Fundsmith Equity manager Terry Smith, like many other professional investors, continues to navigate the challenge of global stock market returns being significantly influenced by a handful of US technology companies.
In a communication to investors, Smith highlighted that during the first half of 2024, nearly half of the 17% sterling return of the S&P 500 index could be attributed to five specific companies:
Amazon.com Inc (AMZN) with 0.03%
Apple Inc (AAPL) with 0.38%
Meta Platforms Inc Class A (META) with 0.13%
Microsoft Corp (MSFT) with 1.44%
NVIDIA Corp (NVDA) with 2.48%
Smith further noted that 25% of these returns originated solely from NVIDIA, recognized for its role in advancing artificial intelligence (AI).
The influence exerted by US tech giants extends to the performance of global indices as well. In the first half of 2024, the MSCI World index recorded a sterling return of 12.7%, with Microsoft, Apple, and Nvidia collectively contributing nearly 15% to the index.
This tech dominance has posed challenges for many active fund managers seeking to outperform global markets, including Fundsmith Equity. While the fund showed a 9.3% increase in the first six months of 2024, it has consistently underperformed over the past three calendar years.
Smith conveyed in his investor letter, ‘A 9% rise in a year would typically align with the long-term average for equities, so achieving 9% in a half-year would normally be cause for celebration, except that it falls short of the index. Part of the issue lies in the concentration of returns within a handful of stocks.’
Fundsmith Equity holds positions in three of the top-performing stocks in 2024 – Apple, Meta, and Microsoft. However, the investment in Apple is relatively small.
Regarding Nvidia, Terry Smith remarked, “We have yet to convince ourselves that its outlook is as predictable as we seek.”
He further commented, “Without owning this stock, and indeed all five stocks at least in line with their index weights, achieving outperformance was challenging.”
Meta, the parent company of Facebook, significantly contributed to Fundsmith Equity’s returns in the first half of the year, ranking as the second-best positive contributor with an attribution of 2.7%.
Novo Nordisk A/S ADR (NVO) emerged as the top contributor with a 3.4% attribution, fueled by its significant role in the booming weight-loss drugs sector. Its share price surged accordingly.
Conversely, L’Oreal SA (OR) was the largest detractor, experiencing a -0.7% attribution.
Most actively managed US and global funds typically maintain an ‘underweight’ stance towards the dominant US tech giants. This cautious approach stems partly from portfolio concentration rules that restrict funds from holding more than 10% in any single stock. Such rules are designed to enhance diversification and mitigate risk.
In contrast, index funds and exchange-traded funds (ETFs) can allocate up to 20% of their assets to a single stock, with exceptions allowing for higher percentages in certain market conditions. ETFs often impose additional internal limits, capping individual constituent weights, such as at 10%.
It’s worth noting that certain tech-focused index funds can be highly concentrated. For instance, the L&G Global Technology Index holds substantial individual weightings in Microsoft (16.1%), Apple (14.7%), and Nvidia (13.9%). This fund garnered significant interest in June, ranking as the most-purchased fund among interactive investor customers.
Unlike mutual funds subject to single-stock limits, investment trusts are not restricted in this manner. However, most trusts typically refrain from consistently holding more than 10% of their portfolio in a single stock, and positions exceeding 15% are rare. Some investment trusts establish their own internal rules regarding stock concentration.