The rally in the S&P 500 Stock Index ($SPX) (SPY) to an all-time high is proving difficult for many active fund managers underperforming the index.  With just a handful of technology stocks leading the broader market higher, many active fund managers are giving up picking stocks and are mirroring the index. A gauge kept by Bank of America called the active-share ratio, which tracks how holdings of active funds deviate from the S&P 500, is at the lowest level since 2013.   

Many active fund managers are abandoning their stock-picking strategies and are letting the S&P 500’s static allocation guide their own picks.  Socorro Asset Management LP states, “Active managers typically justify their fees by producing alpha by security selection.  But in a market where returns are being driven by just a handful of large-market-cap names, it becomes increasingly difficult to fulfill that mandate.”

Driven higher by the artificial intelligence (AI) craze, the seven largest technology stocks, Apple, Alphabet, Amazon.com, Nvidia, Microsoft, Meta Platforms, and Tesla, have doubled on average in the past year, four times as much as the S&P 500. With the rally in the overall market concentrated in a narrow band of stocks, the rest of the market has languished. Only 27% of the S&P 500’s stocks were ahead of the benchmark last year, the narrowest market breadth in the history of the Bank of America data since 1987.

According to data compiled by Goldman Sachs Group, the wide divergence between the top seven technology stocks and the overall market has soared.  At one point last year, the combined weight of the seven stocks in the S&P 500 reached 29%, the most since at least 1980.  If money managers were not invested in the big seven technology stocks, their returns suffered.   According to Bank of America, only 38% of large-cap funds beat their benchmark last year as any aversion to the megacap tech stocks dragged down their performance.

To be able to meet or beat the performance of the S&P 500, fund managers need big tech exposure.  However, regulations limit how concentrated a “diversified” mutual fund can be.  The SEC’s diversification rule says funds must cap the number of individual securities that equal more than 5% of their assets, and such stakes can’t add up to more than 25% of their overall portfolios.  Socorro Asset Management LP said, “As market cap-weighted indices become more concentrated in a handful of names, it creates an inherent conflict for active managers who are not willing or able to have such concentrated positions.”

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