The Index Trap

Kilian Niemarkt: Good afternoon. Welcome everyone to today's Global Equity webinar. My name is Killian Nemak, Senior Client Portfolio Manager here at the RBC Global Equity team in London, and I'm joined today by Habib Sajali, Head of Global Equities. Welcome, Habib. How are you today?

Habib Subjally: Hi, Killian. Thanks very well, very well. Thanks for hosting this.

Killian: No, thank you very much indeed as well. And you know, Habib, to set the scene for this webinar, and if we think about global equity markets a bit more holistically, I think we all on this call can agree here that the last couple of years have been really a fantastic place for global equity investors. The MSCI world, the index increased by over 20% in U.S. dollar terms 3 consecutive years in a row. Now that doesn't happen that often.

And, you know, you and I, Habib, work together on this same team for just over 5 years now. You're a very experienced investor, over 30 years of stock picking experience doing that since the early 1990s. And I got to know you during that time as a really calm personality. However, more recently, I feel you're increasingly nervous about the overall market, but at the same time, also incredibly excited. Walk us through your current thinking.

Habib: Oh, thanks, Killian. Yeah, you know, you're, you're right. It's been—the last three years have been a great time in equity markets, markets have gone up, risk appetite is high. You know what's not to like? And maybe that says something about me. I'm just one of these sort of paranoid people that maybe overthinks things a little bit.

But yeah, you're right. I, I have to say I am nervous. I'm, I'm nervous because while markets have done very well, they are highly concentrated because the drive for markets to go up has been driven by a very narrow set of stocks, driven by a very narrow set of themes. And this leaves markets highly concentrated, not very diversified. And that is an unhealthy state of affairs. And that kind of makes me uncomfortable and, and, and a bit jumpy and, and, and sort of maybe that's nervousness.

But at the same time, I'm also very excited and I'm excited for active management because as markets have got more concentrated, they will inevitably diversify. And when that happens, there are many overlooked companies, out of favor companies that are doing some great things, that are great wealth creating businesses. Those are relatively cheap, unrewarded now, and when that time comes, it will be a great opportunity for us as active managers, not just us, but other active managers.

Killian: You know how people really like the point that you raised there, and I think you described it as sort of an unhealthy index composition. I think you're very right about that, because we always think about the MSCI world as this broadly diversified 1,300 stocks kind of index, but in reality, the top 10 of this index account for almost one-third of the index, so I think it's fair to assume that the index has really shifted over the last couple of years from being a diversified beta pure play to being a very narrow concentrated bet on a certain narrative, on a certain theme, I feel.

Index Concentration: Beta and Alpha

Habib: Uh, yeah, that's right, and you know, this chart you put up, Killian, really shows that, because, you know, when we think of an index, we think of it, and sorry, pardon the statistical language, we think of an index as beta 1.

Killian: Yes.

Habib: And Alpha Zero—that it is because it owns every stock in the asset class that no individual stock has any particular major impact on the overall index. And what you're seeing here is the top 10 make up 29% of the index, and this is unusual. Normally, um, you know, it's kind of 10% or under.

S&P 500 Concentration

Killian: That's right, and this is for the MSCI world. We do see the same, actually, to a more extreme extent in the S&P 500. To your point, has been always remarkably constant, the top 10 of that particular index around 20% in recent years. It jumped to around 42%. And what we've done here, and I think this is really interesting, we compared the index concentration to fundamental bottom-up active managers towards their allocation towards the top 10. And I think it's quite striking. For the first time ever in history, the index has a higher allocation towards the top 10 than active managers, so passive allocations have essentially emerged to a higher active risk than actual active managers. And that just—think for a minute.

And to further highlight the diversification failure of the index, we did an analysis of the effective membership of those indices, because, you know, the bottom part of the index maybe has a weight of around, you know, 0.01%, so it doesn't really matter if there's a great business and the stock price doubles, or even if you have a 10-bagger. As an index investor, you would not participate in it. Now, on the other hand, you have companies like Nvidia, who have an allocation of 7.4% of the entire index, right? And in fact, have the same rate, then the smallest 100 stocks in the index.

