Tech dominance keeps Fundsmith Equity trailing global markets

Fundsmith Equity manager Terry Smith, like other professional investors, is continuing to face into the headwind of global stock market returns being heavily influenced by a small number of US technology companies.

In a note to investors, Smith said that in the first six months of 2024 nearly half the 17% sterling return for the S&P 500 index was down to five companies – Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Meta Platforms (NASDAQ:META), Microsoft (NASDAQ:MSFT) and Nvidia (NASDAQ:NVDA).

Smith added that 25% of the returns came from Nvidia alone, which is seen as the star stock to play advancements in artificial intelligence (AI).

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The dominance of the US tech giants also translates to the performance of global indices. In the first half of 2024, the MSCI World index sterling return was 12.7%. Microsoft, Apple and Nvidia account for nearly 15% of the index.

As a result of tech dominance, many active fund managers have been struggling to gain an edge over global markets, including Fundsmith Equity.

The fund was up 9.3% in the first six months of 2024, but over the past three calendar years, it has underperformed in each year.

Smith said in his letter to investors: “An increase in value of 9% in a year would be in line with the long-term average for equities, so 9% in a half-year would normally be cause for celebration except, of course, that it is less than the index. Part of the problem is that returns have been concentrated in a very few stocks.”

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Fundsmith Equity owns three of the five stocks that continue to be star performers in 2024 – Apple, Meta and Microsoft. However, the position in Apple is small. 

Addressing Nvidia, Smith said “we have yet to convince ourselves that its outlook is as predictable as we seek”.

He added: “Without owning this stock, and indeed the whole five in at least an index weighting, outperformance was difficult to attain.”

Meta, the owner of Facebook, helped drive Fundsmith Equity’s first-half returns. It was highlighted as the second-best positive contributor, with an attribution of 2.7%.

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The top contributor was Novo Nordisk (NYSE:NVO). Its share prize has sizzled due to it being one of the two main beneficiaries of the weight-loss drugs’ boom. It had an attribution of 3.4%.

The biggest stock detractor was L'Oreal (EURONEXT:OR), which had an attribution of -0.7%.

Active funds tend to be ‘underweight’ the Magnificent Seven

Most actively managed US and global funds tend to hold less than the wider market in the US tech giants.

One reason is because portfolio concentration rules prohibit funds from holding more than 10% in a single stock. Such rules are in place to ensure funds are sufficiently diversified, which helps to reduce risk.  

In contrast, index funds and exchange-traded funds (ETFs) can hold a higher percentage.

For index funds, 20% of assets can be held in a single stock, which can rise to 35% in exceptional market conditions. For ETFs, the same 20% rule applies, but some put their own rules in place to cap each constituent at a certain level, such as 10%.

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Bear in mind that some tech-focused index funds are highly concentrated. One example is L&G Global Technology Index, which has big individual weightings to Microsoft (16.1%), Apple (14.7%) and Nvidia (13.9%). It was the most-bought fund in June among interactive investor customers.

For investment trusts, there is no single-stock limit. However, in practice, most trusts don’t continually hold more than 10% in a single stock, and it is rare to see a position of 15% or more. Some investment trusts have their own stock position rules.

As ever, it is important for investors to look under the bonnet and understand how much concentration risk they are exposed to. A look at the top 10 holdings offers a quick snapshot.