Last Word on Money: August 2023

Monday, August 28, 2023

How the Mighty Have Fallen

While preparing my last post, “Warnings for Index FundHolders”, I came across some interesting facts in my research and thought they would be of interest to you.

But before I go there, let me share something I read last week about the S&P 500 index. According to this source, some stock market analysts project that the potential for gains over the next year in an index fund that gives equal weight to each of the 500 companies represented in the index is double that of an index fund that invests in the 500 companies in proportion to their capitalization/size. A relative handful of large, high-tech companies have accounted for most of the recent gains in mutual funds that are indexed to the S&P 500. Now (at least according to some) it is the turn of the rest of the index to outshine in their performance and reward investors. Something to consider if you are tweaking your stock portfolio.

[Reminder: I am not a registered advisor and cannot and do not make stock recommendations.]

Now to those interesting findings.

You’ve probably heard people say—and maybe you’ve even said it yourself—that certain companies or industries are getting too powerful and dominating the market. Maybe. But time tends to upend the market and conventional wisdom. Consider, for example, who were the top 10 companies (by capitalization) in the S&P 500 in June 2000:

General Electric (4.19% of the index)

Intel (3.59%)

Cisco Systems (3.56%)

Microsoft (3.38%)

Pfizer (2.42%)

Exxon Mobil (2.19%)

Walmart (2.06%)

Oracle (1.89%)

AT&T (1.70%)

Nortel (1.62%)

Compare that to the current top 10:

Apple (7.56%)

Microsoft (6.92%)

Amazon (3.17%)

Nvidia (3.05%)

Tesla (2.06%)

Alphabet Class A (Google or GOOGL) (1.90%)

Meta Platforms Class A (1.83%)

Alphabet Class C (Google or GOOG) 1.64%

Berkshire Hathaway (1.60%)

UnitedHealth Group (1.23%)

So twenty-three years later only one of the top 10 still held that spot. There are no “Big Pharma” companies there. And no “Big Oil.” And Nortel? Bankrupted over fraud and liquidated just seventeen years after being the tenth biggest company in the U.S. by capitalization.

And how about this list of S&P 500 top 10 companies from 1973:

IBM (8.44%)

AT&T (5.19%)

Exxon (4.05%)

Kodak (4.04%)

General Motors (3.49%)

Sears Roebuck (2.73%)

Xerox (2.24%)

General Electric (1.92%)

3M (1.74%

Texaco (1.71%)

Kodak? Sears Roebuck? How times have changed.

And that’s my point. Any number of factors can shuffle the ranking of companies and how much—or how little—they are valued by Americans. From fraud, to changing technology, to regulation (or deregulation), to changing consumer tastes, to pandemics….it can all rearrange the corporate picture in a relatively short time. It seems nothing in this world is forever.

Until next time,

Roger

“See, I am doing a new thing! Now it springs up; do you not perceive it? I am making a way in the wilderness and streams in the wasteland.” Isaiah 43:19 NIV*

Wednesday, August 9, 2023

Warnings for Index Fund Investors?

On Point, a broadcast heard on National Public Radio (NPR), had a program this week titled “Are Index Funds Getting Too Powerful?” The title lured me in to listen because it is a subject to which I’ve given some thought as I contemplate moving some investments around. But I was a bit careless. My concern has not been about index funds being too powerful but, rather, too concentrated. But both might be legitimate worries that affect a great many investors, likely including you. I enjoyed the broadcast. So let’s look at both potential dangers.

First, I should give a brief background on index funds. John Bogle, the founder of Vanguard and considered the father of index funds, launched his enterprise in 1975. His premise was that mutual fund managers who tried to outperform the general market through savvy selection of stocks were, over time, doomed to fail. He instead promoted owning the “whole market” by creating mutual funds that held shares of all the companies contained in a certain index. The S&P 500 (an index that tracks the nation’s largest 500 publicly owned companies) is considered the prime example. So rather than employ researchers and analysts to select the investments likeliest to increase the most in value, he simply created mutual funds that bought them all, counted on the generally upward movement of the stock market to propel investment returns, and charged a much lower fee to investors since he didn’t have to pay elite stock-pickers—who, again, he believed would fail to outperform the market anyway.

So the low-cost index fund has become a go-to investment for those not wanting to worry about picking the right stocks or paying others to do so. But my concern is that this is pushing too much money into a smaller group of companies. For instance, mutual funds tracking the S&P 500 index are typically based on market capitalization. That means the shares of the most valuable companies (the most “highly capitalized”) dominate the holdings. (There are mutual funds that buy shares on an equal basis across companies rather than by capitalization.) In fact, I’ve read statistics that show the five largest companies in the S&P 500 (that’s 1% of the companies in the index) currently represent about 23% of its value. And as you might guess, these are tech companies (Apple, Microsoft, Google, Amazon, and Nvidia). And that’s fine….when the tech sector is booming. And it has been booming, and therefore driving some good returns for investors in S&P 500 index funds. But what happens when the tech sector goes sour? The whole idea of a mutual fund is to diversify your portfolio—across companies, across sectors of the market, across industries. Is that truly happening now with any index funds tracking that index? And is it good or bad for investors? I’ve read pros and cons on this. (It seems the “experts” can never agree on anything!) But if you are one who is invested in an S&P fund, it might be worth some thought as to whether you should make any changes to your portfolio.

Now as to the other concern, the “too powerful” argument, that was applied by the guest speaker on On Point, John Coates, to the mutual fund companies themselves. Coates, a professor of law and economics at Harvard University and a former executive in the Securities and Exchange Commission, sees the big fund companies (which he identified as Black Rock, Vanguard, State Street, and Fidelity) holding 20+% of the shares of publicly owned companies and therefore as shareholders able to exert a concentrated, outsized influence on those companies’ decisions relative to selection of board members, deciding company policies, and votes on resolutions coming before shareholders.

Again, this may or may not be a problem. It depends on whether those funds exert a benign influence. And that determination tends to be very subjective, even political. As a former regulator, Professor Coates proposes that these fund companies offer their clients (investors who have entrusted their money to them) an opportunity to express their policy preferences through surveys, offering “families or groups of values” from which clients select. Of course, it’s an imperfect proposal, and there will not be unanimity among those clients, but it would give the fund companies some indication of their preferences; and since the fund companies can split their vote (i.e. vote a portion of their shares one way and another portion another way) they might actually approach some level of democracy in the voting process on the nearly 3500 proposals voted on by the companies each year.

A lot to chew on, I know. It gets complicated. But I thought it worthy of a post here. Next time you get a notice from your investment firm wanting to know how to “vote your shares” or asking you to “designate X as a proxy for you” in a shareholders’ meeting, think about all this.

Until next time,

Roger

“Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land.” Ecclesiastes 11:2 NIV*