Although we have seen a lot of commentary about the “magnificent seven” driving returns in the US, concentration in equity markets has been increasing around the globe. Looking at concentration within the UK stock market in a global context, Morningstar’s latest report assesses where we currently are, analysing recent market concentration, with a particular focus on UK equities and UK equity managers.
“In the UK equity market, a familiar trend of concentration remains prevalent, with a few dominant players leading the charge. Despite a market shift favouring value stocks since 2022, the top UK companies still represent less of the index when compared to their peak in 2009. This environment poses challenges for active managers trying to outperform passive indexes, as you need to have an overweight position in the top stocks in order to outperform. Funds maintaining a momentum bias in growth markets, like the US, fared well recently by riding the wave of top stock performance, yet they face difficulties when market dynamics shift. Despite the UK’s value bias meaning much of the UK market has not benefitted from growth tailwinds, it has not escaped this trend, and outside of the top 10 stocks, only 30% of the FTSE 100 have beaten the headline index since January 2022.” – Michael Born, Investment Research Analyst, Morningstar
Globally, a lot of the concentration has been in “growth stocks”, but UK stock indexes remain heavily weighted to miners, banks, and oil majors, which sit in the value camp. Since 2022, “value”-oriented sectors have been much more in favour thanks to an environment of higher interest rates and sharply rising commodity prices. Combined with the merging of Shell‘s European listing onto the London Stock Exchange, this has sizably increased the concentration in the UK equity market.
In recent years, global equity markets have increasingly seen narrow leadership. The US has been dominated by the “Magnificent Seven”, and similar trends are evident worldwide as low interest rates and technology adoption favour growth stocks. Even traditionally value-oriented markets like the UK and Japan show that the largest stocks have dominated returns, heightening concentration.
It has been challenging for active managers to outperform in the UK if they do not have sufficient exposure to the largest stocks. Concentration in a few names with an outsize contribution to returns poses a risk to diversification and can encourage herding behaviour, with active managers under pressure to invest in the top names on fear of missing out on returns. While shunning the top performers has been a recipe for underperformance over this most recent run, many fund managers may be unwilling to increase their current weights to large-cap stocks to avoid such herding behaviour. It is challenging for active managers to beat market indexes when giant-cap stocks make outsize gains, as tends to be the case in periods of high concentration since the biggest driver of returns tends to be relative weight in the top stocks as opposed to stock selection elsewhere.
Indeed, we have seen select managers across the UK and the US being able to benefit from the momentum in the top end, allowing them to benefit from a rising exposure to the largest names. This is similar to trends we have seen over the last run-up in concentration, however we should note that in the subsequent period when the investment regime shifts, these managers were often amongst the worst performers.
The UK market has experienced much narrower leadership than other global equity markets, with concentration previously peaking at 37% in 2008. The Morningstar UK Target Market Exposure Index has 35% in its top five holdings, which is substantially higher than for the Morningstar US Target Market Exposure Index.
To read Morningstar’s full report you can use this link.
