In the beginning, fund managers didn’t worry about competition. In those happier times, the first big collective vehicles aimed at retail investors in the UK bought portfolios of 25 or so stocks, mostly with an income bias (the tastes of British investors have not changed), and typical managers did nothing but maintain the portfolio in “an administrative capacity,” says Nigel Morecraft in Towering Investors: The Origins of Asset Management from 1700 to 1960. They bought and they waited — mostly without much reference to what anyone else did. These professionals knew nothing of benchmarks. Their aim was to do better than inflation, cash or government bonds. Not so for the modern version, who is no longer allowed to think in absolutes or for the long haul. Instead, he must think only in terms of performance relative to one of the many indices to which his performance is benchmarked — over no more than five years.
That’s a terrible shame. That’s partly because relative performance is not what the average punter cares about: Our first hope is always that we not lose money, not that we lose less than a spreadsheet. It also puts the focus in the wrong place. If your main aim is not to do worse than an index (there are no bonuses in that!), something that tempts you to replicate much of the index in your portfolio, you will also find it hard to do better than that index. And sometimes you will find it harder than other times.
Now is one of those times, thanks in large part to the extraordinary dominance of megacap stocks in global markets, in the US in particular. Over the past 12 months the Dow Jones Global Titans index (the biggest 50 companies in the world) is up about 35%. The MSCI World Index (which is market-cap weighted and so biased toward the Titans) is up 21%. The equal-weighted version of the world index is up about 14%.
The biggest companies have been the only real out-performers and hence the thing to beat. Almost no one has managed it. Look over the last decade, says fund manager GMO and 90% of large-cap blend managers have underperformed the S&P 500 Index. Horrible. Look to the actively managed funds in the UK (of all types) says Alex Paget at fund-management firm Downing: 2.5% of them have outperformed the Titans in the last 12 months. The few that have made the grade have almost all had a US, growth and technology bias and have been overweight the biggest stocks out there.
The MSCI World index comprises a weighting of 3.4% Nvidia Corp., for example. The average outperforming fund has been 5.33% Nvidia, according to research from Downing. The only way to outperform has been to take a massive bet on megacap exceptionalism and to hold the giants in higher weightings than they already hold in historically concentrated indices.
Not many have done that — for the simple reason it’s really hard. You have to be ridiculously brave to take that kind of stock-specific risk, particularly at today’s toppy valuations. And often your compliance department won’t let you (this kind of thing rarely suits the risk matrix). In normal times, all sorts of routes to outperformance can work. In these times, only this slightly scary one does so reliably. So what next? If the megacaps keep this kind of growth up, nothing. US and global active managers will either end up holding only Nvidia and Meta Platforms Inc. in a desperate effort to remain relevant — or the industry’s benchmark obsession will mean that they underperform themselves out of existence.
That doesn’t seem the most likely result. Look the late 1990s. The world’s biggest companies were also on a roll - and active managers were also struggling. The figures weren’t quite as awful as today’s: Paget reckons around 20% of active funds outperformed the Titans between 1995 and 2000. Then came March 2000. Microsoft Corp., which was the largest company in the world by market cap in early 2000 (and again in 2024) was down 60% over the next six years, a stretch that turned out to be a “golden period” for active managers. Of the active funds in the Investment Associationuniverse at the time 84% outperformed the Global Titans between 2000 and 2007 with some of the best performers being the exact opposite of what you had to have in 1998 — smaller company value funds.
There is an argument that that won’t happen this time: Today’s big companies are just too profitable and too awash with cash. They said that in the early 1970s too. But it didn’t stop the one time-one decision megacaps, the Nifty Fifty, suffering horribly in the late 1970s. If you had hung on to the seven largest from their peak to the end of the decade you would have been roughly evens. If you’d bought almost anything else you’d have ended it up (the S&P 500 rose around 80% over the same period).
It has seemed mad to invest in anything but the biggest stocks in the past — and it might seem mad now too. But the sands are shifting. The US rally has considerably more breadth than it did. Small caps are keeping pace with mid and large caps and equal-weighted ETFs are doing as well as market-cap weighted ETFs. More sectors are on the move too - even energy and utilities have joined the rally. At the same time, not all the megacaps are showing the exceptionalism we assume: The Global Titans index is flat over the last few weeks; Tesla Inc. and Apple Corp. are down so far this year and Microsoft and Alphabet Inc. are barely tracking the index. Not so much the magnificent seven says Gavekal Research
as the magnificent three (Nvidia, Meta and Amazon.com Inc.) — which doesn’t have quite the same feel to it.
The only way to outperform an index is to be different from that index in the right way. For the last few years, there has only been one way to do that. But if the Titans tank, if they flatline or even if they are just joined in their bull market by more sectors and companies, there will be many more. And active managers, particularly those open to value and smaller-company investing should have an opportunity to show that they are not quite as useless as the last few years have made them look — both against inflation and their benchmarks.
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