How AI megacaps are creating investment opportunities
July 15, 2024
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3 min read
Large cap indices are now increasingly concentrated
The incredible success of megacap tech has also led to the large-cap indices becoming increasingly concentrated in technology as the charts below show.
On June 19th, 2024 Nvidia became the world’s most valuable company. Its rise has been stunning, up 181% so far in 2024 and taking only three months to add US$1 billion in market capitalisation1. While some of the other US-based megacap tech stocks have also seen impressive share price rises this year – Meta +44%, Alphabet +26%, Microsoft +20%2 - Nvidia’s explosive growth has left them looking like laggards.
While most investors’ attention has been drawn to the individual stocks, the incredible growth of these very large companies has also driven significant increases in indices that contain these names, including the S&P500, the NASDAQ and the global MSCI indexes.
Global large caps have out-performed in recent years
The impressive performance of the megacap tech stocks has driven large-cap indices to outperform mid and small cap indices over the past three years as can be seen in the graph below.
Total return of MSCI ACWI vs MSCI ACWI SMID in AUD from 06 2021 to 05 2024. Source: Morningstar Direct
However, if you take a longer-term view you can see that this recent outperformance is unusual. The chart below shows that for most of the last 20 years global SMIDs outperformed global large caps, only closing the gap when mega-cap tech companies surged.
Total return of MSCI ACWI vs MSCI ACWI SMID in AUD from 06 2004 to 05 2024. Source: Morningstar Direct
Large cap indices are now increasingly concentrated
The incredible success of megacap tech has also led to the large-cap indices becoming increasingly concentrated in technology as the charts below show.
Technology sector concentration
Source: Morningstar Direct, as of 20 June, 2014 and 31 May, 2024
In 2014, the technology concentration of all three indices was reasonably similar, however now in May 2024 technology makes up more than 30% of the S&P 500 and 25% of the global large cap index. The global SMID index has stayed relatively consistent, rising from 12% to 14%.
The increased concentration of the large cap indices is a concern for investors that prize diversification as a way of decreasing risk and reducing the volatility of their investment returns. The SMID index remains more diversified than the large cap index, and of course active managers can construct portfolios which are better diversified than the index through considered stock selection.
Can large caps continue to outperform?
This is the key question for investors. According to Vaughan Nelson Portfolio Manager James Eisenman:
“Large cap names have been largely driven by excitement around AI, while the tangible benefits of implementing the technology have yet to be seen. If AI is over-hyped and needs time to mature as a technology, then large cap tech could give back some of its recent outperformance. However, if new use cases are developed quickly then the tangible benefits of AI could provide an outsized benefit to small companies by allowing them to scale their operations more efficiently as they grow.”
While the question of whether large cap outperformance will continue can only be answered in the future, James Eisenman thinks all investors should be aware of, and adjust to, the new market dynamics.
“Due to the incredible success of the AI-related megacaps the stock market has changed significantly in a short period of time and all investors should be looking at their investment portfolios and deciding whether they need to adjust or rebalance them to align with their investment plans. These market movements have also created great opportunities for active managers and stock pickers to out-perform their benchmarks over the long-term. Any big market changes are opportunities which active managers and astute investors can capitalise on. This year we have been able to open positions in companies that will benefit from the success and growth of AI, but are trading at much lower multiples.”
1 Reuters, 19 June, 2024. ‘Nvidia becomes world’s most valuable company’
2 Stats as of 19 June
* IML’s Equity Income Fund (EIF) has several differences from the ‘Generic ETF’ mentioned in the article. Investors should closely examine each fund, as well as seeking independent financial advice, before considering investing in any fund. Some key differences are outlined below.
Differences in the funds’ objectives:
• EIF’s investment objective is to provide income 2% above the S&P/ASX 300 Accumulation Index, after fees and before franking, at lower volatility, on a rolling four-year basis.
• The underlying ETFs referenced in the Generic ETF have investment objectives that try to track or closely match the performance of the S&P/ASX 200 or S&P/ASX 300, before fees and expenses.
Differences in the funds’ fees: EIF has higher fees than the Generic ETF. Please see footnote iv below for details.
Difference in the number of stocks invested: EIF has the risk of being exposed to a smaller number of stocks than the Generic ETF.
Difference in the use of options: EIF uses a conservative derivatives strategy to increase income while the Generic ETF does not use derivatives to increase income.
For more details of the benefits and risks of the funds, please consider the EIF PDS and TMD and the PDSs and TMDs of the funds referenced in this article: A200 (betashares), IOZ (ishares), STW (State Street) and VAS (Vanguard).
i Natixis Investment Managers 2023, Global Individual Investor Survey.
ii Source: Morningstar Direct, as of 30 November 2023
iii The generic ETF was created by taking the median performance, franking and fees from 4 different passive index funds which track the ASX200 or ASX 300. The index funds used are A200 (betashares), IOZ (ishares), STW (State Street) and VAS (Vanguard).
iv The fees and franking for EIF are on the EIF Fund page on the IML website, the fees and franking for the generic ETF were calculated using the median of the four funds mentioned above, 5 basis points of fees and 75% franking.
This communication has been provided for information purposes only to investment service providers or other Professional Clients, Qualified or Institutional Investors, and licensed financial service providers. This communication must not be used with Retail Investors. It is the responsibility of each investment service provider to ensure that the offering or sale of fund shares or third party investment services to its clients complies with the relevant national law.
Natixis Investment Managers is the holding company of a diverse line-up of specialised investment management and distribution entities worldwide. The investment management subsidiaries of Natixis Investment Managers conduct any regulated activities only in and from the jurisdictions in which they are licensed or authorized. Their services and the products they manage are not available to all investors in all jurisdictions.
Natixis Investment Managers includes all of the investment management and distribution entities affiliated with Natixis Distribution, L.L.C , and Natixis Investment Managers International. For a comprehensive list, please visit: https://www.im.natixis.com/intl/podcasts-and-other-media
The provision of this communication and/or reference to specific securities, sectors, or markets within this communication does not constitute investment advice, or a recommendation or an offer to buy or to sell any security, or an offer of any regulated financial activity. Investors should consider the investment objectives, risks and expenses of any investment carefully before investing. The analyses, opinions, and certain of the investment themes and processes referenced herein represent the views of the individual(s) as of the date indicated. These, as well as the portfolio holdings and characteristics shown, are subject to change and cannot be construed as having any contractual value. There can be no assurance that developments will transpire as may be forecasted in this material. The analyses and opinions expressed by external third parties are independent and does not necessarily reflect those of Natixis Investment Managers. Any past performance information presented is not indicative of future performance.
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