active management?
Are we really trying tooutperform during strong periods
or are we trying to kind ofmaintain during strong periods
(23:33):
and protect some to the downside?
Ben Inker (23:35):
You know, I think active management as an activity
comprises so many differentways of trying to pick stocks.
I'm not sure there's a way tosay, oh yes, all active managers
are trying to give you betterdownside protection.
That one can't possibly be truein the end.
(23:57):
But even the various differentways active managers are putting
together portfolios right, likeif you talk to Kathy Wood, she
would say wonderful things aboutthe company she owns, but I
don't think she would say andthe great thing about our
portfolios is they're going tohave less downside risk.
(24:19):
You know, in terms of what wouldit take to get a move back to
active management?
Back to active management, someof this die has simply been
cast right.
Some of the move towardspassive really occurred as
defined benefit pension plansturned into defined contribution
pension plans.
Defined benefit pension plans,where the company was on the
(24:42):
hook for the payments and wastrying to minimize the cost of
those payments to them.
Hired a lot of active managersIn defined contribution plans.
They are never going back toactive.
The incentives are completelyin the direction of passive,
because the most important thingif you are a sponsor of a 401k
(25:06):
plan is making damn sure youdon't get sued and the one
decision you can pretty muchguarantee that you cannot get
sued for is putting people inthe lowest cost passive
portfolio they can, you know.
Otherwise, there will come atime again when active managers
look pretty good against a capweighted benchmark.
(25:29):
It will not mean that the activemanagers have gotten any
smarter, and I'm not convincedthat all of the money that has
gone to passive will go back toactive.
I am convinced there will be atime in the foreseeable future
where the people who have hiredactive managers will stop saying
why on earth did I do that?
(25:50):
That was so idiotic.
I should have just bought theindex and say, well, I'm kind of
glad I did that.
Back in 2005, active managershad trounced the S&P 500.
And as an active manager atthat time, man.
I thought we were pretty smart.
I thought we had it all figuredout.
(26:11):
Now it turned out in 2005, theequally weighted S&P had beaten
the cap weighted S&P by 10points a year for five years and
relatively few active managershad done any better than that.
So mostly it was just you werecomparing yourself against a
(26:32):
really easy benchmark to beat.
In the last 10 years you'vebeen comparing yourself against
an almost impossible benchmarkto beat.
I think that will change.
But you know there's owning themarket is a reasonably
compelling investment idea.
Stephen Biggs (26:50):
Yeah, well, surely not everyone can be
passive.
It seems like there'd bestructural issues, but we will
see.
I'm sure it'll shift back andforth.
Ben Inker (26:59):
Yeah, I mean, if we got to the point where it was
overwhelmingly passive, then thecool thing is active managers
as a group can outperformbecause their liquidity
provision to the passiveinvestors.
One of the things about passiveinvestors is they always have
to pay for liquidity and thepeople who provide that
liquidity get paid for it Inround numbers.
(27:22):
That's the active managementcommunity.
The bad news for the activemanagement community is they get
that payment through tradingand the thing about passive
investors is they don't do muchtrading.
So if the world was 95% passive, active managers would
outperform, but if the world is60% passive, it's a pretty small
(27:46):
benefit, unfortunately.
Maybe the alpha comes fromtrading.
Stephen Biggs (27:50):
We do have a number of questions that came in
, so let's see.
I'll try and get through someof them.
One on the difference betweenthe S&P 500 and EFI.
Maybe international stocks haveobviously lagged for the last
15 years or so.
Would you favor tilting awayfrom the US for this reason, or
(28:10):
perhaps not tilt as much the way, given that most US stocks have
P ratios more than non-USstocks?
Just a question on the P,basically evaluation.
Ben Inker (28:20):
Yeah.
So if you look in general,non-us stocks have lower P's
than US stocks.
That's kind of true across theboard.
There are some pockets where itisn't so.
Sometimes when people do sectoradjustments they say aha, the
rest of the world isn't actuallytrading cheaper.
It really depends on whichdirection you do things in.
(28:41):
So, for example, in Europe thereare actually very few tech
stocks.
There just aren't that many.
The ones that there are areactually pretty cool companies.
So ASML trades at a pretty highearnings multiple because
they're a monopolist.
Nobody else can do what ASMLcan do, but they're a pretty
(29:03):
small piece of the universe.
If you scale them up to the 32%that tech is in the US, you
make Europe a lot more expensive.
2% that tech is in the US, youmake Europe a lot more expensive
.
But if you did the reverse, ifyou said, okay, let's look at
the US, but with Europe's sectorweightings, what you see is US
(29:24):
banks traded a premium toEuropean banks.
Us autos traded a premium toEuropean autos.
Us healthcare companiesgenerally traded a premium to
European healthcare companiesnot Novo Nordisk, but fine and
in general US companies aretrading at a premium.
I think that's probably apretty good reason to over-own
the rest of the world.
I've been wrong on that for awhile, so at best I've been
(29:48):
really early.
Stephen Biggs (29:49):
Many of us are in the same boat, still waiting.
A question on small caps andkind of the role I think private
equity is playing versus, say,you know, the 90s.
So you see the role of smallcaps playing the same role in a
diversified portfolio.
It's a smaller universedistorted by biotech.
Companies are staying privatelonger.
(30:10):
Im into the mid-cap universe isbasically the advent of growth
equity.
And it came into play late 90s,early 2000s and there's part of
that.
So, that's the question, andkind of interesting to see.
I'd be kind of curious to getyour thoughts on.
We talked passive versus activeon an S&P benchmark.
Get your thoughts on.
(30:30):
We talked passive versus activeon an S&P benchmark.
That's an interesting questionon the small cap side, because
you have very large ETFs thatare buying an index.
By definition, they're kind ofpulling up the numbers on the
small cap companies.
Ben Inker (30:46):
I would think, yeah, I mean there's so much going on
with small caps, right?
