Market Leadership Is Narrow. Your Portfolio Shouldn’t Be

Key Takeaways:

• Exceptional performance: 2024 S&P 500 Index performance has been among some of the strongest in history, adding to similarly strong performance in recent years. Can it continue?
• Extreme concentration: Near-term success has been driven, in large part, by a select few mega cap companies. This has driven market concentration to levels we have not seen since the 1970s.
• Broad ownership/overlap: Most investors likely have significant exposure to these leading mega cap stocks—not only from core index funds but also from many investments that bill themselves as smart or differentiated.
• Stretched valuations: Rightly or wrongly, market valuations are stretched. Historically, similar valuation levels have been followed by long-term periods of muted or negative returns from the S&P 500.

2024 has been the year of the S&P 500 Index—thanks to a select few mega cap companies. This well-documented lack of market breadth and narrow market leadership among mega cap tech companies have propelled the headline index to what is panning out to be its second straight year of extraordinary gains, something that has only occurred three times since 1930.

Many index-based alternatives to the “beta” offered by S&P 500 Index investments have also thrived this year from exposure to the same leading companies. These alternatives range from factor investments to dividend strategies to the tech-heavy Nasdaq 100.

The performance leadership of these mega caps has increased concentration across the market, driving their portfolio exposure higher and stretching valuations. While these dynamics have challenged differentiated and valuation-focused strategies like that of the VanEck Morningstar US Wide Moat UCITS ETF (MOTU), they highlight the need for diversification in core equity allocations. Heading into 2025, investors may benefit from reassessing their equity portfolio diversification. Please note that financial markets are constantly changing and investing in equities is risky. Investors should be aware of the Main Risk Factors, including Equity market risk and limited diversification risk. Please refer to the KID and the Prospectus for other important information before investing.

Equity Market Performance in Perspective

The S&P 500’s torrid pace in 2024 almost certainly won’t reach all-time high calendar year levels, but on a historical basis, its return has been among its best in nearly 100 years.

2024 S&P 500 Index Performance Among Strongest Since 1928

Calendarized Performance Since 1928

Source: Bloomberg, Datastream, Goldman Sachs Global Investment Research. Past performance is not a guarantee of future results. Index performance is not illustrative of fund performance. It is not possible to invest in an index.

Recent history has been particularly eye catching. Many of the S&P 500’s strongest years have occurred in the last five years. Since 1930, the S&P 500 has posted a calendar year return of greater than 25% twenty-five times, three of those occurring in 2019, 2021 and 2023. The list also includes 1995, 1997 and 1998, preceding the dot-com bubble.

Market Concentration at Decades High

The drivers of impressive 2024 index returns have been concentrated in a select few companies and have made some of the world’s largest companies even larger. Most investors may not appreciate that these companies have grown to account for an increasing portion of headline market indexes, and in turn their own investment portfolio. For example, the largest U.S. companies haven’t represented this much of the MSCI All Country World Index since the 1970s.

Largest US Companies Dominating Global Index

Weight of Largest US Companies in MSCI ACWI (1973 – 2024)

Source: Datastream, Goldman Sachs Global Investment Research. Past performance is not a guarantee of future results. Index performance is not illustrative of fund performance. It is not possible to invest in an index.

Extreme Overlap Across Portfolios

As these mega-cap companies grow bigger, their corresponding exposure increases in S&P 500 Index funds, as well as many other U.S. equity funds that provide similar exposures. This means that these companies will also naturally represent a more significant portion of investor portfolios.

Look no further than the top 10 holdings of many widely popular indexes that underly mutual funds and ETFs. Below is a small sample of popular indexes--ranging from factor indexes to dividend indexes—linked to funds with hundreds of billions in assets under management.

For ease of reading, we have highlighted below the holdings that are unique among the top 10 for each index. Outside of the Morningstar Wide Moat Focus Index, which underlies our VanEck Morningstar US Wide Moat UCITS ETF (MOTU), almost all of the top 10 holdings of these popular indexes significantly overlap with the others.

