Investec warning to South African investors

Investec specialists warned that while indexes may seem like a great investment strategy, they are often overly concentrated and risky. 

This warning came from Investec’s head of investment distribution and intermediaries, Ebeth Van Heerden, and portfolio manager at Investec Investment Management, Paul McKeaveney.

“Concentration can be especially risky when the concentration results from a common theme or factor affecting the group of investments, and especially when the valuation of the investments doesn’t leave a large margin of safety,” McKeaveney said. 

“There’s no question that the S&P 500 is very concentrated regarding the weightings of its top 10 companies.”

He said there are always new names to group them, like the Magnificent Seven (Apple, Microsoft, Google, Nvidia, Meta, Amazon, and Tesla) or the Fab Five (Nvidia, Meta Platforms, Google, Microsoft and Amazon). 

If things don’t work out as expected for even one or two of them, the index at the headline level will come under pressure.

Coronation has similarly warned investors against the Magnificent 7 group of companies, with Chris Cheetham and Neil Padoa saying that the index’s rise exemplifies the narrowness of stock market returns.

An equal-weighted index of these seven shares has returned an annualised 47% over the last five years, roughly triple the S&P 500’s 16%. 

To put this into perspective, $1 million invested in the Magnificent 7 five years ago would now be worth $6.8 million, compared to $2.1 million if invested in the S&P 500.

However, Coronation cautioned investors interested in this group of companies that there have been massive differences in performance between individual companies in recent years. 

Studies over a period of time showed clear winners and losers, highlighting the importance of stock picking.

The table below shows the divergence in these companies’ fundamental performance, while the graph below shows the significant variance in their share price performance.

“A concentrated index is also difficult for the active managers in the short term because as excited as they may be about some of these companies, they need to hold a very high weight in them to outperform the index, assuming they keep going up” McKeaveney said.

Locally, this was the case a couple of years ago when Naspers became over 20% of the JSE index. 

For a fund manager to outperform the benchmark as Naspers kept going up, they would have needed to hold over 20% in Naspers. No matter how much you like a company, this isn’t a good risk management strategy.

“The inherent risk management that good fund managers practise is sometimes underappreciated in concentrated market environments, which we have today, specifically in the US.”

“Invest and forget” is good guidance for investors in this regard, Van Heerden explained. “Do your homework, identify your goals, get the right plan and instruments in place, then invest and forget about it.”

He cautioned investors against switching every time the market goes up or down. “Don’t fiddle or tinker with it too much,” he said.

Market concentration is another important thing to consider when indexes are concerned. “Indexing is a great idea when you struggle to find active asset managers or firms to outperform the index.” 

Van Heerden added that we are fortunate to have many high-quality managers who have done that over time in South Africa.

“The problem with indexing is that you perpetuate what everyone else is doing. If the Fab Five is ruling the index, you are as concentrated in that investment as everyone else is.”

Active asset managers have the opportunity to differentiate from that, making your portfolio look different from the index over time. 

In the long run, with the right managers and the right plan, this will prove to be very valuable for you.