The rise of private equity,which has given companies
(31:10):
another avenue than going public.
The creation of Sarbanes-Oxley,which has really made it very
difficult for small companies,or at least quite expensive for
small companies, to be public.
The rise of VC, which givescompanies a way of raising
capital at sizes that couldnever have been done
historically on a private basis.
And then you've got the rise ofbiotech, and biotech is the one
group of companies that reallydoes have to go public pretty
early because the cost ofbringing drugs or devices to
(31:34):
market is really high.
So all of these have made smalltoday different from what small
used to be.
Now there's another piece whichis large today is also
different from what large usedto be, from what large used to
be, and the most important pieceof that, to my mind, is the
(31:59):
increase in effective monopolypower within the large cap
universe.
That is particularly prevalentwithin the mega caps, all of the
very largest names in the US,maybe kind of the weird
exception of Berkshire Hathaway,because they're this very
anachronistic conglomeraterelative to everybody else is
either an effective monopolistor oligopolist and has a lot of
(32:21):
market power.
And so, among all of the otherthings that have changed, we
have seen over the last 30 years, a sea change between the
apparent return on capital forlarge cap companies, which is
really dominated by the megacaps and everybody else the
small cap companies and profitsas a percentage of GDP in the US
(32:42):
have really grown.
You see that in a large capspace, in the small cap space,
nothing has changed, and whatthat means is if that higher
profitability means large capsare deserving of a higher
valuation, well, the small capsaren't.
So the discount they shouldtrade at versus the large caps
(33:04):
has grown.
Now, what role do small capshave in your portfolio, man?
I don't know.
It really depends on what theywere there to do.
If they were there tooutperform and they really had
from the 70s until the early 90swell, I don't know why small
should outperform.
There's no inherent reason whysmallness should lead to
(33:27):
outperformance.
They are more domestic thaninternational.
Is that a good thing or a badthing?
I'm not sure.
Uh, I mean, they have somedifferent characteristics.
Um, they the strongest reason Ican think of to want to over
own small relative to theirweight in the general benchmarks
(33:48):
is if you are hiring activemanagers.
There still is pretty goodevidence that within the small
cap universe, active managershave an easier time
outperforming.
But that's I mean you can, inprinciple, exploit that without
having to be overweight.
The factor small cap and somuch about small has changed and
(34:09):
so much about small has changed.
It is a research project for usto try to understand exactly
which of the various things thathave changed about small caps
are the most important and whatone should do about it.
Stephen Biggs (34:24):
Okay, maybe another webinar.
We had a couple questions comein on the end of this, the end
of the MAG-7, I guess.
So it says once it has priorerrors of concentration have
ended badly, you don't seem tobe concerned that concentration
(34:44):
this time is elevated marketrisk correct.
And then another person askedwhat?
Triggered the valuationcorrection back in previous
periods, 2000s to the 70s.
Ben Inker (34:54):
Yeah, you know, the funny thing is, I'm not even
sure we know the answer in 2000,or in kind of the in the nifty
50.
In 2000, it really does seem asif they kind of collapsed under
the weight of unreasonableexpectations for future growth,
(35:15):
but there wasn't, like nobodyrung a bell and nobody pointed.
Here's why I sold this stock onthis day.
And with regard to the nifty 50, right there, the beginning of
their fall coincided with thebeginning of the very nasty
(35:36):
74-75 recession, and you couldsay maybe these are companies
that were assumed that they weregoing to be immune from the
business cycle and then theyrealized, oh no, that's not true
the business cycle.
(35:57):
And then they realized, oh no,that's not true.
But man, even with the benefitof hindsight, it is hard to know
exactly what caused the change,and so that makes it
particularly difficult to guesswhat would cause the change this
time.
What we have seen of the market,and particularly the market for
growth-oriented companies inrecent years, is the market is
(36:19):
pretty unforgiving, if youdisappoint.
Now it's been a long time sinceNVIDIA disappointed anyone, and
I don't know when they nextwill.
But you know, tesla's fall frommagnificence coincides with
them switching from positivesurprises to negative surprises,
(36:42):
and my guess is that's what'sgoing to do it Exactly.
What causes them to startdisappointing?
I don't know.
Stephen Biggs (36:50):
Yeah, I was.
So I co-managed the growthstrategy through the tech bubble
, focused on technology.
So just to offer one thoughtthere, it's just yeah.
Expectations got too high andyou had a huge buildup spend in
IT infrastructure headed intothe year 2000.
If those of us around toremember, you know, all your
(37:12):
computers were going to die likeon January 1st 2000.
So that was a massive spend andobviously those numbers got
extrapolated into the future andwe just never hit those there
was a minor recession in 2000.
And that was a combination ofjust the equipment providers
catching up and being a surplusinstead of a backlog and
numerous order cancellations andyou know, eventually,
(37:35):
eventually things, expectationsget too high.
So that's, that's my thoughtthere.
We just have a couple of minutesleft, not too many more
questions.
Someone mentioned that the morethese, oh, here we go.
So someone mentioned inconflict that more money going
past the benefits of the indexproviders.
(37:57):
I don't know if there's muchyou can do about that.
Another one under performanceof value versus growth continues
has continued.
Ben Inker (38:14):
Should value investors keep the faith?
Should they do anythingdifferent based on this recent
experience?
Yeah, so the recent performanceof value looks very different
on an equally weighted basisthan a cap weighted basis, right
, the reason why 2023 was such adisastrous year for value
versus growth is because of theMAG-7.
And outside of the MAG-7, valuedidn't do that badly, and
outside of the MAG7, valuedidn't do that badly.
(38:37):
So part of this is, if youbelieve that the mega cap stocks
, who are, in general, all inthe growth index, are going to
continue to outperform, value isgoing to lose to that, the
value factor, as we see it, isless about idiosyncratic names
(38:58):
and more about the basicquestion of hey, what happens
when you have stocks that aretrading at a big discount to the
overall market?
