Faced with that concern, the asset owners WTW serves have taken “a variety of different approaches,” according to Delaney, who said WTW’s clients include corporate defined benefit and defined contribution plans, endowments, foundations and other institutional asset pools, as well as wealth distribution channels.
“As you might imagine, there are some investors that reviewed the scenario and decided to stay passive,” he said, adding that other asset owners "have decided to shift some portion of their passive exposure into actively managed funds" to address concentration risk.
In addition to those two approaches, Delaney said some other asset owners have gravitated toward a more “hybrid” approach by incorporating into their portfolios passive exposures designed to remove some of the concentration risk, such as products tracking customized or equal-weighted indexes or indexes that screen for certain characteristics, he said.
Delaney declined to name any specific clients that have cited concentration concerns in discussions with WTW. He also declined to name any index providers or products that may have benefited from investor concern about concentration risk.
“I think those conversations are going to continue and investors will likely make a variety of decisions based on their own circumstances and what they believe is the right way to go,” he said.
Delaney added, however, that looking ahead, he expects that the hybrid approach of using a type of passive vehicle that can mitigate concentration risk will become a “larger, more prevalent solution.”
“We have done a ton of research on equal-weight,” said Anu Ganti, senior director and head of U.S. index investment strategy at S&P Dow Jones Indices, an S&P Global division that is home to financial market indicators including the S&P 500 index and the Dow Jones Industrial Average.
“There’s so many different ways to measure concentration and we’ve looked at it in numerous ways and what we’ve found historically is that equal weight has tended to outperform after peaks in concentration,” she said in an interview.
That’s why looking at equal-weight strategies now is so timely, Ganti said.
“In the seat that we’re in right now, nobody really knows when that peak is going to happen,” she said.
Growth in indexing
Another topic S&P Dow Jones Indices has done plenty of research on is the growth of indexing and what’s driving it, according to Ganti, who pointed to a November 2022 report she co-authored titled “Shooting the Messenger.”
“The growth of indexing has been driven by the inability of active managers, in aggregate, to outperform passive benchmarks,” the report said, adding that passive management’s rise is the result of active performance shortfalls that can be attributed to three factors.
“No. 1 is cost,” Ganti said during the interview. “Fees are super important within the indexing space, and we’ve generally seen that active managers tend to have higher fees than that of passive, so that’s been a big driver of the growth of indexing.”
Another factor is “just the professionalization of the industry,” she said. The 1970s marked a key turning point in terms of the professionalization of the investment management industry, Ganti said. “As professionals are now competing against professionals, it has become more difficult for active managers to outperform, as investment management is a zero-sum game, with no natural source of outperformance or alpha,” she said.
The third factor, which tends to be underappreciated, is “the positive skewness of equity returns,” Ganti said.
“And what I mean by that is that outperformance tends to come from a few stocks over the long term,” she said.
Consequently, “it really makes the case for a broad-based diversified approach, which indices offer,” Ganti said.
“We tend to see that if active managers are holding a more concentrated portfolio with fewer stocks, then that can hinder them,” she said.
According to S&P Dow Jones Indices’ SPIVA Global Scorecard report for midyear 2024, 57% of all active large-cap U.S. equity managers underperformed the S&P 500 in the first half of this year.
Active management is difficult and consistent outperformance is usually fleeting, according to S&P Dow Jones Indices’ U.S. Persistence Scorecard for year-end 2023. The report showed that of 529 top-quartile funds in the all domestic funds category as of December 2019, not a single one of those active equity funds remained in the top quartile as of December 2023.