More of the Same - Top 10 Holdings of Popular U.S. Large Cap Indexes

Shading Represents Unique Holdings Among the Group’s Top Ten (as of 30/09/2024)

Source: Morningstar. Past performance is not a guarantee of future results. Index performance is not illustrative of fund performance. It is not possible to invest in an index. Not intended as a recommendation to buy or sell any of the securities mentioned herein.

This eye-opening overlap is an important factor driving returns in many of these indexes in recent periods and suggests investors should be vigilant and aware of potential concentration across portfolios. This is particularly timely in light of the U.S. equity market regularly reaching all-time highs and with valuations at stretched levels.

Stretched Valuations Have Led to Muted Returns

The forward P/E ratio of the S&P 500 Index sat at approximately 24.6 at the end of November. This implies that the index is trading at more than 24x forward earnings estimates. Largely, investors have been happy to pay that multiple as many companies, particularly the Magnificent 7, have managed to notably expand profits in recent periods.

However, there are some forces at play that may cause concern at these multiples. First is the impact that generative AI has had on many of the largest tech companies in the market. Some believe the AI benefit afforded to the largest companies may have played out and expect these benefits to trickle through the market to other industries like software. Second, many attractive investment opportunities of late are in the midst of changing realities, such as the tech sector’s shifting from capital-light to a more capital-intensive segment that is in need of data center infrastructure and is more susceptible to energy price fluctuations.

Stretched valuations and changing market dynamics are not necessarily reasons to shift a portfolio or underweight any given sector. In fact, many believe there is plenty of room to run from here. But they are certainly a good reason to consider diversification. Since 1991, high forward P/E ratios have preceded long-term S&P 500 performance that was underwhelming at best, and in negative territory at worst.

S&P 500 Returns Have Been Underwhelming at Current Valuations

Forward P/E Ratios Relative to Future Annualized Return (8/1991 – 11/2014)

Source: FactSet; Morningstar. Past performance is not a guarantee of future results. Index performance is not illustrative of fund performance. It is not possible to invest in an index.

Odds Have Been Against Off Benchmark Bets

This combination of narrow market leadership, high market concentrations and significant investment overlap has put many differentiated investment strategies that diverge from broad-based indexes on unstable ground. Deviating from “market weight” can clearly put a “stock picker” at risk of underperformance, and most of these strategies – think active management, smart beta and fundamental analysis – have struggled at some point in this cycle.

Looking at the average returns of active vs. passive strategies within Morningstar’s mutual fund and ETF dataset, you can see that active management has struggled this year. The average active fund has underperformed passive peers across U.S. large cap categories with the very minor exception of large cap growth funds.

What’s telling is that even the average return of “passive” funds in the Morningstar US Fund Large Blend category, of which S&P 500 Index funds are members, couldn’t even keep pace with… the S&P 500. Active managers have fared even worse.

So-called “smart money” is not faring much better. Hedge funds, as represented by the Credit Suisse Hedge Fund Index, have lagged the S&P 500 Index notably. Through October, they posted a return of 8.01% vs. the S&P 500’s 20.97%.

Diversify Your Portfolio with Quality Companies at Attractive Valuations

VanEck Morningstar US Wide Moat UCITS ETF (MOTU) seeks to replicate as closely as possible, before fees and expenses the price and yield performance of the Morningstar Wide Moat Focus Index. Its strategy targets high quality companies with durable competitive advantages that are also trading at attractive valuations.

Its focus on attractive valuations is what can give this systematic strategy its contrarian bias by leading it to out-of-favor stocks trading well below their intrinsic value. The strategy has long offered diversification benefits while historically providing a compelling risk/reward profile, in spite of its lack of exposure to mega cap tech and other leading exposures in the most popular core benchmarks.

Please be aware of risks, including the risk of investing in equities, US stocks, and the risk of investing in smaller companies. For full information on the risks, please refer to the prospectus and KID/KIID.

The value of the securities held by a Moat ETF may fall suddenly and unpredictably due to general market and economic conditions in markets in which issuers or securities held by the funds are active. Investors should read the prospectus and other relevant documents before making the decision to invest.

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