And there we are seeing thatthe power of value is still
going strong, and we see thatvery clearly on an equally
weighted basis, because what wehave seen is when growth stocks
(39:19):
are trading at a big premium,which they are today, the
problem for growth in that worldis, if you are a growth stock
that disappoints, it's reallybad.
Right, because not only do theforecast earnings come down that
you were priced on, but the PEthat people thought you were
worth.
You were trading at 40 times PEbecause people assumed you were
(39:40):
going to grow.
And now suddenly they say, ohwell, maybe you aren't and that
PE can fall in half.
And on the other side, if youare a value company, that people
suddenly say, hey, maybe thisisn't such a bad company, and
you know it was trading at 10times earnings.
And they have an upwardsurprise and not only does that
help but they say, ok, well,maybe you should trade more like
(40:02):
the market and be at 20 timesearnings instead of 10.
That is still going on.
So I don't think value is deadat all.
We run a value long short whichhas been making really quite
nice money because it's muchmore equal, weighted on the long
and the short side, againstthat cap weighted benchmark.
In a world where those megacaps are all on the growth side,
(40:25):
if they all continue to win,value will definitionally lose.
If they start performing inline with the market, value's
got a chance.
If they start to lose, valuewill look brilliant.
Stephen Biggs (40:37):
Great, I think we are at time.
So with that, ben, thank youfor joining us Very informative
session today.
Thank you to the audience andwe hope to see you at a future
event.
Ben Inker (40:49):
All right, thanks very much, steve.
Stephen Biggs (40:50):
Thanks, bye.
Lindsey Helman (40:54):
Thank you for listening to this month's chats
segment on market concentrationsand MAG7 stocks.
Chats is a monthly segmentfeaturing audio from our
recently recorded webinarsairing on the second Tuesday of
the month.
To view the video recording ofthis episode and discover
(41:15):
additional Society webinars,visit the CFA Society San
Francisco YouTube channel.
Join us next month for ourregularly scheduled Financial
Perspectives podcast episodeairing on the last Tuesday of
the month, and make sure to sendin a message to the show using
the link at the top of eachepisode description or by
mailing podcast@cfa-sf.
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We'd love to hear what youthink of our new chat segment or
(41:37):
any suggestions on futuretopics you'd like us to cover.
Thank you for being a dedicatedlistener.
This podcast is produced by CFASociety San Francisco, a
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professional learning and careerresources to over 13,000
(41:57):
investment industryprofessionals worldwide.
To learn more about CFA SocietySan Francisco, visit cfa-sf.
org or connect with us onLinkedIn.
Hello and welcome to this month's chat
segment of the FinancialPerspectives podcast.
Our chats episodes featuredynamic conversations between
industry experts from some ofour recent and most popular
webinar recordings.
This month you'll hear from BenInker, co-head of GMO's Asset
Allocation Team, and StephenBiggs, managing Director and
(00:27):
Head of Alternative Investmentsfor the Mather Group, as they
discuss market concentration andinvestment strategies through
an analysis of MAG7 stocks.
Stephen Biggs (00:40):
Good afternoon everyone.
Thank you for tuning in today.
I'm Steve Biggs from CFASociety San Francisco.
It's my pleasure to welcome youto our event today.
Mag7 versus active management.
We are joined by Ben InkerToday.
Mr Inker is co-head of GMO'sasset allocation team, and a,
member of the board of directors, a partner of the firm.
(01:01):
He joined GMO in 1992 followinghis bachelor's degree and has
held several roles in researchand analysis, portfolio
management and CIO of thequantitative equities.
Now I'd like to present MrInker and thank you for joining
us today.
Ben Inker (01:19):
Sure Thanks for having me, steve.
Stephen Biggs (01:21):
Well, sure, sure Now.
Ben, you've done a lot of workon stock market concentration
and this came from a piece thatyou published recently on you
know the bag seven and marketconcentration and how active
managers work in this kind ofenvironment.
You know how does today'sconcentration differ or similar
(01:43):
to prior periods?
I mean, we certainly saw thetech bubble in the late 90s.
That was in my career span andeveryone wanted to compare that
to the nifty-fifty.
Fortunately that was before mytime, but I'm sure you've looked
into both.
Ben Inker (01:57):
Yeah, in terms of the sheer amount of concentration.
So the size of the top seven orthe top 10 names as a percent
of the total S&P 500, we are alot higher than we were in 2000.
Actually looked pretty similarto what the world looked like in
the nifty 50.
(02:17):
But the thing about the nifty50, right, you had this group of
quality growth stocks that werein a bubble, but that actually
wasn't the peak of concentrationin the S&P 500.
Now, most of this doesn'treally matter because this all
sort of predates the kind of themodern period of active
(02:38):
management in the US,professional active management.
But the market in the 50s and60s was actually even more
concentrated than it is now.
The top 10 names were.
You know, if the top 10 namesright now are about 34% of the
S&P, they peaked out at about40% in the mid 60s.
(03:00):
Now those names were kind ofdifferent, right, the largest
stock in the world then was AT&T, and AT&T was legitimately a
gigantic company.
It was kind of boring too.
So it just wasn't that volatile.
And if you looked at the verybiggest companies, one of the
things that makes todaydifferent is these very big
(03:24):
companies are also quiteidiosyncratically volatile.
So from the standpoint of astock investor who is concerned
about tracking error.
Right, it's a combination ofthe size and the volatility.
Right now we've got moreconcentration in terms of pure
size than we have seen in 50years, and even relative to that
(03:47):
world 50 years ago.
It's probably.
I don't have the data on handto prove this, but I would be
willing to bet the giant stockstoday are more idiosyncratically
volatile than they were backthen.
Stephen Biggs (04:03):
Which could lead to more general market
volatility and more volatilityfor funds that want to more
closely align with the benchmark.
Ben Inker (04:10):
Yeah, I mean, it certainly is a challenge to take
, you know.
