Daily Capital

Weekly Market Digest: Why It’s Important to Manage Concentration Risk

We ended a volatile week in markets with mixed results as U.S. stocks finished higher, while international equities finished lower. Safe-haven assets like gold and U.S. Treasuries both finished higher on the week as investors digested mixed economic and Coronavirus data.

Weekly Returns

S&P 500: 3271.1 (+1.73%)
FTSE All-World ex-US (VEU): (-1.02%)
US 10 Year Treasury Yield: 0.54% (-0.04)
Gold: 1974.89 (+3.86%)
EUR/USD: 1.18 (+1.10%)

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Major Events

  • Monday – Positive economic news delivered as the U.S. Manufacturing Sector sees new orders increase by the most in two years.
  • Tuesday – The Federal Reserve announced it would be extending its business lending programs to the end of 2020.
  • Wednesday – The Fed pledges to keep interest rates near zero for as long as it takes the economy to begin to recover.
  • Wednesday – The next stimulus bill appeared to have stalled in congress as Democrats and some Republicans struggle to agree on priorities and size.
  • Thursday – The U.S. Economy contracted 32.9% in the Second Quarter.
  • Friday – Consumer spending for June reported to Rise 5.6%.

Our Take

Although a slew of negative economic data was released this week, investors continue to look ahead to a potential COVID-19 vaccine (A vaccine developed by Moderna began its Phase 3 Trial this week). The virus, U.S. response, and presidential election continue to be front and center in the minds of investors. With so much uncertainty still ahead, we believe diversified portfolios will begin to look more and more attractive. As my colleague Paul Deer mentioned in last week’s post, the concentration of the largest U.S. companies continues to increase and did so again this week despite testifying in front of congress as part of U.S. Antitrust Probes.

A study by FactSet and Goldman Sachs showed that the 5 largest companies in the S&P 500 have accounted for all of the growth in the index this year, while the remaining 495 companies have produced negative returns. This sort of market dislocation is one of the reasons why we take a more equal-weighted approach to equity investing. The S&P 500 may appear diversified if one simply looks at the number of constituents, however, in reality, it is becoming increasingly concentrated in a few companies and two sectors.

It is important to manage this concentration risk as it begins to leave investors over-exposed to certain companies or areas of the market. Using a common valuation metric, forward looking P/E Ratio, most of the companies that have been driving the growth of U.S. Stock Indexes (known as FAANG) are being traded at significantly higher valuations than other index constituents.

While calling a top or bottom is a fool’s errand, the core concepts of successful long-term investing still remain in place: Create a diversified allocation and remain disciplined when short-term fluctuations occur. Portfolios that are highly concentrated in just a few names tend to be more volatile both on the upside and the downside. Our strategies are designed to reduce concentration risk and minimize some of the potential pitfalls of severe downturns in single companies or sectors. It is important to remember that sector and company rotation can occur abruptly and at any time. The largest companies 15 years ago are not the largest companies today, meaning if you used a concentrated, cap-weighted approach, you would have underweighted some of the mega-cap leaders of today (Amazon, as an example).

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Matthew Vibert
Matthew Vibert, CFA is a Financial Advisor for Personal Capital. Matthew has several years of experience working with institutional and high net worth investors. Prior to Personal Capital, Matthew served on teams at JP Morgan, Fieldpoint Private Bank and Trust, and Janus Henderson Investors.

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