Many fund managers consider the Magnificent Seven technology stocks a hugely crowded trade and the frenzy for all things artificial intelligence to be in bubble territory.nicoletaionescu/iStockPhoto / Getty Images
Rush hour traffic is no one’s idea of fun. Studies show idling on crowded roads affects our health negatively and lowers satisfaction with work and life. Likewise, crowded trades are no picnic for advisors who must decide whether to jump in.
Very popular stocks, such as yesteryear’s General Electric Co. and today’s Nvidia Corp., pull focus and capital that drives their share prices up, sometimes away from business fundamentals.
Many fund managers consider the Magnificent Seven technology stocks a hugely crowded trade and the frenzy for all things artificial intelligence to be in bubble territory. Stock data going back 75 years show market concentration in a few stocks is not sustainable over the long term.
To that end, the following three investment concepts are simple, but their application takes practice. Advisors who make the effort are likely to be rewarded with better long-term outcomes for their clients.
1. Use low sentiment to your advantage
Following market momentum leaves little room for error or surprise. Expanding exposure to include more reasonably priced companies gives advisors more flexibility. It also offers a much larger opportunity set and greater portfolio diversification, which is a proven risk management tool. Investing in companies and sectors currently experiencing low sentiment means investment dollars go further.
Market concentration in the U.S., measured as the market capitalization of the top 10 companies relative to total capitalization, has varied from 1950 to 2023 between a low of 12 per cent in 1993 to a high of 30 per cent in 1963, according to a recent Morgan Stanley Investment Management Inc. report. In the 10 years ended in Dec. 31, 2023, concentration in the U.S. stock market almost doubled to 27 per cent from 14 per cent in 2013, and expanded to more than 30 per cent in the first half of this year.
The rate of increase in market concentration over the past decade is disconcerting to many investors. A return to more normal market concentration would necessitate a broadening of market returns.
2. Make haste slowly
Sometimes, a little patience goes a long way. On Feb. 5, 1999, Nvidia’s share price was US4¢. Since inception, the share price has risen more than 262,000 per cent. Apple Inc. debuted on the Nasdaq in 1980 at US$22 a share (on a split-adjusted basis, the initial stock price was US10¢). By 1997, the company was practically left for dead and on the verge of bankruptcy. Yet, in 2022, it became the world’s first company with a $1-trillion market capitalization.
These are dramatic examples but they remind us that stock prices rise and fall – sometimes a lot. Good or even great businesses occasionally stumble but usually right themselves over the long term. Advisors who react to the market’s gyrations can potentially miss out on impressive turnarounds.
Patience is in low supply today. In the 1960s, investors held stock positions for an average of eight years. Today, the average is closer to six months. That makes an advisor who practices patience more valuable to their clients than ever because patient capital is a source of outperformance. Being willing and able to hold onto high-quality assets during periods of market turbulence is the not-so-secret weapon of successful advisors.
3. Know your circle of competence
Warren Buffett has often spoken about staying within his circle of competence, focusing on those companies and sectors that he believes he understands better than the average investor. The size of that circle is less important than knowing its boundaries.
An advisor must have the courage to occasionally say, “I don’t know” when clients ask about company X or sector Y. Staying within the perimeter of one’s competence is a prudent use of both time and capital. Not only does it reduce the risk of loss, it keeps us humble – which, along with patience, is a valuable trait for investors.
Acknowledging that we don’t know everything about everything is a great incentive to remain vigilant about our decisions and to continually improve and serve our clients better.
Aman Budhwar is a portfolio manager at PenderFund Capital Management Ltd. in Toronto.
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