Market experts have long opined on the benefits of diversification. More recently, many of them have called attention to increasing concentration risk in some previously diverse broad market equity gauges.
That’s one result of a small number of stocks — namely the “Magnificent Seven” — taking on increasingly large percentages in market-cap-weighted indexes and related ETFs. Indeed, the Nasda-100 Index (NDX) is highly concentrated in a small number of stocks.
The Invesco QQQ Trust (QQQ ) and the Invesco NASDAQ 100 ETF (QQQM ), both of which track NDX, allocate approximately 43% of their rosters to the Magnificent Seven. Critics may assert that implies a lack of breadth in those ETFs. But it’s hard to argue with the results. QQQ and QQQM posted a gain of 17% in the first six months of the year.
Concentration Risk Fears May Be Missing the Mark
As Stephanie Aliaga, global market strategist at J.P. Morgan Asset Management, pointed out, the S&P 500 is up nearly 46% since the start of 2023. But when Nvidia (NVDA) is removed, that gain declines to 37.4%. Nvidia is the third-largest holding in QQQ and QQQQM.
Take the five best-performing S&P 500 names over that span out of the equation and the index is up “just” 23.4%. That’s sparked fears of an artificial intelligence (AI) bubble — one reminiscent of the tech bubble of 2000. However, Aliaga, encourages investors to not make that comparison.
“During the dotcom bubble, rampant speculation surrounded young companies flaunting internet excitement before profitability. In contrast, today’s AI beneficiaries are already very profitable companies that make their money selling key infrastructure and resources to the rapidly growing market of AI adopters,” she wrote.
Aliaga points out that Magnificent Seven members are more fundamentally sound than their dot-com era counterparts. Those fundamentals include strong balance sheets and impressive free-cash-flow-generating capabilities.
Shareholder rewards shouldn’t be forgotten, either. While QQQ and QQQM sport trailing 12-month dividend yields of 0.56%, the ETFs are homes to recent payout initiators and dividend growers. And technology, the largest sector allocation in the ETFs, accounts for the largest percentage of S&P 500 share repurchases.
“The recent boost in shareholder return can also be attributed to tech strength. Certain mega-cap tech companies have announced substantial share buyback programs or first-ever dividend payouts this year. These announcements have contributed to a 6% increase in S&P 500 shareholder payout in 1Q24, and the S&P return-on-common-equity stands at a solid 18.5%,” concluded Aliaga.
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