The obvious one today is NVIDIA.
Nvidia is really big.
It is not the largest name inthe S&P yet, but it's a lot more
volatile than Apple andMicrosoft are.
So for the vast majority ofactive managers in US large cap
(04:32):
space, nvidia, whether they ownit or not, is their largest
single source of stock-specificrisk.
Stephen Biggs (04:39):
So you, also mentioned that since 1957, nine
out of the top 10 stocksunderperformed the following
year.
This year, I mean, it seems inthis mag seven or whatever.
We have going back to 2020,other than the period of 22,
where we had a sell off and alot of these really contracted
(04:59):
seems like this kind of momentumhas continued for several years
.
What do you think is drivingthe outperformance relative to
previous time periods?
Ben Inker (05:10):
You know it's a little bit tricky trying to pull
that apart Kind of on abackward looking basis.
It is almost always the casethat the companies that are very
large have outperformedhistorically, because that's
kind of how you get to be verylarge and it's the forward
looking returns that tend to bedicier.
(05:31):
If we look over the longhistory, the biggest problem for
these very large companies hasbeen a combination of the fact
they tend to be trading at apremium to the market and that
should not be a surprise becausewe're defining that size on
market capitalization, andvaluation is a piece of market
(05:51):
capitalization, right, it isyour earnings, to oversimplify,
times your PE.
The higher your PE is, thebigger your market
capitalization is.
If we're looking at the verylargest stocks, they are
normally trading at a premiumvaluation.
The other piece that to datehasn't been true of this
generation of giant companies,but was true of previous
(06:21):
generations of giant companies,was they used to seem to have
some trouble growing.
Again, all of these companies,to oversimplify, had done a very
good job of growing in the past.
That is how they got to begiants.
But once you are a giant,normally there are some
diseconomies of scale.
It is harder to run a giganticcompany.
There tend to be more costsinvolved.
(06:41):
It can be harder to grow if youalready dominate the businesses
you are in and then you kind ofhave to continually enter new
businesses and somehow win inthere as well.
So, historically, thesecompanies have tended to
underperform because they'vebeen expensive and they haven't
grown.
More recently, these guys, Imean the striking thing about
(07:04):
them is they have grown.
They have grown very nicely.
Obviously NVIDIA the mostextreme.
In the last couple of yearsNVIDIA has grown in a way that
no giant company has ever donebefore.
But even kind of a slightlyboring Microsoft or Alphabet has
done a very good job of growing, given their giant size, I
(07:29):
think that brings up a questionon just valuations.
Stephen Biggs (07:33):
So we think about these having stretched
valuations.
I mean, maybe the market doesas a whole, because if we're
looking at relative valuations,maybe they're less elevated,
with the S&P at 25 timesapproximately.
But if we go out here on theNVIDIA and Microsoft, it's kind
of roughly 35 times, which,given the growth rate.
I don't know if NVIDIA candouble revenue every year.
(07:56):
That seems like the law oflarge numbers should kick in at
some point.
But still, even with adecelerating growth rate, it's
pretty solid growth there.
Thinking back to the techbubble, see, not all of those
top companies had huge multiples, but Microsoft was up there
with about a 65 times multiple.
(08:16):
Obviously there are a lot oflower quality names that were
smaller stocks, but it does seema little bit different.
In that the, as you mentioned,they seem to seem to have the
growth and maybe the I don'tknow if the premium relative to
the rest of the market is ashigh as it was in at least 1999.
Ben Inker (08:38):
Yeah, it's definitely not as high as it was in 1999.
But it's worth recognizing that, yes, microsoft was trading at
65 times earnings, but Coca-Colawas trading at 50.
The whole damn market wastrading at 35 times earnings.
So it was a very expensive timeand today, as you say, the
overall market is expensiverelative to history.
(08:58):
So these guys aren't trading atan absolutely enormous premium
to that.
They are trading at a premiumto it.
If they continue to outgrow themarket, they're probably worth
that premium.
If they don't, they're not.
(09:19):
And I think one of the things weare starting to see right, the
Magnificent Seven as a name Idon't think existed before last
year.
Maybe I'm wrong, but I think itwas coined in 2023.
And today you wouldn't callTesla a member of the
Magnificent Seven.
They're no longer the one ofthe top seven names.
I don't even think they're inthe top 10 anymore.
And so the kind of the factthat they were all growing so
(09:45):
well, my guess is, if we look atfive years from now, maybe a
couple of them will have grownnicely over the next five years,
but maybe a bunch of them willnot have.
Stephen Biggs (09:58):
Well, it's interesting.
So, as this applies to how thisimpacts active management, we
say that markets are gettingmore efficient and you state
that the concentration has beenconflated with the markets
becoming more efficient.
I mean, it's to some extent, Iguess, for several stocks maybe
not Tesla, but Nvidia, you know.
(10:19):
Despite the huge valuations, itseems to be correct.
So what exactly are yourthoughts around this?
Ben Inker (10:26):
Well.
So I want to tear apart acouple of things.
There is, to my mind, aconflation of the rise of the
MAG-7 with market efficiency,because a thing that has
occurred quite strikingly overthe last 10 years is active
managers have really gottentrounced by the index, and there
is this assumption that, well,in an efficient market, active
(10:50):
managers should not be able tooutperform and therefore, if
they have been underperforming,that must be a sign that the
market has become efficient.
And what we are trying to do isargue against that particular
thing.
And that's because when themarket is getting more
concentrated and by that we meanwhen the very largest stocks
(11:13):
are outperforming, that isinherently a very bad situation
for active managers.
Active managers as a group arestructurally substantially
underweight, the very largestnames.
It is really hard for them notto be, and the way they were
generally trained they don'thave any none of the heuristics
(11:36):
they have built around buildingportfolios would push them in
any other way.
So they tend to be underweight,these very largest names when
these very largest names areoutperforming that bet has been
hurting them.