Historical Country-Level Concentration

Killian: Suppose it's I mean...

Habib: Yeah, I have to say I haven't seen anything like this before. I mean, the only time I've seen this level of concentration is in individual country markets. So, you know, Nokia became a very big percentage of the Finnish market. Nortal became a very big percentage of the Canadian market. Vodafone was a huge percentage of the FTSE. You know, over 10% of the FTSE. But we haven't seen this at a global level. So this is relatively… unusual, I would say.

Sector Concentration

Killian: Indeed, and perhaps the sector contribution is the same story here, isn't it?

Habib: And… Yeah, and I think it's not only about concentration by stock. When you look at the composition by sector, again, the composition of the index has changed quite a lot. So if you bought an index fund 10 years ago, what you bought then has transformed into something quite different today. So the technology share of your index fund that you bought 10 years ago has now doubled from 18% to 36%. And the defensives component of that has fallen from 27% to 17%. So you get a very different flavor of beta. Both are beta 1, right? I mean, this, by definition, the index fund you bought 10 years ago was Beta 1 at the time. Today, it's still Beta 1, but it's a very different flavor of beta. And the beta is much higher today than it was when you compare it to what you would have bought 10 years ago.

Killian: So then…

Country Allocation: U.S. Dominance

Killian: And there's really a third. Yeah, a third component to it, which is the country allocation. I would probably say, which is, apart from the concentration on holding and industry base, is something to really bear in mind, because we all know the MSCI world heavily skews towards the United States, but this is now completely detached from the true economic output that the US is actually having as a share of GDP of developed market economies, which is much closer to 50%. So you're really having a jurisdictional overexposure and risk, especially towards the United States here.

Habib: Yeah, this is kind of one of the reasons why people went global, because they want to diversify away country specific risk. And look, the US was always a big part of the global benchmark. But now it's got bigger and bigger. And the whole point is that now the global portfolio is a big bet on the US and is disproportionately impacted by US policy, whether that is US monetary policy, economic policy, foreign policy, tariff policy, and all of those policies, right? So you get disproportionate impact from that.

And I think this is something that the whole point of going global was that if one central bank makes a policy error, whatever, it doesn't impact you that much. You diversify that away. That diversification now is significantly reduced.

Currency Exposure

Killian: And it's also another component to it, actually, because if I think about the currency element of the equation, you're actually heavily exposed towards the US dollar, and over the last year, we did see the US dollar weakening quite significantly, to some extent to what you just described, Habib, around political noise, geopolitical noise. And I mentioned at the very beginning that equity returns have been spectacular. Yes, in the US dollar, not so much so in other currencies, including Euro, some of the Northern currencies, where the Krona, Norwegian Krone and Sterling—on some of those currencies, the return last year was only around 3 to 4%, very far away, actually, from this 20% headline returns in US dollar. So this is something to really bear in mind. It's a big bet you're actually taking within the index on the US dollar. Now, obviously, we have established our markets are concentrated, we get that. The question is now, obviously, why is this concentration by stock such an issue?

Why Concentration Matters: Idiosyncratic Risk

Habib: Okay, so I go back to the index right? So we said the index was beta one, but alpha 0, and what I mean by alpha 0, it is maximum diversification, because it owns every single stock in the asset class. So, it diversifies away company-specific risk. So if one company wins and another one loses, it doesn't really matter, because you own them both. Something bad happens to one company, something good happens to another company. Again, it doesn't really matter to you so much because you own them both.

And over time, you participate in the overall economic growth and wealth generation of all the companies in aggregate. Some companies are generating a lot of wealth, some companies that are destroying wealth, but net net, more companies generate wealth than that is destroyed. And that's what an index kind of measures, and that's why people want to invest in an index fund.

But this point about when we said that the top 10 companies were disproportionately high percentage of the overall index means that those companies can have—if something bad happens to them or something good happens to them—that can have a big impact on the overall index level, right? And that is something that is not meant to happen. And in this chart, we measure idiosyncratic risk, which is a measure of stock-specific risk.

