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David Kimberley
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Updated 02 Dec 2022
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Alliance Trust. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

One of the graphs finance people have enjoyed gawping at over the past five years is a comparison between the S&P 500’s performance without the so-called ‘FAANGM’ stocks (Facebook, Apple, Amazon, Netflix, Google, Microsoft) and the performance of those stocks alone.

According to Yardeni Research’s latest data, if you were to rebase the US index to zero at the end of February 2012 and track performance until 18/11/2022, the FAANGM stocks would have increased by 501.5 points. Without those tech companies, the index would have increased in value by 135 points. This remarkable disparity was even more pronounced in 2021, when the FAANGM’s would have been up over 800 points, compared to less than 200 points for the rest of the index.

For active managers in global equities, this has been less of an amusing curiosity and more of a headache. The dominance of big tech in global indices has meant it has been a struggle for most managers to outperform. Those that did were often overweight to these companies, a strategy which is likely to have exacerbated losses in the last 12 months. So it’s been a bit of a case of ‘damned if you do, damned if you don’t’.

Nonetheless, it’s worth thinking about what actually drove FAANGM performance. Even taking into account their performance over the past year, we shouldn’t forget the impressive earnings growth that was often at play. Facebook’s parent company Meta, for example, saw its profits almost quadruple from 2016 to 2021.

However, it’s hard not to see the impact ultra-low interest rates and speculation had as well. Amazon was, for example, trading at more than 100x earnings in mid-2020. Its share price has also nearly halved in value in the 12 months to 24/11/2022.

Some investors may claim that these companies are just going to bounce back. That’s plausible but it’s worth thinking about Cisco, a company that was one of the main beneficiaries of the Dot Com bubble in the early 2000s. The firm has still performed well since then in financial terms but it has never reached the all-time high it hit in 2000.

It’s always going to be the case that a small number of stocks will have an outsized impact on an index’s overall performance. But the last five years have witnessed a mix of speculation, in large part driven by monetary policy that helped drive up valuations, which seems to have created an extreme level of concentration in global indices that may not continue moving forward.

That may be bad for tech fans but it could mean active managers are better able to deliver outperformance for shareholders. And for investors that are looking for core exposure to global equities, Alliance Trust (ATST) may provide a simple solution to their needs.

The trust’s managers, Craig Baker, Stuart Gray and Mark Davis of Willis Towers Watson (WTW), go through a list of hundreds of managers and identify 20 that they believe are likely to deliver the best returns. They then choose managers from that group of 20 to give their highest conviction picks, with the ability to ‘sub in’ managers if they want to. The portfolio is then weighted to achieve optimal diversification and capture what the WTW team believe are likely to be the major drivers of returns.

WTW has been managing ATST since April 2017 but there was some initial drag on performance created by legacy assets that were owned by the previous managers. Speaking at a Kepler Trust Intelligence event at the end of September, Craig noted that although the trust had outperformed its peer group average despite these problems, they had seen annualised underperformance of 0.3% from the time that WTW took up management of the trust until the end of August 2022.

However, a significant point made during the presentation was that if the MSCI ACWI, the trust’s benchmark, was equal weighted then they would have delivered outperformance. A year or two ago that might seem like a moot point. Today it doesn’t.

The reason for that is because of the dynamics described above. If underperformance is solely the result of being underweight six US tech stocks and that is not going to be the case moving forward, it seems plausible that the managers can deliver above benchmark returns in the future.

Indeed, in the year to 24/11/2022 ATST has delivered relative outperformance of its benchmark and is substantially ahead, again on a relative basis, of the average returns delivered by its peers in the Association of Investment Companies Global sector.

Whether or not this will continue moving forward is hard to say. What does seem possible is that the years ahead will see a market whose performance is less dominated by a few mega cap tech stocks. That would mean less gawping at Yardeni Research charts and fewer headaches for active managers.

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