So we don't think that justbecause it's been a bad period
for active managers necessarilymeans the market has become more
efficient.
(11:57):
With regard to, hey, thecompanies have done
fundamentally really well.
Doesn't that mean the marketgot it right?
I mean, in a sense, the marketgot NVIDIA profoundly wrong.
Right, I mean, if NVIDIA is upI don't know threefold, fourfold
, however much it is up over thepast 12 months, that is a
profound sign that the marketwas wrong 12 months ago.
(12:19):
The market might be wrong today.
It is unlikely to be wrong byso much that it was right a year
ago.
But if it was right a year ago,it's be wrong today.
It is unlikely to be wrong byso much that it was right a year
ago, but if it was right a yearago, it's profoundly wrong
today.
If it's right today, it wasprofoundly wrong a year ago.
So you know, you might havethis magical moment in time
where these stocks are fairlypriced, but their past
(12:41):
performance means they haven'tbeen continuously fairly priced.
It may have been a period whereit was good to be a gigantic, in
particular a gigantic techcompany, and it is possible it
will continue to be a wonderfulperiod to be a gigantic tech
company.
I would say it's probablyunlikely to be as wonderful to
(13:04):
be a gigantic tech company.
I would say it's probablyunlikely to be as wonderful to
be a gigantic tech company.
If nothing else, the governmentis viewing you less favorably
than it used to.
In general, your customers areviewing you less favorably than
they used to Regulatorily in theUS and elsewhere.
There are issues.
There are some geopoliticalissues that may well bite you as
(13:26):
well.
So it's probably not going to beas smooth sailing for these
companies over the next 10 yearsas it was over the last 10
years.
That's not to say they'reabsolutely guaranteed to do
badly.
Stephen Biggs (13:42):
So is it even possible for active managers to
have that kind of concentration?
I know, at least in mutualfunds.
Obviously not all assets aremutual fund assets, but there's
restrictions on position sizesover 5%, so there's limits to
what you can do.
I mean, how would a managerwith a positive view on some of
these stocks actually expressthat?
And then the opposite side ofthat, if all the concentrations
(14:05):
in the top sectors, if you'renegative on a smaller stock I
think I looked the outside ofthe top 100, everything's less
than a 20 basis point positionon the S&P 500.
If you don't like something,you don't own it.
You're really not benefitingfrom that view because you're
just not short that much.
(14:25):
It's not that meaningful of aweight in the benchmark.
Ben Inker (14:28):
Yeah, that's exactly right.
You know the active shareconcept, which is a perfectly
reasonable way of looking atactive managers.
Basically, it says you own themarket and then you own a long
short portfolio on top of it.
The thing about that long shortportfolio you are owning on top
of the market is you have verysmall positions in any company.
(14:50):
That's a small percentage ofthe index and, as you point out,
the vast majority of companiesin the S&P 500 are a very small
piece of the index and therefore, if you hate them, you still
don't have much of a bet againstthem.
And therefore, if you hate them, you still don't have much of a
bet against them.
And by default, your biggestbet against a company will not
(15:11):
come from the stock you hate themost, but from the largest
stock that you don't like enoughto own a material amount of.
There are some regulatory issuesaround mutual funds.
I don't think that requires youto be underweight the MAG7.
(15:32):
The biggest issue there is, ifyou're going to own a market
weight of the Magnificent 7,that automatically pulls down
your active share.
It reduces the amount of yourportfolio that you can use to
make bets against the market totry to outperform the market and
(15:54):
that is annoying.
It makes life more difficult.
You know, once we get to thegrowth indices, then those
mutual fund restrictions reallydo start to bite Right.
The Magnificent Seven are or thetop seven names are more than
(16:15):
half of the Russell 1000 growthor the S&P growth or any any of
the growth indices you want tolook at.
And that's a problem given themutual fund restrictions.
But even where it isn't aregulatory problem, it does come
up against the way activemanagers tend to think about
(16:38):
their portfolios and how theywant to own stocks in their
portfolios that they like andhow they want to think about
their absolute risk versus theirtracking.
Error risk A lot, particularlyon the fundamental side.
If you're dealing with peoplewho kind of pick stocks the old
fashioned way they tend to thinkin terms of absolute risk.
(17:00):
I only want to have so much ofmy portfolio in my favorite
stock because I could be wrong.
And for a lot of those managersthe largest position they would
have might let's say it's 5%.
Well, if you've got a 5%position in Microsoft or NVIDIA
or Apple, you're betting againstit versus the benchmark.
Stephen Biggs (17:23):
That would be betting against it.
I mean there's been.
Versus 20 years ago, 30 yearsago, there's a lot more focus on
active share right.
So even if you try to staysomewhat neutral, to the larger
you like the names it makes ittough to, I guess, to provide
that much active share ortracking error.
Ben Inker (17:40):
Yeah, I will say I do think the myth of active share
has been a little bit overblown.
Right when the original paperabout active share came out, the
authors noted that the veryhigh active share managers had
systematically outperformed, Ithink like 1980 to 2003, in
(18:10):
which the equally weighted S&Phad beaten the cap weighted S&P
by about two points a year andthese highly concentrated
managers had beaten theirbenchmarks.
It doesn't specify what theirbenchmarks are, but probably
mostly where the S&P orsomething similar, by 1.1 points
per year.
One thing you can say aboutvery high active share managers
is they don't own very muchthat's in the benchmark and
therefore are systemicallyunderweight the very largest
(18:32):
names.
They have to be right If you'vegot 95 percent active share,
you couldn't own more than fivepercent in the benchmark.
So I think part of the reasonwhy people got so enamored of
high active share managers wasthey're looking at this period
of time in which it was reallygood to look different from the
(18:52):
cap weighted benchmark.
It was a really good idea tolook much more like an equally
weighted portfolio which you'regoing to as a very high active
share portfolio.
So I do think it's in order tobe a good active manager.