And you can see that the idiosyncratic risk was fairly low, about 1% for MSCI World, and about 1.5% for the S&P 500. And now, since about… since about 2000, it has slowly been drifting up. And now, like MSCI World has two and a half percent stock specific risk, which is enormous. I mean, that is equivalent to the stock specific risk that many active managers would have in that portfolio. And this just goes to show how individual stocks can now have a big impact on an index.

Historical Examples: AOL and Nortel

Killian: Yeah, and indeed, they can have, and I think there are many historic examples in time where those stocks had an impact. I mean, AOL is perhaps just one to mention. I suppose the stock you remember from your active time, I keep doing that during that particular point in period.

Habib: I do indeed.

Killian: It was the go-to play to get exposure towards the new economy, towards internet. It was, at some point, even part of the top 10 holdings, but as technological change happened, they completely missed the switch from dial up towards broadband, and in the end, we saw wealth destruction of 97%, but there are a lot of other examples, I think we can think of, Habib. For instance, Nortel, I think.

Habib: Oh, yeah, absolutely. I mean, look, this has been the history of the stock market, right? The history of corporates, and we'll come to that in a little while when we talk about the corporate lifecycle, for sure. But I think we also have to talk about valuation.

Valuation: Market Cap Weighted vs. Equal Weighted

Killian: Yes, indeed. And this is quite interesting, because if you do think, or if you do read the FT, the Wall Street Journal, or whatever your financial publication of choice might be, you will read, valuations are rich. Valuations are high. And this is correct. In fact, valuations are not just high. They're at all time high if you speak about the market cap weighted version of the index. Now, if you compare that to the equally weighted version of the index, it's an entirely different picture. The valuations are not just not at all-time high. In fact, the valuations are fair. They're around their 10-year historical average. But what's even more interesting is that now the spread between the market cap weighted and the equally weighted version is one of the highest we've ever recorded. And the fact of the matter is that market cap weighted indices are pro momentum and anti-value. Because of this bunching that we described earlier, you also have to be aware that you are taking increased factor risk, because if valuations grow in market cap weighted indices, they get a larger share.

And plus, you have the ETF crowd when the ETF is rebalancing that also pour into these now higher valued companies. So this is a reinforcing feedback loop that we are currently in that is completely decoupling the market cap weighted version from the equally weighted version.

Equal Weight Performance vs. Market Cap Weight

Killian: Um, of the index. Now, if we think a bit more about this debate, equally weighted versus market cap weighted, I think it's quite interesting if we look at the performance between those two indices, because equally weighted actually spectacularly underperformed during the buildup of the dot-com bubble. However, it delivered a tremendous outperformance after the dot-com bubble burst. And if I think about the more younger generation of portfolio managers like myself, for investors like us, there are two circumstances that are true. And, even if they go down during COVID or whenever, they recover very quickly within a couple of months. So my question for you is, do you actually believe that a circumstance that we have seen during the buildup of the dot-com bubble and the years afterward could that happen again? Are we perhaps in such a scenario right now?

Long-Term Trends: Equal Weight Outperformance

Habib: Okay, this is this is a really interesting question, and I think this chart really sums it up. I really like this long-term picture, because, look, in financial markets, we are worrying about what's happening minute by minute, day by day, quarter by quarter. And when you sit back and you look at the long-term picture, right? So this is the S&P 500 equal weight relative to the S&P 500 cap weight. So the first observation I would make is that the long-term trend line is upward sloping.

Killian: Mm-hmm.

Habib: That suggests that equal weight outperforms cap weight over the long term. What that is really saying in simple terms is that small caps tend to outperform large caps. Now, this may seem counterintuitive right now, but over the long term, this is true. We have almost 100 years of stock market data that many academics have analyzed. Eugene Fama got his Nobel Prize in part for this work on the small cap effect. Right, so this is a well-established trend. And the way I think about this is actually just in simple capitalism, right? Small companies find a new technology, execute on it amazingly well. They do amazingly well, grow their profits, grow their customers, they become hugely profitable, become large companies, and this might take 20, 30, 40 years. They become very large companies.

