The US stock market is now highly concentrated to the Magnificent Seven
\nThe ASX also has concentration risks
\nWhat investors can do to manage this risk<\/p>\n
\u00a0<\/p>\n
Soaring tech share prices have driven the US stock market concentration to unprecedented levels and pushed valuations to a record premium relative to other markets.<\/p>\n
Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, Tesla<\/em> \u2013 dubbed collectively as the \u201cMagnificent Seven\u201d \u2013 have grabbed a much bigger share of the S&P500 Index thanks to their stellar performance.<\/p>\n Richard Saldanha<\/strong> and Joao Toniato<\/strong> at Aviva Investors<\/em> believe this trend could persist, and investors need to be aware of the implications.<\/p>\n \u201cIf you\u2019re a US passive investor, you may believe you\u2019re getting broad market exposure, but the fact remains 30 per cent of your money is in just seven stocks,\u201d said Saldanha.<\/p>\n \u201cEven if you\u2019re exposed to global equities, the dominance of the US market means the same seven stocks account for 18 per cent of your investment.\u201d<\/p>\n Although it\u2019s quite conceivable that this high degree of concentration will persist a while longer, history suggests current high levels will not persist indefinitely.<\/p>\n \u201cWhile we may not know when some of these stock valuations normalise, they almost certainly will at some point. You don\u2019t want to be stuck on the wrong side of that trade when they do,\u201d Saldanha says.<\/p>\n \u00a0<\/p>\n Portfolio managers such as Saldanha are now facing a dilemma.<\/p>\n On one hand, shunning these seven stocks altogether could result in the portfolio underperforming the benchmark. On the other hand, keeping these richly valued stocks runs counter to the philosophy of seeking undervalued stocks.<\/p>\n Saldanha says he takes a pragmatic view of this problem.<\/p>\n \u201cWhen it comes to the Magnificent Seven, ultimately the question one needs to ask is: is the price you\u2019re paying justified? If it isn\u2019t we simply don\u2019t own them,\u201d Saldanha says.<\/p>\n Joao Toniato meanwhile argues that while the level of concentration within the US stock market may look unsustainable, it would be a mistake to lump The Magnificent Seven into the same bucket.<\/p>\n \u201cTheir valuations are simply not comparable to each other,\u201d said Toniato.<\/p>\n Tesla, for example, trades on a 12-month forward price\/earnings ratio of around 60x (on March 4th). Amazon is trading at 39x, while Nvidia and Microsoft were trading at forward P\/Es of around 30x.<\/p>\n \u201cWhile that is not cheap relative to a market trading on a forward P\/E of around 20x, both companies (Nvidia and Microsoft) are expected to be big beneficiaries of the growth in AI,\u201d said Toniato.<\/p>\n \u00a0<\/p>\n The Australian stock market also has a concentration problem, although not as pronounced as the US market.<\/p>\n The benchmark index ASX 200<\/strong>, which contains the top 200 companies by size, accounts for over 80% of the total stock market.<\/p>\n The ASX has a total of 11 sectors, and as the pool of eligible ASX stocks is relatively small, some sector indices only contain a handful of companies.<\/p>\n Size of each ASX sector compared to the overall market cap:<\/strong><\/p>\n Financials: Approximately 30% to 35% \u00a0<\/p>\n Source: MarketIndex<\/strong><\/em><\/p>\n \u00a0<\/p>\n The Aussie market is also too concentrated by securities, with the top 10 stocks representing around 40% of the S&P\/ASX 200 index.<\/p>\n BHP alone makes up around 10% of the overall market, resulting in cyclicality (due to the cyclical nature of commodity prices) becoming more pronounced.<\/p>\n The top 10 ASX stocks by size<\/a> are:<\/strong><\/p>\n 1. BHP Group (ASX: BHP)<\/a> \u00a0<\/p>\n The concentration to bank stocks is intrinsically linked to housing and property market in Australia.<\/p>\n Many Aussies are worried about this concentrated exposure, \u00a0however not many do anything about it.<\/p>\n One of the best ways to reduce your portfolio\u2019s concentration risk is through regular monitoring and portfolio\u00a0rebalancing<\/strong>.<\/p>\n Investors should regularly review their portfolios to make adjustments as needed. This may involve selling stocks in your portfolio that have become overweighted, and reinvesting the proceeds into underweighted stocks to maintain the desired asset allocation.<\/p>\n \u201cRebalancing is a crucial component of maintaining a healthy investment portfolio. It ensures that your asset allocation remains aligned with your investment goals and risk tolerance over time.\u201d \u2013 said John Smith, chief investment officer at ABC Capital Management.<\/em><\/p>\n \u201cWhile it may seem counterintuitive, rebalancing often involves selling winners and buying losers. This disciplined approach forces investors to sell high and buy low, which can enhance returns and reduce portfolio volatility,\u201d said David Lee at DEF Investment Group.<\/em><\/p>\n \u201cInvestors should rebalance their portfolios at regular intervals, such as annually or semi-annually, to ensure that their asset allocation remains on target. However, it\u2019s essential to avoid excessive trading and focus on long-term strategic goals,\u201d said Emily Chen of GHI Financial Services.<\/em><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n <\/span><\/p>\n The post \u2018Concentration risk\u2019 can put your portfolio out of whack. Here\u2019s what you can do about it<\/a> appeared first on Stockhead<\/a>.<\/p>","protected":false},"excerpt":{"rendered":"Sell or keep?<\/h2>\n
Concentration risk on the ASX<\/h2>\n
\nMaterials\/Resources: 15% to 20%
\nReal Estate: 10% to 15%
\nHealthcare: 7% to 10%
\nIndustrials: 5% to 10%
\nConsumer Discretionary: 5% to 10%
\nInformation Technology: 5% to 10%
\nEnergy: 5% to 10%
\nUtilities: 3% to 5%
\nConsumer Staples: 3% to 5%
\nTelecommunications: 2% to 4%<\/p>\nASX COMPOSITION<\/h2>\n
\n2. Commonwealth Bank of Australia (ASX:CBA)<\/a>
\n3. CSL (ASX:CSL)<\/a>
\n4,5,6. National Australia Bank (ASX:NAB)<\/a>, Westpac (ASX:WBC)<\/a> and ANZ Banking Group (ASX:ANZ)<\/a>
\n7. Macquarie Group (ASX:MQG)<\/a>
\n8. Woodside (ASX:WDS)<\/a>
\n9. Fortescue Metals (ASX:FMG)<\/a>
\n10. Wesfarmers (ASX:WES)<\/a><\/p>\nRegular rebalancing is the key<\/h2>\n