12 Dec 2018 4 min read

Standing on the shoulders of giants

By Andrzej Pioch

How 2018 taught us about the perils of concentration and what it all meant for equity factors.

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Have you ever wondered what the world would look like if countries grew or shrank in line with the size of their financial markets? If their geographical size was determined by the aggregate value of their domestic equity market?

As we took on the challenge to re-draw the map of the world, the level of concentration in global equity indices only became more apparent. In the world of global equity markets, Australia and New Zealand combined are smaller than Switzerland. And some of the global superpowers; including Brazil, Russia or India, are hardly noticeable!


If you were to invest in a global equity benchmark, you would also need to accept that half of your portfolio will be invested in US companies and your exposure to Apple, Microsoft, Alphabet (the parent company behind Google) and Facebook exceeds your weight in the UK.

Looking more closely at the level of concentration in the US, it’s fair to say that market capitalisation (market-cap) investors in this region seem to stand on the shoulders of just a few (tech) giants. These giants carried them through 2017 and most of 2018 mostly unscathed, but they might have left them feeling a little bit exposed in recent months. Many have realised that the underlying index has started carrying significant stock specific risk and become very sensitive to the newsflow on a handful of the largest companies.

When the giants started to wobble, investors definitely felt it

Dissecting the year-to-date performance of S&P 500, the index that brings together 500 largest US stocks and weights them by their market-cap, reveals that the first half of the year really belonged to the 'big five'. Amazon, Microsoft, Apple, Netflix and Facebook contributed 2.4% to an index that returned just over 2.6%. The performance of the remaining 495 stocks was not much more than a sideshow to what was happening at the headquarters across Silicon Valley and the outskirts of Seattle.

Fast forward to late November and the ‘usual suspects’ were behind the third equity sell-off seen in the US over the last two months. When the giants started to wobble, investors definitely felt it.


While market-cap weighting remains the most common approach in index investing, there is an alternative systematic way to access equity markets.  

Factor-based strategies are designed to be suitable for investors who carry quite a distinct set of beliefs:

  1. They believe there is a premium to be had from a broad exposure to equities
  2. They believe this premium is driven by a small set of stock-level characteristics (perhaps valuations or profitability) rather than the market-cap of individual securities
  3. They believe that stock-specific risk can be diversified away and as such is not rewarded over the long term

To reflect these beliefs, their strategies tend to move away from the ‘tallest trees’ in the index and replace stock-specific risk with a well-diversified exposure to established equity risk factors. 

Importantly, those strategies do not come without risks. Over the short term, when markets are driven by few concentrated positions, such as the information technology sector in the US in the beginning of the year, moving away from the largest companies spells trouble even for diversified multi-factor investors. However, while the underperformance of the multi-factor approach grabbed the headlines in the US, a well-diversified allocation to value, quality, low volatility and size added to returns across other regions.

And how did factors behave when market volatility picked up after summer?

There is no doubt that allocating to factors such as low volatility, and having a lower concentration risk within the portfolio lowered the drawdown investors would have experienced if they had held a conventional market-cap weighted equity portfolio.

As a result, a multi-factor approach outperformed across all developed regions.

Importantly, these positive relative returns did not just arise as a result of a lower correlation with market-cap returns. Note that within emerging markets, where the correction started earlier in the summer, most of the factor outperformance came in the third quarter which explains a more muted contribution after September.

At the end of the day, investors will need to choose their own giants and an approach that will be consistent with their own investment beliefs. They can opt for a simple but potentially more concentrated approach of market-cap investing or explore a multi-factor approach.

In the game of ‘concentration’ vs ‘diversification’, it will be up to investors to decide which shoulders they want to climb on.

Andrzej Pioch

Fund Manager

Andrzej is a fund manager who places a lot of importance on being mindful. He starts the day with a one-mile swim and a cycle to work. In the office, he focuses on multi-asset income strategies and multi-factor equities, and regularly lectures on asset allocation at one of the London universities. With his newly found enthusiasm for running, he now hopes to tick off one of his bucket list goals and take part in a triathlon. Watch this space…! Andrzej joined in 2014 after five years in the multi-asset team at Aviva Investors.

Andrzej Pioch