Corporate Life Cycle

Habib (continued): And then large companies tend to attract political attention, regulatory attention. They attract new competitors, smaller companies look at this big profit pool and say, I want a piece of that. And they find new ways of stealing some share and profits from them. And of course, large companies that have been large for a long time tend to become complacent, lazy, and then they fail.

And smaller companies take that place, and this is the great sort of circle of life in the corporate world. Academics call it the corporate life cycle. And this is well established. It has been going on since before stock markets were even invented. And I think this continues. This is a natural trend of entrepreneurialism and capitalism.

But there are periods where this gets suspended, where large companies continue to grow larger and larger, and maybe this is because we have an unusually good cohort of large companies. Perhaps that. Perhaps the regulators and antitrust authorities have been a bit too lenient on them, for whatever reason. This, you, you go through these periods where large companies become larger and larger.

But then over the long term, they do fail, and smaller companies come and take their place, and then normal service is resumed. We have been through this period now for the last four or five years. The last time we saw this was in the late 1990s.

Killian: Mm-hmm.

Habib: That didn't end well. Now, I'm not saying that… exactly the same thing is going to happen again, because that is a sample of one, and it's very easy to say, you know, history is just going to repeat itself. History doesn't repeat itself, as as they say, history rhymes.

But if you were to ask me what does this chart look like in 10 years time, five years time? I would say the line is in the top right hand side rather than the bottom right-hand side. And that corporate life cycle is a very natural, powerful gravitational pull.

Historical Technology Disruptions: Railroads

Killian: You know, Habib, I really like your analogy about the corporate lifecycle there, because I give you another example. I know you're a very experienced investor, but you probably haven't been around in the 19th centuries, where we essentially saw...

Habib: Definitely not.

Killian: Good. Well, we essentially saw that major technological innovations actually have led to market concentrations before, and even before that, in the 18th centuries, with the build-out of the canals, but they quickly became irrelevant after your new technology with railroads. And this was the cutting-edge technological innovation at the time, and actually led to a concentration of two-thirds of the entire index or market capitalization, the equity market at that particular point in time. But what's interesting about rail is railroads are still around. A very important part of society. In fact, they're still one of the most efficient ways to transport goods and services from A to B, yet the market capitalization weighting has shrunk from two-thirds to just 49 basis points. So, so a big change here. Although the technology is still around, it really has transformed the way we travel, we transport goods.

Habib: You know, you're right, Killian, and railroads, don't forget, railroads displaced canals. Canals were the main form of transport before then, then railroads came along, and then, of course, you had roads and trucks and automobiles. And that brought the demise of railroads. And then, of course, car companies, you know, whether it was Ford, General Motors, Volkswagen, Toyota, these were the largest companies in their countries, right? Some of the largest companies in the world. And look at where they are now. Most of them are, you would charitably describe them as value traps. So this is, again, the corporate life cycle at work, and what it teaches you is not to fall in love with these companies. It's great new technology, there are great companies, but things change. Change is the only constant.

Why Is Concentration Happening?

Killian: I really like that. I think this is a very important point you raise there. Don't fall in love with companies' business models or technological innovations. And, you know, we have established that our markets are concentrated around holding, around sector, around geography. We've established that the idiosyncratic risk of the benchmark is increased, but we still have to answer the question, why that is the case, apart from this obvious AI hyperscaler capex story?

Habib: Yeah, look, why this is the case is a complex problem, right? And it could be, like I said, this is an unusually great cohort of companies. It could be because antitrust and other regulatory authorities are setting back and allowing these companies to continue. But in part also, and also to your point about valuation, why have valuations got so high? And so many people are sitting there scratching their heads and wondering why this is… this concentration has happened.

Who Sets Prices? The Retail Investor Rise

Habib (continued): And I think the mistake that we make is that we as professional investors, we think that everyone else thinks like us, right? That we sit and we study and analyze these companies and we try and predict and do different scenarios of the future. And what these businesses will look like in 5, 10, 15 years time, and we build our discounted cash flow models and we agonize over the discount rate that we apply to that to see if these companies are overvalued or undervalued and how much growth they might have, and so on.

