It’s Time for Investors to Scrutinize Their Portfolios

We can all agree that periodically rebalancing asset classes is an important discipline in managing diversified, long-term portfolios. Typically, this conjures up a need to make some adjustments to bring equity and bond weightings in the portfolio back to strategic allocations. Or maybe the allocations between domestic and foreign stocks or large and small caps are out of whack due to market movements. Today, investors should investigate a different issue in their portfolios: Is there too much of a growth bias and is it time to reduce growth exposure and increase value?

The problem, in a nutshell, is that due to soaring mega-cap growth stocks in 2023, the putatively well diversified, 11-sector S&P 500 Index increasingly resembles a large-cap growth fund. Since the start of 2023, technology’s weighting in the index has soared from 22% to nearly 29%. In the first half of the year, just 10 mega-cap growth stocks (including Apple, Microsoft,, and Nvidia) accounted for more than 70% of the entire market’s 17% gain (tech-dominated NASDAQ vaulted 32% in the same six months, after plummeting 33% in 2022).

According to JP Morgan, those 10 stocks traded at an average price-to-earnings ratio of 29.3 times projected 12-month earnings as of June 30, 45% higher than normal for the top 10, compared to a PE ratio of 17.8 for the rest of the market. Those 10 names now account for nearly one-third of the entire market capitalization of the S&P 500 (but only 21% of the profits), a record level of concentration looking back 30 years, reports JP Morgan.

As some of us learned only too painfully in the tech bubble of the late 1990s and the subsequent stock market crash of 2000-2003, market-cap-weighted indexes come with a risk: When investors buy the index, they’re indiscriminately purchasing shares of hot stocks—regardless of valuation--that drive up the index. For example, nearly 40% of the index weight now is large-cap growth stocks, more than double the weighting of large-cap value.

Growth vs. Value

Speaking of growth and value, when you compare the relevant indexes, you find that growth is much less diversified, far more expensive, and much more volatile. For example, just four stocks represent 35% of the Russell 1000 Growth Index, compared to under 10% for Russell 1000 Value; the Growth index’s average P/E ratio of 28 is twice that of Value, and the price-to-book ratio is nearly 5 times as high as Value. Growth is about 25% more volatile than Value (as measured by standard deviation), and the maximum drawdown during the past three years was double that of Value.

So perhaps it’s time to analyze whether portfolios are lopsided and too heavily concentrated in large-cap growth stocks--and perhaps, along with the increasingly “growthy” S&P 500 fund, ifinvestors separately hold growth in index funds that track NASDAQ or Russell 1000 Growth in their accounts. Keep in mind that, due to slow or imperfect reporting systems, it can be hard to analyze numerous equity funds in a portfolio to determine just how much overlap there is in stocks and sectors. For instance, a fund billed as a large-cap blend or even value fund may have Microsoft, Google, and other growth stocks in their portfolios. How many contain stock in Apple, the $3 trillion market goliath?

Just because Growth returned 28% in January-June 2023 (after plummeting 29% in 2022, which was reminiscent of the tech bubble crash), more than 20 points better than Value, doesn’t mean this trend will persist (and most of us are prone to hindsight bias). For instance, if interest rates stay higher for longer than the market anticipates, that would tend to favor value stocks over growth stocks since the cash flows of value are more near term than for growth and thus more valuable when using formulas such as discounted cash flow for valuation.

When investors complete their analysis of portfolios, they’ll quite likely find that it’s time to reduce some of the growth exposure and redirect some of the proceeds to opportunities in the value universe. In the value space, active, bottom-up stock-pickers could add value to a fund by, for instance, identifying banks that were unfairly beaten up and are still undervalued after last spring’s distress in the banking system. A long-short value fund expands the opportunity set since it can also short stocks that are overvalued or vulnerable in an environment of rising interest rates and a slowing economy.


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