Bob Homan: We are starting to look like hedge fund managers

February 13, 2024

By Bob Homan, Head of the ING Investment Office

Whether or not you have a single, heavily weighted share in your portfolio leads to increasingly large differences in returns. In this way, 'long only' is slowly turning into 'long/short' investing.

Nearly three thousand shares are represented in the widely used benchmark MSCI All Country World Index: a well-diversified index. However, not all shares have the same weight. For example, the ten largest shares make up 20% of the index and the top one hundred almost 50%. The index is therefore less diversified than you might think. Apple and Microsoft have the highest weight, both at 4.25%.

In other indices the concentration is often somewhat greater. For example, the weight of the Microsoft share in the MSCI World SRI Index is already above 16%. The 'winner takes all' principle and the meteoric rise of the 'Magnificent 7' have significantly reinforced this great weight effect.

At the same time, I note that price movements of individual shares are increasing. In the past, you only saw sudden price movements of 10% or more in small and midcaps, but recently large caps such as Meta and Adyen have also shown enormous results. That seems strange, when you consider that financial markets are supposed to be extremely efficient and that these types of shares are still closely monitored by analysts who provide them with the necessary price targets and advice.

How to explain this phenomenon? I think that the large price movements have to do with the character of the companies in question: in terms of valuation, growth shares are dependent on profits that are somewhat further away in the future and are therefore more interest-rate sensitive and difficult to estimate than the rest of the market.

Because interest rates are now clearly more volatile than a few years ago and in terms of profit development it is also more difficult to estimate profits that are further in the future than profits that come a little earlier in time. After better than expected or disappointing quarterly figures, for example, the entire expectation for the next ten years must be changed and discounted.

Because the shares with the largest weight are growth shares, the dispersion within the index increases considerably. Owning a share that is not or barely included in the benchmark (index) or not having a significant share leads to enormous differences in returns.

Because you would have missed Microsoft in the past year. Then you, as an investor who is measured against the sustainable world index (MSCI SRI World Index), will be in for a nice dip. The share price has risen approximately 60% in 2023, the index itself by 20%. That's a difference of 40%, and with a weight of more than 16% in the index, missing Microsoft would have cost you more than 7% in returns.

Now this may be an extreme example, but it clearly shows how important specific choices have become. The life of a traditional 'long only' equity investor is becoming more and more like that of a 'long/short' hedge fund manager.

More columns by Bob Homan