We assume everyone else thinks the same way, but that is not the case. If you look at the data, long-only investors like us make up only 6% of the order flow of the purchases and sales of shares on the US stock market. This is down from 11% 15 years ago.

So we're only 6% of setting prices. The big increase has been the retail investor. That is now 21% of US order flow. Now, retail investors come in many shapes and sizes and forms. Many of them are very sensible, very conservative investors, but here, the big increase we've seen in the democratization of share trading. So think of the meme stocks. Think of all the stock...

Killian: Yeah.

Trading Platforms & Leverage

Habib: Discussions on Reddit and on Twitter, X, think of platforms like Robinhood. Right? This is where people are buying stocks using leverage, they're buying… they're investing in crypto, you know, equities is just another asset class for them. They will buy either direct equities, they will buy ETFs, and many times there are now these double, triple geared ETFs on narrow themes, sometimes on an individual stock. They also invest in these complex option strategies. Some of these we've seen this an explosion of single-day expiry options.

Where you are essentially betting on what a stock is going to do in the next few hours before the close. You've seen a massive explosion in that trading.

And that gets followed by hedge funds who try and anticipate what retail investors are going to do. And of course, the high frequency guys are trying to anticipate what they're trying to do. And then passive comes in to magnify that even further. Now, none of these investors care about valuation. None of these investors, I mean, some hedge funds might build DCFs, but most of them have a very short time horizon and are thinking about what the stock is going to do in the next few minutes, hours, days, weeks, perhaps months. Right? And so… This is a short time horizon. Everyone thinks that they can get out at the top.

Volatility and Leverage

Killian: Yeah, I think there's…

Habib: Right? And I think this is a difference. One thing to remember is that equities are volatile. And leverage and volatility kind of don't go well together over the long run, right?

Options Volumes & Dopamine-Driven Trading

Killian: That's right. I think this is a fascinating topic, because what you're describing there is that trading essentially evolved from being a transactional utility, the two of us exchanging shares of Apple, Alphabet, Microsoft, whatever, towards a dopamine-driven experience. And I think your point towards the rise in option volumes is a very important one, because last year, for the first time ever, option volumes actually surpassed the volumes of stocks, which is simply mind-blowing if you think about that. You saw an increase of 260% over the last 10 years, and it really has worked, and we have to acknowledge that handsomely well on the way up. But the question is, are investors prepared for the pain trade on the way down? Because the same mechanism you described will work on the inverse as well. So as soon as there's a technological change, we talked about that coming up for whatever reasons, and equity markets of those top 10 holdings began to fall. They will flash on Robinhood as the biggest losers. They will be part of the Reddit army debate. And if those people actually use this time put options, and these trades get sold to the market maker. The market maker would actually have to short the actual stock, so creating non-fundamental selling pressure on those businesses, creating a feedback loop that can be quite violent and painful on the way down, actually.

The Only Constant Is Change

Killian: I can probably summarize it with the only constant is change. We do see here on the next slide the top 10 that we spoke about a lot today over history, and I think it's quite foolish to assume that 20 years forward from now on, the top 10 of today, some of the so-called Magnificent Seven, will still be in the top 10 of 20 years going forward, perhaps one or two names, but the vast majority, certainly not.

Top 10 Companies: 2000 vs. 2025

Habib: Yeah, Killian, I think this… I love this slide because it really puts that corporate life cycle into context, right? And what you see is companies don't get into the top 10 for no reason, right? These are great, great businesses. They got there because they did something very right. They did amazing things with technology, they executed on it, they created a huge amount of value for their customers and their other stakeholders and for their shareholders. So, don't get me wrong, these are great companies, and these are the types of businesses we like to invest in. But when you look at them over time and you look at the top 10 at the peak of the dot-com bubble, so this is March 2000.

Killian: Yeah.

Habib: The only one company, Microsoft, has made it from the top 10 in 2000 to the top 10 at the end of 2025. And that also, Microsoft is remarkable and unusual, because it had, like, 14, 15 years in the doldrums, until Satya Nadella came.

