Over the past decade, a South African investor would have done very well holding a broad, market cap-weighted global index tracker. In rand terms, the MSCI All Country World (ACWI) Index has returned around 14.5% per year since the August of 2014.
This has made ETFs that track this or similar indices valuable building blocks in portfolios managed by wealth managers or stockbrokers. They have provided efficient access to the strong returns in global markets at low cost.
However, investors are growing increasingly concerned about the resilience of the US economy and what that might mean for global markets – particularly because recent returns have been so concentrated in just a few mega cap stocks.
Over the past 24 months, the “Magnificent Seven” of Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla have dominated returns in a way we have rarely seen. In 2023, these seven tech giants delivered an average return of 76%. The rest of the S&P 500 returned just 8%.
This disconnect has continued so far in 2024. The “Magnificent Seven” are up 39% for the year to the end of August. The rest of the S&P 500 has gained 5%.
The average US company has therefore provided quite modest returns. And we think that is more reflective of the reality in the US economy. Investors have chased the returns from the “Magnificent Seven” and directed flows to these stocks because this has been the only growth area in the market. But this is now a crowded trade, and we think a risky one.
Multiple expansion
This is the challenge for global investors now. The consensus has been that they need to hold risk, because anyone who didn’t own the “Magnificent Seven” has been left behind. But many investors are becoming increasingly uneasy with this position.
Consider that the heavy demand for these mega cap stocks has driven their price-to-earnings (P/E) multiples to levels almost double those of the rest of the market. The 10 largest counters in the S&P 500 currently trade on P/Es of around 30x. That is 40% higher than their long-term average.
By contrast, the rest of the stocks in the index are on P/E multiples of around 18x, against a long-term average of 15.7x.
The growth of these stocks has also led to record levels of concentration. The 10 largest stocks in the S&P 500 now account for 37% of the entire market capitalisation of the index. This is not just a US story, but a global one too. Because the US is now over 64% of the MSCI ACWI. That means that, on a see-through basis, over 20% of any allocation to broad global index tracker is going into just10 companies.
The result is that the diversification you would normally want and expect from this kind of investment just isn’t there. This poses real risk for investors. When you have a situation where just a few, richly-priced stocks with similar drivers dominate an index, any sector rotation or pull-back can have an outsized impact on your portfolio returns.
The tide can also shift rapidly. Consider that Nvidia’s share price recently fell 20% in just two weeks.
A different approach
At 10X Investments, we have therefore increasingly been re-thinking our global equity allocations. We have been moving away from a broad, market cap-weighted index in favour of using indices that provide globally diversified exposure to companies with valuations that offer good upside potential, such as the constituents of the 10X S&P Global Dividend Aristocrats ETF. We have also seen an increasing number of portfolio managers using this ETF as a core global equity holding in personal share portfolios for their clients. The 10X S&P Global Dividend Aristocrats ETF invests in over 350 companies across North America, Europe and Asia, all with a solid long-term track record of paying stable or growing dividends. These are not high-growth businesses innovating in ways that are going to change the world, but they do own trusted and established brands with strong market positions. They also offer high visibility of consistent and predictable earnings.
The stocks in this fund are the likes of Nestlé, Johnson & Johnson, Coca-Cola and L’Oréal. They are quality companies that have a long history of paying out stable and increasing dividends. These companies have historically delivered predictable growth through economic cycles because their products are always in demand. They deliver robust earnings, are highly cash generative, and have strong balance sheets.
Their focus on paying out income also provides significant downside protection. Even in market downturns, these companies have historically never cut their dividends. That has supported total returns for investors, even when prices fall.
Attractive exposure
Essentially, we see this ETF as a global building block that allows investors to maintain their growth exposure, but through a much more diversified and defensive portfolio than they would currently get from a vanilla global index.
At the moment, the fund allocates 57.6% of its portfolio to the US, compared with 64.5% in the MSCI ACWI. Information technology is also only 5.8% of the 10XS&P Global Dividend Aristocrats ETF, while it is 24.9% of the MSCI ACWI.
Importantly, we are not giving up earnings growth through this strategy. Over the past decade, the earnings growth of the S&P 500 Index has been 87%. The earnings growth on the S&P 500 Dividend Aristocrats Index – which is the US component of the 10X ETF – has been 90%.
We believe this ETF therefore offers investors diversification and downside protection, without sacrificing returns. Ultimately, it provides access to growth assets with a robust cash-generative underpin, without the expensive price tag.