You don't have to have 90%active share, but life gets
(19:14):
difficult if you are spendingmore of your portfolio just
getting up to the benchmark innames either that you don't have
a view on or you don't reallylike, but you don't want to have
a giant bet against.
Stephen Biggs (19:30):
And you touched on it.
Something we spoke up yesterdayand a question came up on this
from the audience is thedifference between an equal
weighted S&P index versus thecap weighted and difference in
performance.
Ben Inker (19:45):
Yeah, so over the long run, we've got decent data
on this, going back to 57.
The top 10 stocks hadunderperformed the equally
weighted S&P by about two and ahalf points a year since 1957.
And since 2014 or so they havebeaten the equally weighted S&P
(20:06):
500 by about five points a year.
So for most of history you werebetter off in the equally
weighted version of the S&P.
That's not again.
That's not shocking.
We know that the big guys havetended to underperform.
By being equally weighted, youdo get something of a value bias
(20:27):
to you, which for most ofhistory has helped.
But, as we were saying yesterday, there is a difference between
deciding whether you want tohire active managers and
deciding whether you simply wantto own the cap-weighted
benchmark, you could say well, Idon't really want to hire
(20:47):
active managers because they'reexpensive and most of them
underperform.
But I think in a concentratedworld the equally weighted
version of the index has anadvantage.
Stephen Biggs (20:58):
You can just buy that.
Ben Inker (20:59):
ETF cost a little bit more than the cap weighted ETF
and it's got a little bit moretrading to it, but it's not hard
and it's probably not a badidea.
Stephen Biggs (21:09):
Which kind of brings up.
I mean so if you equal weight,you have you're more value
biased and you're a smaller capbiased too.
So smaller cap, you knowconsidered factors.
There's a number offactor-based ETFs these days.
You know value, size, momentum,quality, dividends, cash flow,
everything.
What are your thoughts on thatversus active management in a
(21:33):
way to try and avoid some of thepotential traps with a market
cap weighted index that's goingto have a big concentration in
these large stocks?
Ben Inker (21:43):
Well, depending on how these portfolios are put
together, they may have similarconcentration.
If you were going to buy aquality biased portfolio which
was starting from the S&P 500and then owning the top third of
quality or something like that,you're going to have even more
(22:04):
concentration at the top end Nowyou own high quality companies.
You may say it's even moreconcentration at the top end,
now you own high qualitycompanies.
You may say it's okay to beconcentrated in high quality
companies, but you've got a lotof concentration risk there.
There are ways to build factorportfolios that are more biased
towards equally weighted orindeed are equally weighted, but
(22:27):
a lot of them.
In a world where the mega capsare just a lot bigger than other
companies, you still have a lotof that individual stock
concentration.
It's hard to get away from thatuntil and unless you are
willing to ignore thoseunderlying market capitalization
(22:49):
weights.
Stephen Biggs (22:50):
So we had another question come in on what would
it take for active management tobe able to generate returns
that would bring people back toactive management and I asked
the question yesterday.
You know is the point of activemanagement to control the
drawdown risk.
So we know that potentiallythese large stocks that make up
a large part of the index arehighly volatile relative to
(23:13):
previous periods.
So we would expect a majordrawdown if we had something
happen to tech, say a systemicproblem like Taiwan, a massive
drawdown.
Is that what we're trying to doin active management?
Are we really trying tooutperform during strong periods
or are we trying to kind ofmaintain during strong periods
(23:33):
and protect some to the downside?
Ben Inker (23:35):
You know, I think active management as an activity
comprises so many differentways of trying to pick stocks.
I'm not sure there's a way tosay, oh yes, all active managers
are trying to give you betterdownside protection.
That one can't possibly be truein the end.
(23:57):
But even the various differentways active managers are putting
together portfolios right, likeif you talk to Kathy Wood, she
would say wonderful things aboutthe company she owns, but I
don't think she would say andthe great thing about our
portfolios is they're going tohave less downside risk.
(24:19):
You know, in terms of what wouldit take to get a move back to
active management?
Back to active management, someof this die has simply been
cast right.
Some of the move towardspassive really occurred as
defined benefit pension plansturned into defined contribution
pension plans.
Defined benefit pension plans,where the company was on the
(24:42):
hook for the payments and wastrying to minimize the cost of
those payments to them.
Hired a lot of active managersIn defined contribution plans.
They are never going back toactive.
The incentives are completelyin the direction of passive,
because the most important thingif you are a sponsor of a 401k
(25:06):
plan is making damn sure youdon't get sued and the one
decision you can pretty muchguarantee that you cannot get
sued for is putting people inthe lowest cost passive
portfolio they can, you know.
Otherwise, there will come atime again when active managers
look pretty good against a capweighted benchmark.
(25:29):
It will not mean that the activemanagers have gotten any
smarter, and I'm not convincedthat all of the money that has
gone to passive will go back toactive.
I am convinced there will be atime in the foreseeable future
where the people who have hiredactive managers will stop saying
why on earth did I do that?
(25:50):
That was so idiotic.
I should have just bought theindex and say, well, I'm kind of
glad I did that.
Back in 2005, active managershad trounced the S&P 500.
And as an active manager atthat time, man.
I thought we were pretty smart.
I thought we had it all figuredout.
(26:11):
Now it turned out in 2005, theequally weighted S&P had beaten
the cap weighted S&P by 10points a year for five years and
relatively few active managershad done any better than that.
So mostly it was just you werecomparing yourself against a
(26:32):
really easy benchmark to beat.
In the last 10 years you'vebeen comparing yourself against
an almost impossible benchmarkto beat.
I think that will change.
But you know there's owning themarket is a reasonably
compelling investment idea.
Stephen Biggs (26:50):
Yeah, well, surely not everyone can be
passive.
It seems like there'd bestructural issues, but we will
see.
I'm sure it'll shift back andforth.
