A handful of tech stocks, which together account for about 15% of the market weight of the S&P 500, are responsible for almost all of the index’s gains year to date. They’re also the reason the Nasdaq has gained close to three times as much as the S&P 500 so far this year: up 13.2% compared with 4.8%.
This top-heavy index performance, due to six stocks — Amazon, Microsoft, Apple, Facebook, Alphabet (Google’s A shares) and Google (Google’s C shares) — presents a huge concentration risk for investors that few appreciate, says Robert Sharps, head of investments and group chief investment officer at T. Rowe Price.
“Such narrow leadership has benefited passive strategies, but there are alpha cycles,” says Sharps, referring to cycles when active management can outperform.
“Active managers can do well when there’s breadth in the market, not when it’s dominated by a handful of large names, which is the environment we’re in…. Passive is beta exposure at very low cost … not lower risk.”
Asked about data showing that actively managed funds have generally underperformed their passive counterparts over 3, 5, 10 and even 15 years, Sharps admits that active management in the current bull market “has not been great, not even good,” which was also the case in the last downturn.
“It will be really important for many active managers to do better in the next downturn.”
Many active managers argue that active funds are more likely to outperform in a bear market, and intellectually that makes sense. Active managers can be nimble, take advantage of market dislocations and hold more cash — actions that index managers can’t take.
Passive funds are “fully exposed to market risk” and their investors are “married to the market for better or for worse until liquidation do they part,” says Ben Johnson, director of global ETF Research at Morningstar.
But passive funds continue to grow in popularity. According to Morningstar, one-year net flows into passive U.S. mutual funds and ETFs through the end of May totaled $577.08 billion compared to $2.88 billion into active U.S. mutual funds and ETFs. Passive U.S. equity funds experienced net inflows of $174.7 billion through the end of May, while their active counterparts saw net outflows of $195.5 billion.