Underperforming Growth Managers Showed Skill

The U.S. equity market’s “Magnificent Seven”¹ surged to a 27% weight in the MSCI USA Index in July 2023, up from 7% a decade ago. The concentration is even more conspicuous within the MSCI USA Large Cap Growth Index, for which the same seven companies now make up 55%.

In the middle of the last decade, from 2013 until mid-2017, when the cumulative weight of the Magnificent Seven was modest, their median weight in U.S. large-cap growth managers’ portfolios closely mirrored the benchmark, the MSCI USA Large Cap Growth Index. But as the index weight of these stocks climbed, nearly all active growth managers began to underweight them. Managers may have had several motivations, such as low conviction in their performance prospects and the desire, or the regulatory requirement, to mitigate concentration risk.

Active bets often offset underweights in the Magnificent Seven

Underweight positions in the Magnificent Seven have been a drag on growth managers’ performance relative to their benchmarks over the 10 years ending March 2023. Yet, nearly two-thirds (63%) of growth managers partially or more than offset this negative contribution with active bets on other stocks.

The headline performance of an active manager relative to their benchmark does not tell the whole story. A manager’s skill can be revealed by understanding their active bets in the context of high levels of market concentration. Thus, assessing an active manager on their prioritization of concentration risk over tracking risk can be prudent in markets where concentration is elevated.