Stephan Langen: The Magnificent 7 and the paradox of concentration risk
This column was originally written in Dutch
By Stephan Langen, Head of Portfolio Management at ASN Impact Investors
A sustainable investor with ambition selects sharply. That leads to a more concentrated portfolio than following an index. That creates concentration risk, critics then cry. So why don't I hear them about the dominance of the famous Magnificent 7 in the indices?
They also steamed through the past year at a breathtaking pace: the share prices of Apple, Amazon, Meta, Alphabet, Microsoft, Nvidia and Tesla. They continued to soar again, resulting in staggering market caps. Nvidia's market capitalisation last week, despite some setbacks, was still $3.300 billion. That's about twice the total assets of all Dutch pension funds.
Club of 7 dominates indices
The consequence of that trillion-dollar bonanza is that the club of 7 is increasingly dominating the indices. Now, 33% of the total value of the S&P 500 consists of the successful big-tech stocks; they claim more than 20% of the total even in the MSCI World Index.
As a result, the diversification of the indices is declining sharply. In fact, according to research by Aegon Asset Management, which Pension Pro recently wrote about, the diversification of the most widely used MSCI indices is at its lowest point in the past 14 years. And that while many investors follow those indices precisely to diversify their risk.
Concentration risk grows
So the concentration risk for index investors is growing. There is currently no reason to believe that Big Tech will not continue to outperform its index peers in 2025. So far, that concentration risk has mainly had an upside for those looking purely at financial returns. And nobody expects a rapid implosion of the tech monopolists.
Still, it falters. On two counts.
If you want your portfolio to contribute to a more sustainable world, you cannot passively follow such an index. An impact investor does its own in-depth research. Perhaps then there are fewer companies in the portfolio than index followers. Until now, the resulting concentration risk was considered an important argument against such a sustainable selection. But apparently that concentration risk weighs less with the weight with which the Magnificent 7 presses on the indices.
Benchmark with mega-profits
Thanks to the dominance of semi-monopolists in online advertising, e-commerce and electronics, the indices show dazzling returns. Full disclosure: one of the seven, Nvidia, was recently admitted to our sustainable universe after due diligence.
Which leads to my second point. Those indices are the benchmark for the bulk of investors, while a portfolio that meets the strict sustainability requirements on climate, biodiversity and human rights has to do without the mega-profits of Elon Musk, Jeff Bezos and other billionaires. So that sustainable portfolio will lag this year, which in turn leads to that other, increasingly loud complaint: sustainable yields less than ‘conventional’ investing.
See what creates concentration
Leaving aside the benchmarkism I have written about before and the limited view it offers on sustainable financial returns, I wonder this: how long will we continue to be allergic to concentration risk without looking at what caused that concentration?
With indices, the cause is now clear and profitable; with an impact portfolio, it is the result of sustainable choices. I know one thing for sure: the sustainable portfolio contributes much more to a sustainable economy. That concentration is apparently a problem as soon as it produces performance differences with an index.
Beat benchmarks or a healthy return?
But what is your biggest concern as an investor with a big responsibility, say a pension fund? Beating the benchmarks, or contributing with a healthy return to a world where your youngest participants will soon be able to retire safe and sound in 2060?
As long as a concentrated portfolio yields an average absolute return that allows you to offer your participants a value-proof pension and as long as the investment choices are founded on solid sustainable choices, you have done very well as a pension fund, in my opinion.
Stephan Langen is Head of Portfolio Management at ASN Impact Investors. The information in this column is not intended as professional investment advice or a recommendation to make certain investments.