Did you know that about 40% of the gain from the FTSE Russell 1000 Growth Index for the first five months of 2017 was from six stocks? Yes, six out of 608 stocks held in the index have contributed 40% of the total return for the index while representing 21.86% of the total market capitalization of the index. The six names are all tech stocks: Apple, Microsoft, Amazon, Facebook, and Google’s parent - Alphabet Class A and Alphabet Class C. Tech stocks represent the largest sector of the index at 28%, followed by consumer discretionary at 22%, and healthcare at 15%.
While an interesting factoid, you may be asking why I thought this was relevant topic to write about. This market-weighted index is greatly impacted by swings in the value of its largest names. While this disproportionate contribution of gains has continued to drive the index since 2016, large growth investment managers are having an easier time keeping up with the index. Morningstar’s Large Growth peer group average jumped 14.08% versus a 14.30% Index return for the year-to-date period through May 31. While the Large Growth peer average is 22 basis points below the index, this is a large improvement versus 2016 where the peer average underperformed the index by nearly 4%, as only 7.2% of active Large Growth managers outperformed the Russell 1000 Growth Index for the year.
So, what has changed? Many of the active large growth managers had a tough time in 2016 and are working hard not repeat the disappointing performance in 2017. Judging by the Morningstar category average, they are faring better than last year. Most managers we review made minor adjustments to their portfolios and waited for the tide to turn, staying true to their philosophy and process. Given the index anomaly mentioned above, fund managers have likely looked a bit closer at the top weightings in the Russell 1000 Growth.
If portfolio managers have conviction in these top names, they might not stray too far from the index weights in fear of hurting their relative performance. Apple’s index weighting is a whopping 6.45%, the largest weighting in the Russell 1000 Growth Index. For a mutual fund that has a 5% maximum limit on individual holdings, the underweight to Apple alone would have hurt performance by about 47 basis points for the first five months of 2017. Despite the concentrated weightings for the other index holdings mentioned above (Microsoft at 4.45%, Amazon 3.25%, Facebook 2.86%, Alphabet Class A 2.44% and Alphabet Class C 2.41%), 98% of the stocks in the Index have positions of under 1%.
Many large growth funds have additional tech exposures – investing in Chinese companies such as Alibaba and Tencent, whose stock prices have advanced even more than our six companies mentioned above for the year-to-date through May 31. Alibaba is a Chinese e-commerce company competing to become the world’s largest retailer (the Amazon of China). Its businesses consist of core commerce, cloud computing, mobile media and entertainment, and other innovation initiatives. Tencent is China's dominant provider of online and mobile games, and holds one of the largest messaging platforms with its WeChat and QQ offerings (operates China’s version of Facebook).
Through the first five months of this year, active large growth has rebounded from a struggling 2016, helped by both strong performance in a few technology names as well as contributions from other growth names not included in the benchmark.