Should investors be concerned about concentrated positions in an index?

Should investors be concerned about concentrated positions in an index where a substantial portion of the index is exposed to a single sector or stock? Some believe there are credible arguments for staying away from concentrated indices whereas others argue that a simple market-capitalisation index automatically adjusts for weightings to ensure they continue to reflect the true nature of their underlying economies.

 

Where no consensus exists, we should always go back in time and focus our attention on what history has taught us.

 

Basic Materials (not including “Oil and Gas” / “Specialty Chemicals”) made up almost 50% of the FTSE/JSE All Share Index as at 30 June 2008. Market commentators and fund managers believed that once the resource super cycle was over, the All Share Index was due for a pullback. While this proved correct in the short-term and despite the subprime housing crisis which originated in the USA, the All Share Index kept rising.

 

Basic Materials (not including “Oil and Gas” / “Speciality Chemicals”) underperformed the market over the years to follow, accounting for only 17% of the All Share Index as at 31 March 2018 (from almost 50% in 2008).

 

Figure 2 reflects the phenomenal performance of the All Share Index

 

This performance was achieved despite the decline in value of Resource stocks like BHP Billiton and Anglo American over this period. BHP Billiton and Anglo American comprised 16% & 17% of the All Share Index as at 30 June 2008. Today they represent only 4% & 7% of the All Share Index, yet the index still returned 9.67% per annum for 10 years up to 31 March 2018.

 

Over this period of Resource stock underperformance, Industrial stocks like Naspers, Clicks and financial stocks like Capitec and Sanlam were strong outperformers.

 

Many opponents of indexation today refer to the exposure of Naspers in the index (at 18%) as a “high risk” and use this as a justification against indexation. A counter argument would be as follows:

 

  1. The exposure of Naspers in the All Share Index today is not all that different from the exposure of Resource stocks in the index in 2008. As such, the arguments against indexation were as “valid” in 2008, as they supposedly are today.

  2. The statistics clearly indicate that over the 10-year period ending 2017, very few active managers were able to outperform the All Share Index.

  3. While much attention is currently being focused on Naspers performance, not much mention is made of the performance of Clicks, Capitec and Sanlam, which over this 10-year period, also produced stellar returns for investors. To the share price appreciation of these stocks, must also be added the dividends returned to investors.

 

It is clear therefore that active management required two very difficult decisions over this 10-year period. Firstly, the decision to underweight Resource stocks. It would appear that many active managers got this right. However, the second decision active managers had to make was to identify the “winning” stocks over this period and based on their performance it would appear that not many succeeded in doing this.

 

In contrast, these “winning” stocks were automatically included in the All Share Index as the underlying businesses and earnings grew, as did their weightings in the All Share Index.

 

Stock markets are the best performing asset class over the longer term and provide a return much higher than inflation, a force that continually erode wealth.

 

From the above one can see that 73% of fund managers had trouble beating the market in a period that included the Great Financial Crisis and one that provided managers a great opportunity to acquire stocks at bargain prices.

 

One can say unadjusted benchmarks are “smart” in the sense that they do all the hard work for you.

 

Investing in a fund that tracks such an index performance, like the Gryphon All Share Tracker, will ensure that you as the investor secure the index performance.

 

As in the past investors making use of index funds will continue to benefit and we advocate all investors to allocate at least 40% of their equity exposures to indexation products…something Warren Buffet, the greatest active manager in recent history, agrees with.

 

 

 

CL Treurnicht, Portfolio Manager Gryphon Asset Management

 

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