Managing Mega-cap Dominance in a Portfolio

Mega-cap stocks have driven recent market gains, but their dominance has created risks of concentration and elevated valuations in portfolios. To address this, investors can combine different indices to manage their exposure.

The mega caps have dominated stock market indices for much of the past decade. This has been true across most global markets, but has been particularly evident in the US, where technology giants such as Apple, Microsoft and Alphabet have driven market returns through innovation and strong earnings performance.¹

For investors, these US mega cap stocks have delivered extraordinary growth². Apple was the first to surpass a $3 trillion market valuation, briefly in 2022, and then again in 2023³,⁴. Chipmaker Nvidia now has a market capitalisation above $3 trillion, as does Microsoft⁵. Alphabet and Amazon are smaller, but still command market capitalisations of around $2 trillion. A company needs a market cap of $200bn to be designated as a mega-cap⁶.

The rise of these mega cap stocks⁷ has fundamentally reshaped the US equity market. It has created a more concentrated market, with a greater focus on specific sectors, notably technology. These giants offer significant growth potential – and have delivered strong returns for investors – but also come with concentration risks that investors must manage carefully.

By allocating investments between the MSCI USA Mega Cap Select Index and the MSCI USA Ex Mega Cap Select Index, investors can manage their portfolio more strategically, balancing the benefits of exposure to market leaders with the diversification⁸ needed to mitigate risk.

Mega cap performance

The numbers speak for themselves: over the past five years, the MSCI USA Mega Cap Select Index has delivered an impressive annualised performance of 18%, far outpacing the broader MSCI USA Index at 10%⁹. This remarkable performance has solidified the dominance of mega caps in the market, but it should also give investors pause for thought.

Mega-cap stocks, while undeniably successful, can pose risks to investors due to their outsized influence on market-cap-weighted indices. These indices have become increasingly concentrated in a few dominant companies, and just one or two sectors.

While their dominance has looked unassailable, there are reasons for concern. Valuations are high, for example. The MSCI USA Mega Cap Select Index, for example, trades at an average price-to-earnings (P/E) ratio of 32x, compared to 23.6x for the broader market, as measured by the MSCI USA Index.⁹ While these high valuation levels reflect strong growth prospects and investor confidence, they also make these stocks more vulnerable to market corrections.

The case for mega Cap exposure

Despite their high price, there is still a compelling case to hold mega caps in a well-balanced portfolio. These companies are often leaders in innovation and hold dominant positions in crucial sectors such as technology, healthcare, and e-commerce. They generally have strong balance sheets, diversified businesses and, as such, are often better positioned to withstand economic downturns. They are also exposed to significant growth trends such as digitalisation, artificial intelligence, and renewable energy.

Striking a balance: Diversifying beyond mega Cap dominance

However, investors need to manage the concentration and valuation risks associated with mega-caps. With this in mind, allocating to the MSCI USA Ex Mega Cap Index can provide diversification⁸ benefits by incorporating exposure to mid-cap and smaller large-cap companies. Investing in this part of the market may help mitigate sector-specific risks and reduce volatility, such as high exposure to the technology sector. It may also help investors tap into the differentiated growth opportunities found in smaller, more agile companies.

Non-mega cap stocks often trade at more attractive valuations³.These lower valuations could provide a margin of safety for investors, reducing the risk of overpaying for future earnings.

The debate between concentration and diversification⁸ lies at the heart of investment strategy. When it comes to mega cap and non-mega cap stocks, the decision ultimately depends on each investor’s unique priorities and approach. They need to balance the innovation and market influence of mega cap stocks with the opportunities for diversification⁸ and growth available from smaller companies². Ultimately, the choice depends on individual goals, risk tolerance, and market outlook. Each investor must craft their allocation strategy thoughtfully, aligning it with their convictions and adapting it to the evolving equity landscape.

¹ Past performance is not a reliable indicator of future performance.

² Past market trends are not a reliable indicator of future ones.

³ https://www.statista.com/chart/14953/apple-market-capitalization/

⁴ https://www.forbes.com/sites/dereksaul/2024/10/15/apple-stock-rises-to-all-time-high-and-record-36-trillion-market-cap/

⁵ https://www.investopedia.com/biggest-companies-in-the-world-by-market-cap-5212784

⁶ https://www.investopedia.com/terms/m/megacap.asp

⁷ Mega Cap stocks are defined as companies with market capitalisations in excess of $200 billion.

⁸ Diversification does not guarantee a profit or protect against a loss.

⁹ Source: Bloomberg, MSCI, Amundi, Data as at 31/10/2024. Past performance is not indicative of future returns. 

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.

Knowing your risk

It is important for potential investors to evaluate the risks described below and in the fund’s Key Investor Document (“KID”) and prospectus available on our website www.amundietf.com.
CAPITAL AT RISK - ETFs are tracking instruments. Their risk profile is similar to a direct investment in the underlying index. Investors’ capital is fully at risk and investors may not get back the amount originally invested.
UNDERLYING RISK - The underlying index of an ETF may be complex and volatile. For example, ETFs exposed to Emerging Markets carry a greater risk of potential loss than investment in Developed Markets as they are exposed to a wide range of unpredictable Emerging Market risks.
REPLICATION RISK - The fund’s objectives might not be reached due to unexpected events on the underlying markets which will impact the index calculation and the efficient fund replication.
COUNTERPARTY RISK - Investors are exposed to risks resulting from the use of an OTC swap (over-the-counter) or securities lending with the respective counterparty(-ies). Counterparty(-ies) are credit institution(s) whose name(s) can be found on the fund’s website amundietf.com. In line with the UCITS guidelines, the exposure to the counterparty cannot exceed 10% of the total assets of the fund. 
CURRENCY RISK – An ETF may be exposed to currency risk if the ETF is denominated in a currency different to that of the underlying index securities it is tracking. This means that exchange rate fluctuations could have a negative or positive effect on returns.
LIQUIDITY RISK – There is a risk associated with the markets to which the ETF is exposed. The price and the value of investments are linked to the liquidity risk of the underlying index components. Investments can go up or down. In addition, on the secondary market liquidity is provided by registered market makers on the respective stock exchange where the ETF is listed. On exchange, liquidity may be limited as a result of a suspension in the underlying market represented by the underlying index tracked by the ETF; a failure in the systems of one of the relevant stock exchanges, or other market-maker systems; or an abnormal trading situation or event.
VOLATILITY RISK – The ETF is exposed to changes in the volatility patterns of the underlying index relevant markets. The ETF value can change rapidly and unpredictably, and potentially move in a large magnitude, up or down.
CONCENTRATION RISK – Thematic ETFs select stocks or bonds for their portfolio from the original benchmark index. Where selection rules are extensive, it can lead to a more concentrated portfolio where risk is spread over fewer stocks than the original benchmark.

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