Killian: Yeah.

Habib: And turned it around. And that is an amazing feat, what he did. That is highly unusual. If you look at the others, and like I said, these are all great companies. They got there because they did something right.

If you look at them now: AOL and Lucent don't exist anymore.

Killian: Yeah.

GE and Other Fallen Giants

Habib: GE, under Jack Welch, was this great, great company, right? You know, serious people would say back then, and as a young portfolio manager, people would say, why do I need to own a mutual fund? I just invest in GE. It has everything, right? It has industrial assets, it has media assets, it has financial services assets. That's all I need to put into my 401k, on my pension plan, and that's great. And GE is led by the greatest manager ever, Jack Welch.

Right? Well, GE almost went bust. Today, there are 3 public companies that came out of GE, but also so many of GE's businesses have had to be sold off to other owners so that GE didn't, you know, could survive and get through its liquidity crisis.

But also look at some of the others. Intel and Citigroup needed government bailouts. Others like Cisco is around. Some would say IBM is still around. Some would say it's a value trap, you know, Walmart has had to reinvent itself. When I look at the companies today, these are, again, great, great companies. They've got here for a reason.

And rather than just admire them and fall in love with them, we have to be somewhat paranoid and skeptical.

Because what is crucial is that at 2000—now, I know this isn't just… when you look at the top 10, this isn't just the dot-com stocks, there were many others further down in the index, but if you take this as a proxy—that 27% of the index were made up of the dot com. As that deflated, the other 73% had a lot of heavy lifting to do.

Today's Concentration: 41% in Top 10

Habib (continued): Right? And this is kind of what worries me today. Today, we are… the top 10 are made up of some great, great companies. But they make up 41% now of the S&P 500.

And they could stay elevated for a few months, years. Who knows? But we know the forces of gravity are against them. And this is something where we have to be skeptical and our index, of course, just continues to hold them indefinitely.

Echoes of 1999: AOL-Time Warner

Killian: I think that is a very, very important reminder, and I think there are some echoes of 1999 that we can hear here, because that was obviously a period where we saw some really spectacular IPO and M&A deals coming along, often of these unprofitable companies, and really eye-watering valuations. There is, for instance, AOL and Time Warner at that particular point in time, it was the largest deal ever struck in 2000, it was worth 320 billion. Again, in 2000, a ginormous market cap, and that company spectacularly fell. It was a 97% wealth destruction with those businesses, and what's very funny is how business… sorry, history starts to repeat itself, because right now, Warner Brothers, again, within this big M&A proxy battle between Paramount and Netflix, now Paramount won. Kudos to them, but they paid also a very large price for them at a time where the narrative is shifting towards AI being essentially a threat to Hollywood. You see these videos that you and scenes that you can create on your phone that essentially are almost the quality, like, professionally shot movie films, so there's actually a question, is that asset, that Paramount acquired, worth so much?

Killian: Well, you know, Killian, this is the thing that, uh, you know, egos are high, confidence is high, and this is, you know, you're right, it was similar in 1999, and now, you know, with these kind of transactions, uh, you disrupt… things change, right? And disruption happens. AOL failed to make the move from dial-up to broadband.

Warner Brothers and AI Risk

Habib (continued): The same thing about Warner Brothers. Warner Brothers has some great assets, right? HBO, some amazing content, some amazing filmmakers, but… With AI, there are some risks there. And when someone pays a very full price, assuming that the future is not just the same as the past, but the future is going to be better than the past, that may not be the case.

Right? I think AI raises some question marks around that business model. And this, I think...

Killian: And…

Habib: ...is why investors have to be skeptical. Now, admittedly, in this amazing bull market of the last three years, you have not been paid to be skeptical. That skepticism has not been rewarded, because everyone thinks they can get out in time, but… Yeah, we'll have to wait and see.

SpaceX & XAI IPO

Killian: I mean, speaking of skepticism, we have a big, big IPO coming up. First of all, the merger between SpaceX and XAI, biggest M&A deal in history by now, and they're eyeing an IPO for later this year. A valuation definitely above 1 trillion US dollar. 

