Fund boss reveals hidden market risk in tech stocks dominance
The popularity of big US tech stocks has created unprecedented concentration levels in global equity markets, opening opportunities for investors elsewhere.
The world’s equity markets are dangerously concentrated in a handful of big US tech stocks, creating unprecedented risks that could catch investors off guard, according to the chief executive of one of America’s biggest active global fund managers.
MFS Investment Management chief executive Ted Maloney warns global markets have become so focused on the ‘magnificent seven’ tech giants they’re approaching concentration levels “without precedent” in modern financial history.
“When you get that much concentration of earnings, margins, multiples and therefore market cap in such a small number of names, you introduce an enormous amount of risk into the system,” Maloney told The Australian.
The Boston-based executive, who became CEO in January, lived through the dotcom crash of 2000 as an analyst covering smaller industrial companies. He sees troubling parallels with today’s market.
“At that time, it was ‘the internet is going to be big’, and the internet was, in fact, big,” he said. “The internet did change how the whole world operates and financial markets work.
“And yet, the stocks that were extremely concentrated in the benchmarks then had massive periods of underperformance.”
Formerly known as Massachusetts Financials Services, MFS was founded in 1924. It was instrumental in pioneering the first modern day mutual fund, the Massachusetts Investors Trust Fund. MFS has about $US644bn ($975bn) of assets under management.
Cash on the sidelines
But, despite record highs in risk markets, Maloney believes many investors globally remain under-invested, with vast amounts of money sitting in cash.
This creates potential for significant market moves if that cash flows into equities.
He’s concerned that when investors do participate, however, they’re piling into the most expensive parts of the market.
“The end investor is actually not as heavily invested as you might imagine, given that where they’re invested is in the punchier parts of the world, which we think is maybe a doubly bad combination,” he said.
Fund managers surveyed by Bank of America show extremely low cash allocations as they compete against “supercharged benchmarks” dominated by tech stocks. But, this masks the reality that enormous amounts of money remain parked in money market funds.
Finding opportunities
Maloney argues investors don’t need to venture into small-cap territory to find opportunities outside the dominant tech names.
“You don’t need to go even close to small cap in order to find opportunities outside of five to seven stocks that have dominated all the performance,” he said.
His firm manages risk by maintaining positions in the mega-cap tech stocks but at significantly lower weightings than the extremely concentrated benchmarks.
The changing global landscape — from inflation regimes to employment patterns, geopolitics and trade — provides risks and opportunities for nimble investors and companies.
Fed independence under threat
One key concern is potential political interference with the Federal Reserve’s independence under the Trump administration. Some commentators have suggested dramatic rate cuts could be on the cards if the central bank’s composition changes.
Maloney believes the Fed has “remained independent” and chairman Jerome Powell “has done an excellent job” of balancing the dual mandate of controlling inflation and supporting employment.
“We certainly have a team of folks that are constantly analysing where the Fed and all central banks will be moving policy rates over time,” he said.
He notes, however, that “nothing ever stands entirely outside of politics” and warns about the risks of losing the “tether on inflation or expectations of Fed independence”.
Bonds looking attractive
Perhaps most surprisingly for equity-focused investors, Maloney believes fixed income markets may outperform equities over the next five to ten years.
“Equity markets have returned, for a number of years, multiples of what the long-term expected returns would be,” he said.
“Fixed income markets, by contrast, had pretty weak performance over the period when inflation reared its head. From where we stand today, there actually is income in fixed income.”
He expects some global fixed income markets might outperform global equity markets based on “relative valuation in equities and relative yields in fixed income”.
Private credit risks
Another area of concern is the massive flow of capital into private credit and private equity, which Maloney believes has “masked some of what could happen” in terms of future crises.
While not predicting a private markets-led financial crisis, he warns the lack of transparency and liquidity in these markets could create “meaningful damage” if issues emerge.
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