Apple and Microsoft Hit Their Natural Limits

Funds may start outpeforming again thanks to BigTech become so large a slice of the market that it runs afoul of SEC diversification rules.

Morningstar: Why Some Fund Managers Have to Bet Against Apple and Microsoft Stock

Diversified managers face a real conundrum when it comes to the index's top two stocks, especially. No matter how bullish they are on Apple and Microsoft, they have almost no wiggle room to overweight them. Instead, it leads many of them to bet against the two by owning proportionately less than the index. In fact, all 55 medalist strategies collectively underweight the two stocks. That could hamper these strategies if Apple and Microsoft continue to outperform the broader index and their managers can't find opportunities among relatively smaller companies to make up for the lost ground. This issue affects most large-growth fund owners; of the $1.8 trillion of mutual fund assets in the large-growth category, $1.4 trillion sits in officially diversified mandates.

It's a well written article that explains everything. If you don't want to read it: the SEC has some quirky diversification rules. The bottom 75 percent of a portfolio cannot hold more than 5 percent in any stock. Apple and Microsoft are 23 percent of growth. THe rest of tech adds up to 50 percent of the Russell 1000 Growth Index. This means there's 2 percent to put somewhere, and then Everything else has to be under 5 percent. Growth is highly concentrated in BigTech though, which requires a decision of which BigTech stocks to underweight. Also, Apple and Microsoft cannot keep outpeforming because assume managers are sticking as close as possible to the index. They have to sell if these two go over 25 percent of a fund such as SPDR Technology (XLK). Only in a scenario where you have some big new investors coming in gobbling up Apple and Microsoft shares (leave aside that these companies also have to take over the global economy) could the demand offset the selling pressure. Once you realize this, it's pretty clear these stocks have to underperform. Then you think to front-run the crowd and away it goes...

And then there's Facebook, solving the problem itself.