August proved to be a significant month for stockpickers, particularly those who accurately predicted the success of a select group of Big Tech companies, known as the ‘Magnificent Seven.’
While small- and large-cap stockpickers outperformed their benchmarks last month, the overall picture throughout the year tells a different tale. Only a few funds have managed to surpass their indexes, indicating that passive funds are expected to maintain their dominance.
After a period of underperformance in June and July, large-cap managers made a strong comeback in August. According to Bank of America’s research note, 57% of funds managed to outperform their Russell 1000 benchmark.
Fund managers displayed the ability to choose the ‘Magnificent Seven’ wisely. By underweighting Apple (AAPL) and Tesla (TSLA), which were among the worst performers in August, while overweighting Alphabet (GOOGL), Amazon (AMZN), Microsoft (MSFT), and Nvidia (NVDA), which experienced impressive gains, they made astute decisions. However, their only misstep was being overweight on Meta Platforms (META), which underperformed.
Unfortunately, Apple’s stock has faced a challenging start in September. With shares falling due to a ban on iPhone use for Chinese government officials, investor sentiment has been negatively impacted.
These seven stocks hold significant influence over performance as they constitute 27.6% of the S&P 500 index. In fact, the combined weight of these companies exceeds that of any other top seven companies in the index since the turn of the 21st century, according to BlackRock.
The importance of these stocks in determining performance cannot be emphasized enough. As Savita Subramanian, head of equity and quantitative strategy at Bank of America, explains, “Half the battle for mutual funds these days is just getting that 30% of the benchmark right, and it’s down to seven decisions that make up a huge part of your alpha.”
Despite a minor setback with Meta, fund managers’ choices to overweight and underweight in August aligned well with the performance of these companies, as identified by Subramanian.
August was truly a month of success for stockpickers, with the ‘Magnificent Seven’ playing a pivotal role in driving performance. However, the year as a whole presents a different story, highlighting the ongoing dominance of passive funds in the market.
The Factors Behind the Success of Large-Cap Funds
Large-cap funds have seen a positive performance in recent months, partly due to their avoidance of the utilities sector, according to BofA. By maintaining a lower percentage of holdings in this sector compared to the benchmark, these funds have managed to dodge its underperformance.
However, when taking a longer-term perspective on fund performance, it becomes clear that only 37% of large-cap funds have outperformed their respective benchmarks this year. This finding aligns with existing data that consistently demonstrates how actively managed funds struggle to surpass their benchmarks, especially over extended periods.
An additional concern highlighted by Subramanian is the risk of excessive concentration among certain stocks, which she refers to as the “Magnificent Seven.” Mutual funds have almost reached their maximum capacity for owning shares in these stocks due to concentration risk. Consequently, they may be more inclined to sell rather than increase their exposure to these companies.
This concentration risk restricts the flow of capital, potentially leading to negative outcomes for these heavily weighted stocks. BofA noted that 20% of funds currently have over 40% of their assets invested in the Magnificent Seven, which marks a significant increase from the 12% reported last year.
Moreover, 10% of funds have more than 40% of their assets invested in just five stocks, which are a subset of the Magnificent Seven. Among these stocks, Amazon, Microsoft, and Nvidia are the most heavily weighted, with 80% of funds being overweight in each.
While small-cap managers experienced a high success rate in August, with 88% outperforming the Russell 2000 benchmark, the picture for the full year is not as positive. Only 44% of funds have managed to outperform their respective benchmarks.
