Active equity managers are faced with an important decision over the next market cycle. What is the appropriate allocation to high-quality growth stocks which have dominated returns thus far in 2023, as well as for much of the past decade? Year-to-date through Aug. 31, the 10 largest stocks in the Russell 1000 index have generated a return of 41.76% vs. returns of 18.62% for the broader Russell 1000 index, and now represent 28% of the index, creating the most concentrated market of the past 20 years. Is this a signal that returns are poised to mean-revert, and how should investors evaluate the dominant competitive positions and fundamental momentum of the largest companies?
Concentrated markets are not conducive to active managers who generally focus on less efficiently priced stocks outside of the largest names. History would imply that the largest companies generally lose their dominant position over time, as smaller, more nimble companies embrace emerging technologies and methods to offer superior products and services. Will this apply to Nvidia, Microsoft, and Apple, as dominant companies today with bright analyst prospects? While such companies may ultimately lose their competitive edge, historical returns provide limited clues with respect to timing. However, fundamental analysis combined with an understanding of investor preferences may offer guideposts for making this important decision.