The rise of index concentration

September 2, 2022

Who does not like a new iPhone? The iPhone generated a staggering $71,628,000,000 of net sales in the three months ending December 25, 2021.

With a market capitalisation of 2,864,720 million USD, Apple represents a whopping 4.5% of MSCI ACWI Index as of the end of July 2022. MSCI ACWI is a typical investible global broad market index covering 23 developed markets and 24 emerging markets. Apple has been consistently the top index weight since January 2012, taking over from Exxon Mobil. Only Microsoft topped Apple in terms of market capitalisation sporadically in 2019 and 2020.

The market dominance of the top holding only started in 2020, when the weight of Apple in the index skyrocketed from 2.5% to almost 4.5%, before dropping back to 3.2% by June 2021. Since December 2021, its weight is again above 4%.

The index concentration is not limited to Apple Inc. The top 3 holdings of the index account for almost 10% of the weight. That is a stunning concentration considering that MSCI ACWI counts almost 3000 equities. The top 5 companies account for almost 12.5% and the top 10 has seen a peak at 17.5% at the end of 2021 before falling back to 16.5%. Figure 1 shows this concentration over time.

Source: Asteria IM, MSCI

Such concentration has existed in small countries’ equity indices, such as Switzerland for example. They are the result of huge size discrepancies between a few multinational companies and a high number of smaller firms. However, historically, it has not been the norm for world equity indices. Before 2020, the top holding had never been consistently above 2.5%, whereas the top 10 holdings fluctuated around 8.5%. Indexing historically promises broad diversified market access. With a concentration as outlined above, it is hard to keep defending this stance. Buying a global index such as MSCI ACWI has become an implicit bet on Apple, Microsoft, Alphabet, Amazon and Tesla.

Figure 2 shows a concentration measure (the Herfindahl index) of MSCI ACWI Index. Clearly, the supposedly diversified global benchmark is vastly more concentrated since 2020.

Source: Asteria IM, MSCI

Higher index concentration complicates the task of active managers that are benchmarked against a broad market index such as MSCI ACWI Index. Indeed, under-weighting or even excluding those top index holdings from the investible universe (e.g. for bad ESG practices) implies forced bets against those companies at a scale never seen before. The tracking-error of active portfolios that exclude these companies has increased very significantly.
While this concentration remains, or worsens, active managers with a restricted universe without those names face a difficult time catching up to the index. Once, if ever, the index starts to become less concentrated, the situation reverses, and indexing may again be sold as diversified market access. However, as long as this situation remains, buyers must beware, and active investment offers serious advantages.

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