Whether you like it or not, most likely you will be doing just that with your investment portfolio. Globally, it has been so much a characteristic of equity markets that the largest have been getting a much larger share, ever more influential on broad performance, and at the same time an ever-imposing chunk of market-cap-weighted indices. Indeed, this has largely been a phenomenon of US equity markets in particular, the impact of which has generalized to indices globally, because of the size of America’s largest companies relative to the fact that they make up the vast majority of global benchmarks.

The market-cap share of the top ten stocks in the S&P 500, relative to the rest of the market, is in the 86th percentile relative to history and sits at 29.4%, per statistics from JPMorgan. As we demonstrate below, this has resulted in an exceedingly diverged performance of the weighted version vs the unweighted version of the index. Some members of the “Magnificent Seven” (to which we turn below) accounted for 101% of the return over 2023, according to JPMorgan, with the equal-weight index managing a meagre return of 2.5%. In other words, if you were a stock picker or if you aspired to have a reasonably well-diversified portfolio, then it was an impossible year to generate outperformance.

Find me shelter!

When you’re investing, going against the tide is very difficult. It requires persistence, belief in yourself, and being comfortable being wrong until you are (ultimately) correct. As such, siding away from the Magnificent Seven will require a certain fortitude. But we all know that nothing can last forever.

Setting aside the reduction of stock-specific risks, which is what we illustrate increasingly exists in indices, adding less correlated returns will contribute to risk-adjusted returns in a portfolio. That being said, when one factors in the financialisation of everything, the level of connectivity between investors around the world and the globalisation of capital flows, you have to assume that with a ‘Magnificent’ Seven that is hitting turbulence, stocks everywhere will be impacted in terms of sentiment. However, once the dust settles, we believe the long-standing economic fundamentals will return, and we therefore consider it reasonable to look within the world of equity markets for sources of growth that are very different from the performance drivers of the largest companies in the world. For that reason, we explore other complementary growth avenues as potential markets into which to reinvest those fabulous profits.

Europe

Indeed, we have repeatedly pitched European companies to you as an interesting bit of the market if indeed a frequently underappreciated area of the market that gives exposure to global leaders, which just happen to be resident in Europe. An article in the FT the other day highlighted the ongoing strength of 11 European companies dubbed the 'Granola' stocks. Unlike the Magnificent Seven, which are now the seven largest companies in the MSCI World indices, Granola stocks were first identified in 2020 by a Goldman Sachs analyst as a group of companies with all strong balance sheets, low volatility earnings growth and solid dividend yields. This selection of firms performed well in the 10 years up to February 2020, when they were first identified. The 11 Granola companies (or should it be Grannnolass…) are GlaxoSmithKline, Roche Holding, ASML, Nestlé, Novartis, Novo Nordisk, L’Oréal, LVMH, AstraZeneca, SAP, and Sanofi. Aggregate ongoing performance was strong as well through the Coronavirus sell-off and beyond. These are not, however, what one might call the largest companies in the European Index, which, as of 31/12/2023, also included several energy companies and banks, insurance, miners, and consumer staples.

The 11 Granolas have delivered about 50% of the gains across the European stock market over the past year (to mid-February 2023), per the FT article, and their collective market capitalisation has now ballooned to close to 25% of the Stoxx Europe 600—a near parallel to the Magnificent Seven, which represents 29% of the S&P 500. While the piece argued that Granola’s dominance was echoing that of the Magnificent Seven in the scale of concentration effects in portfolios, we are not so sure. The gap, however, is in the size of these businesses, and therefore their consequence for a non-European investor.

Thematic

Sticking to equities but extending the search for growth and staying away from crowded trades means looking to special funds in space, say thematic funds. At the likes of Impax Environmental Markets (IEM), there are higher-growth tech opportunities of a very different flavour to the Magnificent Seven. IEM focuses on companies across six different environmental sectors, including efficiency & waste management, water, sustainable food, and energy. The Trust has a clear bias towards mid and small caps, giving investors very different exposure from what is likely to be the case in most global equity portfolios. That being said, having a small-cap growth focus has been painful versus the broader global ones over 2023. This is particularly relevant because the managers of BlackRock Energy & Resources Income (BERI) have pointed out the underperformance of their universe of “energy transition” companies and have been increasing exposure to this area. With a strong thematic flavour and an element of in-built balance, BERI provides a very different fundamental exposure to world markets. BERI won a Kepler Growth Rating for 2024 on the back of strong performance. The growthier opportunities from the energy transition part of the portfolio balance the “value” characteristics of traditional energy and mining stocks. Consequently, when it comes to world equity markets, it’s potentially an interesting place to take refuge from any mega-cap technology storms that may batter over the horizon.

Asia

World indices and, some would say, the world economy appear inseparably tied to China. But Asia’s stock markets have also been correlated to China, given that it is the economic engine of the region. In fact, this was the case until 2023. Along with slower economic growth, it has also underperformed in the short term, amid heightened political tensions with the US. Indeed, just as we illustrate in the graphic below, while China has faltered, India has surged forward.

The Ashoka India Equity (AIE) trust is the best-performing since its launch in July 2018, and has sustained this strong performance. It won a Kepler Growth Rating for 2024, the first year it has had a track record long enough to be considered, and has continued to issue shares this year when the majority of trusts are seemingly seeking to buy back shares to protect their discounts.

Japan

Japanese stock markets now exceed the 1989 peak in nominal terms. Nevertheless, Japanese small caps—growth-oriented ones especially—have been in the doghouse, relative and absolute, all through 2023. Japanese small caps could be as close to the Magnificent Seven as you can get, and one could argue too far away from them to speak of growth, pero the new narrative forming around these companies is intriguing, with a potential differentiated growth opportunity underpinned by several different tailwinds heading their direction. Perhaps most tantalizing of all are the prospects of recent corporate governance reforms.

Much of the investor focus was diverted towards the large companies that were larger, liquid, more tradeable, and had already shown meaningful improvement throughout 2023. But according to the manager of Fidelity Japan (FJV), these shifts are beginning to filter down the market-cap spectrum, creating a smorgasbord of underutilised opportunities.

As we pointed out above, the Magnificent Seven have taken a painful tumble before, and in any event, nothing goes up forever. We have outlined a series of very distinct growth opportunities, which could be complementary to a portfolio over the medium-term. Three of these managers are due to present at our upcoming virtual ‘Themes for your ISA in 2024’ event.