Don’t be narrow-minded

It is notoriously difficult to beat the performance of broad equity market benchmarks, and keeping up with the market becomes even more difficult when performance is narrow rather than broad. In a situation where returns are driven by just a handful of stocks, any portfolio that does not have exposure to those names or has a relative underweight position versus the benchmark, is more likely to underperform the market in the short term. Bear in mind that outperformance for active ETF’s is not much different and passive ETF’s substantially underperform indices over time due to fees. 

It is not a coincidence that roughly 75%¹ of global fund managers underperformed the broad S&P Global 1200 Index² last year when leadership was concentrated among a historically narrow subset of large US Tech-adjacent companies. Nearly 90%³ of global fund managers have lagged the benchmark over the last three years of “Magnificent Seven⁴” dominance. In times of narrow markets, investors have a tendency to pivot into funds that would capture the exposure afforded by a narrow market. 

Historically, when an inflection point occurs, and a broader market begins to take shape – more securities add value to the overall performance of the benchmark. As market conditions normalize and performance broadens, active managers tend to fare much better. The question, therefore, is: has anything materially changed since the start of the year that warrants a rethink of the outlook and any related investment thesis? The answer is: not yet. 

For example, equal-weighted equity indices (one where all the securities have the same weight or influence) are considered to be better benchmarks for actively managed portfolios. In fact, research⁵ shows that the S&P 500 Equal-Weight Index historically outperformed its market capitalization-weighted counterpart (the widely quoted S&P 500). By extension, for long-term investors, quality active managers would have a performance advantage over passive investing. 

In summary, when fewer stocks outperform the index (narrow leadership), passive investments are likely to do better than active managers; when a greater share of stocks better the index, active management tends to do better. Moreover, active management can offer risk management benefits by avoiding large allocations to stocks that have run up significantly in price – an unintended consequence of some passive investments during periods of narrow market leadership. 

While it may be the case that extremely concentrated gains within global stock markets in recent years can have investors questioning whether taking an active approach to investing is worthwhile, market history shows that keeping a narrow mind will adversely impact investors when market conditions shift and ultimately see a broadening of market leadership. 

Share of S&P 500 constituents underperforming S&P 500 and S&P 500 return relative to S&P 500 Equal Weight Index

Source: Guardian Capital based on data from S&P Global, Apollo Global Management and Bloomberg to December 31, 2023 

This commentary is for general informational purposes only and does not constitute investment, financial, legal, accounting, tax advice or a recommendation to buy, sell or hold a security. It shall under no circumstances be considered an offer or solicitation to deal in any product or security mentioned herein. It is only intended for the audience to whom it has been distributed and may not be reproduced or redistributed without the consent of Guardian Capital Advisors LP. This information is not intended for distribution into any jurisdiction where such distribution is restricted by law or regulation. 

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