Habib: Well, we haven't done the work on it. Let's see. It'll be interesting to see that roadshow. It'll be very interesting to see if, uh, if the founder comes around and visits investors all around the world. And we'll see what he has to say.

Killian: Oh, sure.

Habib: We would definitely host a webinar around that if the founder comes around, that's for sure. Um… But another thought and reflection of the 1990s, and I think this is just worth reminding investors about, because what we do see here is the S&P 500 after the dot-com bubble burst in March 2000.

Recovery Time After Dot-com Bubble

Habib (continued): The index took seven and a half years to recover. It only recovered in summer 2007, and we all know what happened in Autumn that year, just to be hit again by the great financial crisis. So I suppose, Habib, that must have been a rather tough time for you.

Killian: Um, to invest and live through. I bet. Yeah.

Habib: I learned a lot through that period. It was, um… It was a great period to learn for sure.

But yeah, I think, Killian, this is—look, I don't want to get too bearish, right? Let's be honest. But this is a history lesson.

Killian: Yeah.

Habib: ...that when you get a highly concentrated market and then it starts to diversify, because you get this generational change in companies, and when those companies at the top are highly, highly valued, and then they derate, it takes time. So in this case, let's say, let's use that proxy of the top 10, right? As a 27% that made up the top 10 back then, as they derate, it takes the remaining 73%, in this case, it took seven and a half years to get back to the level that we saw before.

Right? Now we have arguably markets that are even more concentrated.

Killian: Yeah.

Habib: So now, like I said, I'm not saying it's going to happen the same way. It could be a slow, steady deflation, you know, like, we don't know. We have to see how this happens, and we could be early in the process, right? It's not necessarily today, we're sitting at 1999.

Killian: Yeah.

Habib: We could be sitting in 1997 and we could have still a couple of big years ahead of us. We don't know that. But what we do know is when markets go from concentrated to diversified, it creates a big headwind for the index.
And if you are using the index as your measure for the stock market, it right now is highly concentrated and has a lot of company-specific risk, country risk, sector risk embedded in it. And it's not as diversified as perhaps most people think it is.

Opportunities for Active Management

Killian: Yeah, yeah, indeed, and I would probably say this is the opportunity for us as active managers to capitalize from this dislocation and looking back one more time, and I promise it for the last time today in history, and what we've done here is we looked at all the fundamental US active large cap fund managers during that time of the buildup of the dot com bubble.

And the period that follows. And you can really see that active management, and you see the rolling one-year excess returns really struggle to outperform during the build-up, because a lot of portfolio managers simply couldn't justify this eye-watering valuation that we saw before. AOL, Time Warner, Vodafone, perhaps.

But when the bubble deflated, you can really see this big recovery in excess returns and actually fairly consistent. So active managers did really well during that period. And I think this is an important reminder as well.

Habib: Yes.

Summary: Nervous but Excited

Habib: Yeah, so just to sum up, I think, look, you asked me at the start why I was nervous. Well, I'm nervous because of the concentration. And just the mechanism of how we go from a concentrated market to a more diversified market.

I'm excited at the opportunity for active management to diverge from the index and to invest in these unloved, great businesses that today are trading at very attractive valuations. And the key for us is to maintain diversification. We have to be humble, and we don't know when this is going to happen, or the trajectory with which it's going to happen, but we have to maintain diversification and maintain that discipline, that valuation discipline throughout.

Closing Remarks: Benjamin Graham Quote

Killian: I'm going to conclude with a quote from the great Benjamin Graham, who said, in the short term, the market is a voting machine, but in the long run, it's a weighing machine. And what we do see right now is that the voting machine is in full swing about opinions, faith, belief around the latest AI narrative. But over the long run, the weighing machine will answer the question, does that price that we're seeing right now actually justify the valuation? And with that, let me thank you so much, Habib, for joining us today. Thank you so much to all of you as well for joining us. And right now, I would really like to open it up for questions. So, we do use Slido, so please use the QR code that you see there on the screen, and we are very happy to answer all your questions.

So please feel free to ask anything you have on your mind.