US Large Cap Core Funds: Historical Weights at Various Levels of Valuations

  • The chart below shows the average weights at different levels of valuation of a typical index fund made up of large cap companies from 1989 – today
  • The bar on the left shows that, over history, investors in a large cap core equity fund had 57% of their money invested in stocks valued at below 2x price to sales, on average
  • The second bar from the left shows that, over history, investors in large cap core equity funds had 23% of their money invested in stocks valued between 2x – 4x price to sales, on average
  • Looking at the next three bars, you can see that, historically, investors had very limited exposure to stocks valued at 4x – 6x price to sales (8%) with even less at 6x – 8x (4%) and even less at 8x – 10x (2%)
  • At the far right, you can see that, historically, investors had very limited exposure to stocks valued over 10x price to sales (4%)

To summarize, historically, investors in large cap core index funds had the bulk of their money invested in stocks with reasonable valuations with negligible exposure to stocks valued over 10x price to sales.

R1000 Core Historical Weight at Various Levels of Price to Sales As the next slide shows, that is no longer true today.

US Large Cap Core Equity Funds: Historical vs. Today at Various Levels of Valuations

  • The navy blue bars show the same weights as in the chart above – the average exposure of a large cap core index fund investor to stocks at various levels of price to sales
  • The light blue bars show the average exposure of large cap core index fund investors to stocks at various levels of price to sales today
  • The contrast should evoke caution for those using index fund investment strategies with large cap core exposure to make sure they are consistent with your investment objectives, risks, and other goals

Large cap core mutual funds now have high levels of exposure to stocks so expensive they are usually the province of growth funds.  Growth index funds emphasize more volatile and risky stocks in the name of “capital growth.”

R1000 Core at Various Levels of Price to Sales Historical Average vs Today

Large Cap Core: Today vs Dot.Com

  • Index fund investors’ exposure to stocks at excessive valuations with historically poor payoff structures is not without precedent – unfortunately, the precedent is not a good one
  • The red bars show the levels of exposure during the dot.com bubble in 2000 before the most expensive and vaunted growth stocks fell precipitously and inflicted terrible damage on investors
  • The light blue bars show large cap core index funds’ exposure today (identical to the chart above)

The similarities between the core indexes’ exposure to overpriced firms today and in December of 1999 is disconcerting.  The recent sell-off in equities has caught many investors off guard.  What should be more surprising is that after the recent declines, investors in traditional large cap index funds are carrying valuation exposure almost identical to levels in 1999 that were the precursor to a -44.44% return.[1]

R1000 Core Weight at Various Levels of Price to Sales Dot Com Bubble vs Today

KCR would be remiss if we did not remind investors of their exposure to the bars on the far right.  Despite the sharp sell-off in some of the market’s most expensive stocks, large cap core index fund investors still have 16% of their money exposed to stocks valued at over 10x price to sales.

As our quick note on Scott McNealy’s legendary quote explained, this is a valuation bucket that defies common sense.  We have all read about the soaring popularity of index funds, and the portfolio managers here at KCR actually sub-advise an all-cap index fund. We believe that beta with minimal charges and expenses serves as a valuable tool for investors.

At the same time, however, as our piece Asset Allocation in Bear Markets explained, the need to monitor value and growth factor exposure was and continues to be significant.  This piece adds to our note Tesla Price to Sales Ratio & the Coming Tax on Index Funds by highlighting that even core indexes look like growth funds today.

We continue to believe that the recent demise of celebrity portfolio managers of now-notorious active funds has added fuel to the belief that index funds are the only solution.  Please read our brief and simple piece on the Vanguard Small Cap Index Fund to see how even an incredibly simple rule, based on overwhelming empirical evidence (and common sense), can help improve investor outcomes.

The asset management industry is full of superb active managers who have long histories of providing returns above market levels with low costs, low turnover, and excellent tax efficiency.

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra for anyone seeking out more information related to the topics above.

 

[1] 12/31/1999 – 10/09/2002, Russell 1000 Core Index

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seek independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction.

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