- Morgan Stanley CIO Mike Wilson says to consider rebalancing your portfolio.
- Concentration risks are growing as top stocks drive the market’s performance.
- Investing in sector ETFs or other indexes are a couple ways to rebalance, Wilson said.
If your stock exposure mainly consists of an S&P 500 index fund — as experts like Warren Buffett recommend for retail investors — it might be tempting to leave your portfolio how it is. The market is coming off back-to-back years with gains of more than 23%, after all.
But the outsized returns, driven largely by several mega-cap stocks, mean it’s probably a good time to reassess and rebalance your holdings, according to Morgan Stanley CIO Mike Wilson.
“A lot of people just let it run,” Wilson told BI in a December 23 interview. “And you get way out of bounds, you get way concentrated on certain things, and that’s how you get in trouble.”
At 32.5%, the technology sector has by far the largest weighting in the S&P 500 right now. And just the six largest companies in the index by market cap make up around 30% of it, according to S&P Global data.
But over-concentration in a portfolio can happen when any winning investments see big returns, not just when a certain sector fuels the S&P 500.
If your portfolio is more concentrated than you want it to be, meaning it's more vulnerable to the whims of its biggest holdings, there are multiple ways to rebalance, Wilson said.
One might be constructing a portfolio with sector ETFs, weighting each according to their size in the S&P 500 and adjusting the positions as conditions evolve. When you're bullish on the utilities sector in particular, for example, you can overweight it. When you're bearish on consumer staples, you can underweight it.
The strategy is "essentially, I'm going to own the S&P 500, but I'm going to own it my way," Wilson said.
"Take a view on, 'Well this part of the index looks undervalued, this part of the index looks overvalued, or the trends that have been driving this performance are about to change,'" he continued.
For Wilson's part, he likes the energy and materials sectors.
Having a financial advisor or an investor who watches the market closely may be ideal for this strategy, Wilson said.
Another rebalancing strategy could be simply adding other index funds to current holdings instead of trimming them, according to Wilson.
"You need to bring in new passive indices potentially that have underperformed," Wilson said.
For example, there's the S&P 500 equal-weighted index as opposed to the standard market-cap-weighted index. Each constituent in the S&P 500 equal-weighted index has the same size and impact on overall performance, as opposed to the cap-weighted index being dominated by, say, five or 10 companies.
The equal-weighted index is historically cheap relative to the cap-weighted index, but it has also underperformed over the last couple of years.
Other index funds that track various parts of the market include the Russell 2000 for small-caps and the Vanguard Total Stock Market Index Fund, which holds more than 3,600 US stocks.
In addition to concentration risk within the S&P 500, Wilson sees the broader index delivering poor annualized returns over the next decade. He said he expects returns to be "flat-ish" during that period due to how high valuation levels are — namely, the Shiller CAPE ratio and the S&P 500's forward 12-month PE ratio.
"That is a very common view, that given where valuations are today, over the next 10 years, the returns from point A to point B will be basically flat-ish, and on a real basis, maybe negative," Wilson said. "There will be plenty of opportunities to make money over that time in sectors and stocks even if the index is flat."