Ben Inker (26:59):
Yeah, I mean, if we got to the point where it was
overwhelmingly passive, then thecool thing is active managers
as a group can outperformbecause their liquidity
provision to the passiveinvestors.
One of the things about passiveinvestors is they always have
to pay for liquidity and thepeople who provide that
liquidity get paid for it Inround numbers.
(27:22):
That's the active managementcommunity.
The bad news for the activemanagement community is they get
that payment through tradingand the thing about passive
investors is they don't do muchtrading.
So if the world was 95% passive, active managers would
outperform, but if the world is60% passive, it's a pretty small
(27:46):
benefit, unfortunately.
Maybe the alpha comes fromtrading.
Stephen Biggs (27:50):
We do have a number of questions that came in
, so let's see.
I'll try and get through someof them.
One on the difference betweenthe S&P 500 and EFI.
Maybe international stocks haveobviously lagged for the last
15 years or so.
Would you favor tilting awayfrom the US for this reason, or
(28:10):
perhaps not tilt as much the way, given that most US stocks have
P ratios more than non-USstocks?
Just a question on the P,basically evaluation.
Ben Inker (28:20):
Yeah.
So if you look in general,non-us stocks have lower P's
than US stocks.
That's kind of true across theboard.
There are some pockets where itisn't so.
Sometimes when people do sectoradjustments they say aha, the
rest of the world isn't actuallytrading cheaper.
It really depends on whichdirection you do things in.
(28:41):
So, for example, in Europe thereare actually very few tech
stocks.
There just aren't that many.
The ones that there are areactually pretty cool companies.
So ASML trades at a pretty highearnings multiple because
they're a monopolist.
Nobody else can do what ASMLcan do, but they're a pretty
(29:03):
small piece of the universe.
If you scale them up to the 32%that tech is in the US, you
make Europe a lot more expensive.
2% that tech is in the US, youmake Europe a lot more expensive
.
But if you did the reverse, ifyou said, okay, let's look at
the US, but with Europe's sectorweightings, what you see is US
(29:24):
banks traded a premium toEuropean banks.
Us autos traded a premium toEuropean autos.
Us healthcare companiesgenerally traded a premium to
European healthcare companiesnot Novo Nordisk, but fine and
in general US companies aretrading at a premium.
I think that's probably apretty good reason to over-own
the rest of the world.
I've been wrong on that for awhile, so at best I've been
(29:48):
really early.
Stephen Biggs (29:49):
Many of us are in the same boat, still waiting.
A question on small caps andkind of the role I think private
equity is playing versus, say,you know, the 90s.
So you see the role of smallcaps playing the same role in a
diversified portfolio.
It's a smaller universedistorted by biotech.
Companies are staying privatelonger.
(30:10):
Im into the mid-cap universe isbasically the advent of growth
equity.
And it came into play late 90s,early 2000s and there's part of
that.
So, that's the question, andkind of interesting to see.
I'd be kind of curious to getyour thoughts on.
We talked passive versus activeon an S&P benchmark.
Get your thoughts on.
(30:30):
We talked passive versus activeon an S&P benchmark.
That's an interesting questionon the small cap side, because
you have very large ETFs thatare buying an index.
By definition, they're kind ofpulling up the numbers on the
small cap companies.
Ben Inker (30:46):
I would think, yeah, I mean there's so much going on
with small caps, right?
The rise of private equity,which has given companies
(31:10):
another avenue than going public.
The creation of Sarbanes-Oxley,which has really made it very
difficult for small companies,or at least quite expensive for
small companies, to be public.
The rise of VC, which givescompanies a way of raising
capital at sizes that couldnever have been done
historically on a private basis.
And then you've got the rise ofbiotech, and biotech is the one
group of companies that reallydoes have to go public pretty
early because the cost ofbringing drugs or devices to
(31:34):
market is really high.
So all of these have made smalltoday different from what small
used to be.
Now there's another piece whichis large today is also
different from what large usedto be, from what large used to
be, and the most important pieceof that, to my mind, is the
(31:59):
increase in effective monopolypower within the large cap
universe.
That is particularly prevalentwithin the mega caps, all of the
very largest names in the US,maybe kind of the weird
exception of Berkshire Hathaway,because they're this very
anachronistic conglomeraterelative to everybody else is
either an effective monopolistor oligopolist and has a lot of
(32:21):
market power.
And so, among all of the otherthings that have changed, we
have seen over the last 30 years, a sea change between the
apparent return on capital forlarge cap companies, which is
really dominated by the megacaps and everybody else the
small cap companies and profitsas a percentage of GDP in the US
(32:42):
have really grown.
You see that in a large capspace, in the small cap space,
nothing has changed, and whatthat means is if that higher
profitability means large capsare deserving of a higher
valuation, well, the small capsaren't.
So the discount they shouldtrade at versus the large caps
(33:04):
has grown.
Now, what role do small capshave in your portfolio, man?
I don't know.
It really depends on what theywere there to do.
If they were there tooutperform and they really had
from the 70s until the early 90swell, I don't know why small
should outperform.
There's no inherent reason whysmallness should lead to
(33:27):
outperformance.
They are more domestic thaninternational.
Is that a good thing or a badthing?
I'm not sure.
Uh, I mean, they have somedifferent characteristics.
Um, they the strongest reason Ican think of to want to over
own small relative to theirweight in the general benchmarks
(33:48):
is if you are hiring activemanagers.
There still is pretty goodevidence that within the small
cap universe, active managershave an easier time
outperforming.
But that's I mean you can, inprinciple, exploit that without
having to be overweight.
The factor small cap and somuch about small has changed and
(34:09):
so much about small has changed.
It is a research project for usto try to understand exactly
which of the various things thathave changed about small caps
are the most important and whatone should do about it.
Stephen Biggs (34:24):
Okay, maybe another webinar.
We had a couple questions comein on the end of this, the end
of the MAG-7, I guess.
