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At Bloomberg, John Authers explains how Apple and other FANG+ stocks are breaking the way active mutual fund managers work. He writes:
The FANG phenomenon is adding to the torture for active investment managers, as the latest report into U.S. mutual funds’ holdings from Goldman Sachs Group Inc. illustrates. It is only possible to beat a narrow market like this if you grab on to a few of the big winning growth stocks and hold them. This is a problem, because the Russell 1000 Growth index, popular as a benchmark for mutual fund managers, is reaching record levels of concentration:
You can load up on lots of different value stocks, but a few big growth stocks can soon take up an unduly weighty share of your portfolio. This helps to explain why mutual fund managers are historically underweight in growth (just as it is doing so well), while overweight in value (which has suffered years of travails):
Specific and prudent limits placed on funds’ concentration in particular stocks are causing severe pain. As Goldman says:
AAPL, MSFT, and AMZN account for 10%, 10%, and 8% of the benchmark, respectively. Many managers face restrictions around diversification and position weights, making it challenging for them to hold the FAAMG stocks at their respective index weights.
If the $3.5 trillion gorillas Apple and Microsoft are excluded, mutual funds are overweight in technology. Include the two pirates of Silicon Valley and, amazingly, mutual funds are significantly underweight:
A similar effect is at work within consumer discretionary stocks, skewed by the giant that is Amazon.com Inc. The current weightings to consumer discretionary and tech sectors are at eight-year lows. In both cases, this is entirely because of the FANGs:
Mutual funds could beat the index, at least in the short term, by jumping on the FANG bandwagon, but their own concentration limits won’t let them. If you want to ride the momentum behind the FANGs, you will need a passive fund — which, in this case, seems very poorly named. Passive funds are more heavily allocated to FANGs than ever, because the FANGs are a bigger proportion of the index than ever; active funds are less fully exposed to the FANGs than at any point in five years:
In the long run, this may turn out well for active funds. The concentration limits are there for a reason, and they are filling up on value stocks at bargain prices. By comparison, any number of passive funds begin to look like vehicles for speculation.
This does, though, raise the issue of what the role of active management should be, now that passive funds are so important. With passive exposure to the market available cheap, it behooves active managers to be genuinely active, taking concentrated positions in stocks they have researched well. Rather than aping a broadly diversified index, maybe they should be allowed to let rip.
Read more here.
