Beware the titans
Today’s giant shares seem destined to dominate global stock markets indefinitely. But titans are, in fact, regularly displaced by other businesses, and few have the foresight to predict which ones they are going to be. Very few could have predicted that a car company would be in the top 10 shares in 2021. The last motor manufacturer in this august grouping was Toyota, back in 1990. And that was primarily because Japanese shares dominated world markets, rather than because of enthusiasm for the internal combustion engine. This time it’s not Toyota but Tesla, which satisfies the twin themes of technological revolution and a green economy. That’s helped the company achieve an extraordinary market cap of $670bn.
Only Apple and Microsoft have remained in the top 10 since 2010, while the only nontechnology share in the group today is Warren Buffett’s
Berkshire Hathaway.
Research Affiliates, best known for the Research Affiliates fundamental index, recently produced an interesting paper called “The Fall of the Titans”. In a nutshell, the writers argue that investing in large-cap shares, particularly via a highly concentrated market cap index, can mean underperformance for investors over time.
At the moment, the weighting of the top 10 shares in the MCSI world index is at a record high of 16.6%, higher even than at the height of the previous technology boom in 2000, when it was 13.7%. Admittedly, these tech titans are a lot more profitable than the dot.com shares (remember Pets.com?) and they have cash-rich balance sheets. But it’s worth noting that there were also substantially profitable businesses in the 2000 top 10, such as Intel, Cisco — and Microsoft.
Recall that in SA, the main reason for the success of Dimension Data was that it was a Cisco distributor. And Cisco is a valuable cautionary tale: it traded at a p:e of 200 at the height of the 2000 boom, and unlike most of the sector, at least it made a profit. But its price fell 86% during the dot.bomb crash.
Intelligent value
The Research Affiliates fundamental index inevitably favours value shares, but it is intelligent value and far removed from the bull-headed fund manager who won’t touch a share with a p:e ratio above 10. The index does not ignore technology shares, but the weighting of its top 10 shares, at 6.9%, is less than half of their market cap weighting. In 2000 it was 5.4% compared with a 13.7% weighting. But perceptions of technology were different then: cellphones, for example, were still considered relatively new and exciting, so shares such as Japan’s NTT Docomo and Germany’s Deutsche Telekom were in the top 10. Before Netflix there was lots of talk of multichannel television being piped into homes through fixed lines, which sounds archaic today.
Research Affiliates has also gone beyond its original fundamental index to create a multifactor index which also considers size, value and profitability. It is worth considering a blend of this index with a standard market cap index. Though backtesting is often misleading, over the past 6½ years a multifactor portfolio would have added 1.5% a year over a pure market cap fund.
In a US portfolio, the usual suspects such as Apple, Microsoft and Amazon would still be in the fund, but there would be newcomers such as The Walt Disney Co, Walmart and Home Depot. IBM, the biggest share in the world in 1980, also comes into this blended portfolio
So “passive” investing doesn’t have to be so passive after all.