Global trackers funds are dominated by ‘Magnificent Seven’ tech giants

Global trackers are often a core component of a beginner or casual investor’s portfolio

Global tracker funds have become increasingly exposed to a handful of the world’s biggest tech companies.

Widely popular because investments that simply clone top stock markets are both cheap and easy to understand, global trackers are often a core component of a beginner or casual investor’s portfolio.

But right now around 18 per cent of your fund will be concentrated in just seven US giants – Apple, Microsoft, Nvidia, Tesla, Alphabet, Amazon and Meta, dubbed the ‘magnificent seven’.

They took a hit last year, but have seen a strong recovery since investors started getting excited about the potential of artificial intelligence to transform the world, and make new fortunes for the tech titans.

This has been a lucrative play of late, but many investing experts are worried about an AI bubble, and a concentration of returns among a few dominant companies breaks the cardinal rule of diversifying risk.

Below, we look at how exposed global tracker funds are to the US ‘mega-caps’, and what you can do if your investments are too heavily weighted towards them.

Why are tech giants so dominant in global trackers?

The so-called ‘magnificent seven’ have dominated returns from global market indices this year, pulling them out of 2022’s bear market, says Charles Stanley Direct’s chief analyst Rob Morgan .

‘The S&P 500 is up around 15 per cent year to date, but without these seven there would be hardly any rise at all.

‘The Nasdaq, meanwhile, which is more concentrated in these seven companies, is up around 30 per cent year to date.’

Morgan says the rest of the US market and other global markets, including the UK, have more or less gone nowhere in the first six months of this year.

‘The magnificent seven are seen as offering growth in a low growth world, and a number of them stand to benefit from advances in AI, a narrative that has captured investors’ imaginations.’

He says high valuations and a popular narrative are certainly concerns if you are worrying about a ‘mini bubble’.

But Morgan reckons there are other reasons investors have become corralled into this small band of stocks

‘They are not immediately seeing the effects of higher interest rates or an increasingly fatigued consumer.’

Weightings of the seven mega-cap stocks in the iShares MSCI World UCITS ETF (Source: Bestinvest)

Jason Hollands, managing director of DIY investing platform Bestinvest, says. ‘It is understandable that many people will assume that buying a global index tracker is a great way to achieve a highly diversified share portfolio at low costs.

‘However, a traditional index tracker fund, where exposure to individual companies is weighted solely compared to their market capitalisation (size) is only as good as the index which it replicates.’

Among global stock market trackers, the most widely followed index is MSCI World.

But Hollands says that while seemingly offering exposure to over 1,500 companies from 23 countries, this index has become increasingly concentrated due to the rocketing valuations of the mega-sized US firms.

‘These are undoubtedly formidable, world-class companies, but they have now become such a significant chunk of the index, it makes the diversification benefits of a global tracker a bit of an illusion as investors become more heavily exposed to the fortunes to a small handful of businesses.

‘Seven gargantuan companies – Apple, Microsoft, Amazon, Alphabet, NVIDA, Tesla and Meta – together make up 18.3 per cent of the entire index.’

What are the risks of over-exposure to US tech?

‘Investors in global tracker funds may be surprised to find out just how much money they have in the giant US tech titans,’ says Laith Khalaf, head of investment analysis at AJ Bell.

But most index trackers allocate money based on company size, he points out.

‘In the UK, a FTSE All Share tracker will have around 7 per cent invested in AstraZeneca and 6 per cent invested in Shell, while a global emerging markets tracker will have around 7 per cent in Taiwan Semiconductor Manufacturing Company.

‘Stock concentration risk is perhaps particularly problematic in global tracker funds though, because investors expect a very high level of diversification, and many of the companies in the top 10 sit within the technology sector, and trade on very high valuations.’

They also give you a high level of regional exposure to the US, reflecting global stock market capitalisation.

‘That has been a tailwind for global tracker funds in the last 10 years, but that might not always be the case,’ warns Khalaf.

Investors in global trackers should bear in mind US listed companies now make up 69.4 per cent of the entire MSCI World Index, and tech and communication services companies comprise 30 per cent, says Hollands.

‘Apple, whose market cap recently touched $3 trillion, gets more representation in a global trackers than the entire FTSE All Share Index whose 598 constituents represent 98 per cent of the UK’s stock market.

‘UK equities are trading at a very modest 10.2 times earnings, whereas Apple is trading at 32 times earnings.’

Morgan says for the past year, and the past decade in the round, simply following the index has been the best strategy on a global basis or when targeting the US market, but risks could be building.

Global and particularly US indices are top heavy with Apple and Microsoft accounting for just under 10 per cent of all global stock market value, he points out.

‘Investors are increasingly reliant on a relatively small number of businesses carrying on delivering.’

