Over the weekend, Barron’s wrote Tech Stocks’ Dominance Poses Risk for Investors. There were a couple of points in there to explore a little further. To the article’s title and first point, technology grew to 25% of the S&P 500 Index. Since the start of my blogging in 2004 I have been writing about how crucial it is to keep an eye on sector weightings with precedence including energy which grew to 30% in the early 1980’s, tech which grew to 30% in 2000 and financials to 23% before the financial crisis. I view 30% as flashing red light to underweight and 20% as more of a flashing yellow light; be very cautious.
Here are a couple of recent links from me on this here and here.
The article quotes advisor Dan Wiener as not being a fan of indexing because later in the cycle, the broad indexes end up being dominated by whatever has been hot. A look at the S&P 500’s constituency indeed corroborates the assertion, as of last Friday the three largest tech holdings in the S&P 500 accounted for 8.6% of the index. Barron’s notes the tendency of fund managers to end up even heavier than the benchmarks in the dominant sectors which often translates into investors having too much in the sector that ends up leading the decline, we saw in the previous two bear markets.
There was one sentence that made me laugh out loud: “Passive investors who want to avoid the overconcentration risk from cap-weighted indexes can buy funds that own equal proportions of each stock in an index …” The idea may be perfectly valid but it is clear to me that the person who decides to switch to an index fund that uses an alternative weighting process is not a passive investor, they are making a very active decision, using what might be a passive vehicle to do it.
I’ve been saying for a long time that the active/passive debate has become the wrong thing to look at, it isn’t even a thing. My take has been that what “passive” investors really are is users of passive funds and not very active. Rebalancing is an active decision. What threshold causes you the passive investor to rebalance? No matter the answer it is an active decision. What is your asset allocation? That is an active decision. Leave the labels behind, use whatever you think are the best vehicles for the exposures you want and when possible, use a less expensive option where there is more than one choice for an identical exposure.