Heavy concentration of the Tech sector in the biggest Index Funds is risky
The three Wealth Management giants running these index funds have a lot of money invested in the big techs
Investing in equities has come a long way in the past few decades, providing a broad range of choices to active traders & long terms investors alike. You don’t have to pay sky-high fees for sub-par performing stock portfolios anymore. One of the greatest innovations & most popular ones too in this regard have been stock market index finds — a trading instrument that replicates the performance the underlying stock index.
Although it might not provide you with aggressive returns on your investment, the index funds are great long term investments. Since the stock markets tends to go up in the long term, these instruments are especially attractive for retirement accounts offering the diversification of the broader market. No wonder the index funds have gained universal popularity.
Now imagine if you had money invested in an index fund mirroring the performace of the U.S stock market benchmark index S&P 500 last year — you would have bagged 28.5% gains barring 0.04–0.05% management fee. Thanks to the continued bumper performance by the tech sector, the broader market kept posting record highs to end 2019.
The tech sector continues to take the drivers seat as we progress in the year 2020. The changing dynamics of the market dictate that the movement of the market will be dominated by what happens in this sector. So far, the investors seem to have an insatiable appetite for tech. Big tech stocks like Apple, Amazon, Microsoft, and Google/Alphabet with trillion dollar market caps tend to pull weighted indexes like the S&P 500 up with them.
They are also among the most widely-held stocks among index funds and ETFs. The direction of these tech giants, therefore, determines the direction of the market as well. The trouble on the horizon is the stretched valuations of these companies as they trade at a high multiple given their anticipated earnings. Any downside shock will most certainly drive the entire market down.
But the problem doesn’t end there — the biggest index funds run by Asset Management giants like Blackrock, State Street Global Advisors & Vanguard heavily own tech stocks like Apple, Microsoft and Amazon, as reported by Bloomberg. These indices, which have been a runaway success for these companies might pose a huge problem for them as well.
The Big three asset managers own 22% of the typical S&P 500 company — not just the big tech stocks. Individual breakup is as follows:
- Blackrock — The World’s largest asset manager has $ 7 trillion under its management
- Vanguard Group Inc. — manages $5.6 trillion worth of assets
- State Street Corp. — manages $2.9 trillion
These three combined own 18% of Apple’s shares with similar ownership percentages in the four biggest banks of the U.S (infographic above). Collectively, these three companies manage $15 trillion of investors’ money which amounts to almost 80% of all indexed money.
While these funds reiterate that investors have nothing to worry about since they just buy whatever’s in the index, usually in proportion to its market value and are not pursuing any special agenda — nonetheless, they have voting power that can impact the outcome of important company matters like mergers & major investment decisions etc.
Also, critics like Environmental and consumer groups blame these big index managers of ignoring their broader social responsibilites like investing in fossil fuel companies and not blocking lavish pay packages for higher executives of these companies. The big three might also come under the radar for killing the competition with their overwhelming dominance of the indexing space.
For now though, the innediate worry for people heavily invested in these index funds linked to their retirement accounts is the pinch they would feel, if the big tech stocks were to fall.