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  • Chip Rewey

How Risky is Your Index?



Cr-AI-zed?


In 2Q23 investors rushed to buy any company perceived to be involved in the Artificial Intelligence cr-AI-ze. The launch of public ChatGPT brought renewed attention on the potential applications for artificial intelligence. Similar to the year 2000 “.com” boom, investors rushed to purchase companies that could capture AI revenues. While we have long believed that AI will positively impact company productivity (i.e. bank trading reconciliation, call center help line automation, medical pathology diagnostics, etc.), we believe the current boom in valuations has likely ramped too far too fast. We believe valuation always matters, and see stock price vulnerability for many companies that ran up with the cr-AI-ze.


The Magnificent (and Risky) Seven?


The impact of the rush to all things AI was mostly seen in the S&P 500. While the S&P 500 index ETF (SPY) returned 8.72% for 2Q23 and 16.84% YTD, it is notable that the S&P 493, defined here as the S&P 500 (SPY ETF) without the 7-largest weighted positions that are all technology related companies (AAPL, MSFT, AMZN, NVDA, GOOG/L, TSLA, META) returned a much lower 4.13% in the quarter and 5.75% for year-to-date. These top 7 positions in the S&P 500 represented 27.58% of the index at quarter-end. As shown in the table below, the S&P 500 Index, in our view, was not representative of the broad market in YTD 2023. For comparison, the Russell 2500 Value outperformed the S&P 500 less the impact of these 7 top weighted positions YTD.


Source: Bloomberg, RAM proprietary analysis.


How Risky is Your Index?


The concentrated return profile of the S&P 500 is a reminder that although many investors think of an index ETF as a low-risk way to invest in the markets, we believe ETFs do not really represent ‘the market’ and that ETFs can increase one’s risk profile. As an index is a passive group of securities by definition, there are no risk control mechanisms to reduce sector concentrations or other exposures that may not be in the best interest of investors. Any moderation in the growth of these top 7 technology stocks, either from a valuation reset like we saw at the end of the .com bubble, or from the impact of higher interest rates in DCF valuation calculations, would likely drag down the index performance like the way it was propped up YTD.





Notes:

The Russell 2500 Value and the S&P 500 Index performance levels are sourced from Bloomberg. The Russell 2500 Value and S&P 500 indices are an unmanaged group of securities considered to be representative of the small and mid-cap stock market, and the large-cap stock market in general, respectively. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index. There are material differences between the RAM SMID Value Composite portfolio and the indexes used for comparison purposes.

SPY (S&P 500 ETF) Information sourced from Bloomberg. “SPY 493” is not an index, but a term defined in this letter to represent the SPY ETF without the impact its top 7 holdings. This data is not guaranteed and is sourced through Bloomberg and Rewey Asset management proprietary analysis.


Rewey Asset Management is a registered investment advisor in the State of New Jersey

All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results. All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by RIA Innovations. These views/opinions are subject to change without notice.

This material is for informational purposes only and is not a recommendation or advice. Investments and strategies mentioned are not suitable for all investors. No one can predict or project performance, and forward-looking statements are not guarantees. Past performance is not indicative of future results. Investing involves risk, including the loss of principal. Indices are unmanaged and you cannot invest directly in an index.


The information and material contained herein is of a general nature and is intended for educational purposes only. This does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities. There is no assurance that any securities discussed herein will remain in the portfolio at the time you receive this report or that the securities sold have not been repurchased. Securities discussed do not represent the entire portfolio and in aggregate may represent only a small percentage of the portfolio’s holdings. Before investing or using any strategy, individuals should consult with their tax, legal, or financial advisor.

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