This has made things exceptionally challenging for active fund managers who tend to avoid excessive risk from over concentration in certain stocks, sectors or areas of the market, according to Morgan.

‘These companies are also expensively valued in relation to their earnings so they could be more vulnerable to any disappointing news in regard to their profitability or outlook.

‘Therefore they would tend to be avoided by managers taking a ‘value’ approach of seeking out stocks that have limited downside because they trade at levels close to, or below, what they would consider to be their intrinsic value.’

Invested in a global tracker? Options to spread risk

Diversify with active or ‘equal weight’ funds

Investors uncomfortable with the current level of concentration in a global tracker could consider an active fund that takes a different approach or an ‘equally weighted’ tracker, says Rob Morgan of Charles Stanley Direct.

The latter constructs a ‘flat’ portfolio with the constituents all the same size rather than defined by market capitalisation, he explains.

If you want an active global fund, Morgan suggests M&G Global Dividend which targets profitable, dividend-paying companies.

‘Income paying funds like this tend to have an inbuilt valuation discipline, but this is more well-rounded than most of its peers as it includes lots of shares with smaller pay outs that are expected to grow them faster,’ he says.

‘As such it should appeal to all investors looking for a balanced global holding. “New economy” bellwethers such as Tesla or Amazon do not pay dividends and are therefore ineligible for inclusion.

‘However, the manager has invested in Microsoft and into selected semi-conductor stocks such as Broadcom and ASML.’

If you prefer a tracker, Morgan tips the iShares Edge MSCI World Value Factor UCITS ETF.

This tracks an index of global shares that are relatively undervalued using various metrics, he says.

‘There is greater exposure to Japan and Europe, areas that offer less expensive valuations. Top holdings include Cisco, Pfizer and Toyota.’

If you want an alternative to a US tracker, Morgan says Premier Miton US Opportunities invests across the size spectrum in the US market and is well spread across different industries.

‘The managers focus on both the quality and value attributes of businesses, and with a portfolio skewed towards small and medium-sized companies it could make a good diversifier to funds more invested in the tech names including traditional index trackers.’

Meanwhile, a US-only tracker with a different approach is the S&P 500 Equal Weight UCITS ETF.

‘Rather than using the standard market cap weighting, the fund equally weights all the holdings so to approximately 0.20 per cent,’ says Morgan. ‘This ensures a more balanced spread of industry and company type.’

Look beyond the developed markets in MSCI World

‘Despite the name “World” the MSCI World Index is actually only representative of the 23 developed market countries,’ says Emma Wall, head of investment analysis and research at Hargreaves Lansdown.

‘The US is the largest constituent at around 70 per cent of the index, followed by Japan, the UK, France and Canada.’

‘For more diverse exposure at a similarly appealing price point, investors should consider investing in an ETF that tracks the MSCI All Countries World Index or ‘ACWI’. This index tracks the 23 countries in the World index as well as 24 emerging markets’

Wall says the FTSE All World index is similarly a mix of developed and emerging markets.

‘Vanguard and iShares offer ETFs that track these two indices,’ she notes. ‘Alternatively, if you already own an ETF with exposure to the MSCI World, you can supplement with an emerging markets tracker, such as Vanguard FTSE Emerging Markets ETF.

‘Or, if you don’t want to add emerging markets to your portfolio, instead address the growth-style bias of the MSCI World with the addition of a value-tilted global fund such as Artemis Global Income.

Diversify your tracker funds, or choose one that weights differently

‘Given the stock concentration of the MSCI World Index, solely investing via a traditional global tracker provides limited diversification in practice and will expose investors to a brewing valuation bubble in mega-cap stocks,’ says Jason Hollands of Bestinvest.

That goes especially for those which have surged higher since the start of the year based on euphoria about artificial intelligence, he points out.

‘One way to address this risk is to dovetail a global tracker with some holdings in alternatives to improved diversification.

‘This could include the likes of the Fidelity Index Emerging Markets fund to give exposure to the developing world, or the Vanguard FTSE Developed Europe ETF which invests across Europe, including the UK.’

Hollands says another alternative is a global fund that does not weight exposure to companies solely on market cap.

‘The Invesco FTSE RAFI All-World 3000 UCITS ETF invests in very diverse basket of large companies globally but weights these on four fundamental factors: their sales, cash flows and dividends – in each case averaged over the last five years, as well as their book value.

‘This provides a more diversified outcome (with US shares at 49 per cent rather than 69 per cent) and less bias towards sectors with very expensive valuations.

He says this gets you exposure to the big tech stocks but in a far less concentrated way, with the largest weightings being Apple and Berkshire Hathaway at 1.2 per cent each.

This post first appeared on Dailymail.co.uk