So it says once it has priorerrors of concentration have
ended badly, you don't seem tobe concerned that concentration
(34:44):
this time is elevated marketrisk correct.
And then another person askedwhat?
Triggered the valuationcorrection back in previous
periods, 2000s to the 70s.
Ben Inker (34:54):
Yeah, you know, the funny thing is, I'm not even
sure we know the answer in 2000,or in kind of the in the nifty
50.
In 2000, it really does seem asif they kind of collapsed under
the weight of unreasonableexpectations for future growth,
(35:15):
but there wasn't, like nobodyrung a bell and nobody pointed.
Here's why I sold this stock onthis day.
And with regard to the nifty 50, right there, the beginning of
their fall coincided with thebeginning of the very nasty
(35:36):
74-75 recession, and you couldsay maybe these are companies
that were assumed that they weregoing to be immune from the
business cycle and then theyrealized, oh no, that's not true
the business cycle.
(35:57):
And then they realized, oh no,that's not true.
But man, even with the benefitof hindsight, it is hard to know
exactly what caused the change,and so that makes it
particularly difficult to guesswhat would cause the change this
time.
What we have seen of the market,and particularly the market for
growth-oriented companies inrecent years, is the market is
(36:19):
pretty unforgiving, if youdisappoint.
Now it's been a long time sinceNVIDIA disappointed anyone, and
I don't know when they nextwill.
But you know, tesla's fall frommagnificence coincides with
them switching from positivesurprises to negative surprises,
(36:42):
and my guess is that's what'sgoing to do it Exactly.
What causes them to startdisappointing?
I don't know.
Stephen Biggs (36:50):
Yeah, I was.
So I co-managed the growthstrategy through the tech bubble
, focused on technology.
So just to offer one thoughtthere, it's just yeah.
Expectations got too high andyou had a huge buildup spend in
IT infrastructure headed intothe year 2000.
If those of us around toremember, you know, all your
(37:12):
computers were going to die likeon January 1st 2000.
So that was a massive spend andobviously those numbers got
extrapolated into the future andwe just never hit those there
was a minor recession in 2000.
And that was a combination ofjust the equipment providers
catching up and being a surplusinstead of a backlog and
numerous order cancellations andyou know, eventually,
(37:35):
eventually things, expectationsget too high.
So that's, that's my thoughtthere.
We just have a couple of minutesleft, not too many more
questions.
Someone mentioned that the morethese, oh, here we go.
So someone mentioned inconflict that more money going
past the benefits of the indexproviders.
(37:57):
I don't know if there's muchyou can do about that.
Another one under performanceof value versus growth continues
has continued.
Ben Inker (38:14):
Should value investors keep the faith?
Should they do anythingdifferent based on this recent
experience?
Yeah, so the recent performanceof value looks very different
on an equally weighted basisthan a cap weighted basis, right
, the reason why 2023 was such adisastrous year for value
versus growth is because of theMAG-7.
And outside of the MAG-7, valuedidn't do that badly, and
outside of the MAG7, valuedidn't do that badly.
(38:37):
So part of this is, if youbelieve that the mega cap stocks
, who are, in general, all inthe growth index, are going to
continue to outperform, value isgoing to lose to that, the
value factor, as we see it, isless about idiosyncratic names
(38:58):
and more about the basicquestion of hey, what happens
when you have stocks that aretrading at a big discount to the
overall market?
And there we are seeing thatthe power of value is still
going strong, and we see thatvery clearly on an equally
weighted basis, because what wehave seen is when growth stocks
(39:19):
are trading at a big premium,which they are today, the
problem for growth in that worldis, if you are a growth stock
that disappoints, it's reallybad.
Right, because not only do theforecast earnings come down that
you were priced on, but the PEthat people thought you were
worth.
You were trading at 40 times PEbecause people assumed you were
(39:40):
going to grow.
And now suddenly they say, ohwell, maybe you aren't and that
PE can fall in half.
And on the other side, if youare a value company, that people
suddenly say, hey, maybe thisisn't such a bad company, and
you know it was trading at 10times earnings.
And they have an upwardsurprise and not only does that
help but they say, ok, well,maybe you should trade more like
(40:02):
the market and be at 20 timesearnings instead of 10.
That is still going on.
So I don't think value is deadat all.
We run a value long short whichhas been making really quite
nice money because it's muchmore equal, weighted on the long
and the short side, againstthat cap weighted benchmark.
In a world where those megacaps are all on the growth side,
(40:25):
if they all continue to win,value will definitionally lose.
If they start performing inline with the market, value's
got a chance.
If they start to lose, valuewill look brilliant.
Stephen Biggs (40:37):
Great, I think we are at time.
So with that, ben, thank youfor joining us Very informative
session today.
Thank you to the audience andwe hope to see you at a future
event.
Ben Inker (40:49):
All right, thanks very much, steve.
Stephen Biggs (40:50):
Thanks, bye.
Lindsey Helman (40:54):
Thank you for listening to this month's chats
segment on market concentrationsand MAG7 stocks.
Chats is a monthly segmentfeaturing audio from our
recently recorded webinarsairing on the second Tuesday of
the month.
To view the video recording ofthis episode and discover
(41:15):
additional Society webinars,visit the CFA Society San
Francisco YouTube channel.
Join us next month for ourregularly scheduled Financial
Perspectives podcast episodeairing on the last Tuesday of
the month, and make sure to sendin a message to the show using
the link at the top of eachepisode description or by
mailing podcast@cfa-sf.
org .
We'd love to hear what youthink of our new chat segment or
(41:37):
any suggestions on futuretopics you'd like us to cover.
Thank you for being a dedicatedlistener.
This podcast is produced by CFASociety San Francisco, a
not-for-profit professionalassociation providing
professional learning and careerresources to over 13,000
(41:57):
investment industryprofessionals worldwide.
To learn more about CFA SocietySan Francisco, visit cfa-sf.
org or connect with us onLinkedIn.
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