Lost in the coverage is another, equally important, effect of Apple’s explosive performance: The way it forces money managers to play catch-up — and what this means for the stock itself.
The Risk of Not Owning Apple: Unemployment
Apple is the one stock that growth-oriented portfolio managers can’t afford not to own. Most managers are judged based not on absolute performance, but on their performance relative to their benchmark. They can lose 12% in a quarter, but that’s considered a success if the benchmark falls by 15%. And Apple, because of its large weighting in some key benchmarks, is one of the most important factors in relative performance.
Take the Russell 1000 Growth Index, where Apple has a weighting of about 8%. If the stock rises 20% in a given year, that adds about 1.6% to the benchmark’s return. If a fund manager who is benchmarked to the Russell 1000 Growth chooses to hold a zero weighting in Apple, that 1.6% shortfall is extremely difficult to overcome — especially when fees are added into the equation.
This is an essential consideration for portfolio managers right now. While a manager is unlikely to be criticized in a board meeting for holding a market weighting in Apple if the stock goes down, rest assured they will have to answer for the decision of holding an underweighting in Apple if it performs well.
The Impact of Apple-Related Career Risk
The danger of not holding Apple has led to two important outcomes — one of which is important for fund investors, the other for the stock itself.
First, managers are compelled to hold a position in Apple whether they like the company or not. Even those who aren’t particularly enthusiastic on the stock still might hold a 5%-6% position — meaning that they choose to express their negative view not through a zero weighting, but through an underweighting.
While most active managers won’t admit it, this approach is part of a broader, longstanding trend. A sizable percentage of many actively managed funds often is dedicated to stocks that the manager doesn’t necessarily want to own, but that he or she has to hold to mitigate the risk of underperformance. Much was made of “closet benchmarking” in the late 1990s, but the practice is as prevalent as ever.
This is reflected in Apple’s ownership base. According to a Boston Globe article published in May, a full 84% of large-cap growth funds held a position in Apple, while only 20% of large-cap value funds owned a stake. As the author noted, “For most (large-cap growth managers), it’s a matter of how much Apple to own, not whether to own it or not.”
Indeed, a look through U.S. News & World Report’s list of top-ranked growth funds shows a common thread: All have Apple as a top holding, and for the vast majority, it’s the largest single position. This is no coincidence — whether or not a fund holds Apple is one of the most important factors that has made or broken performance results in recent years. According to a study conducted by the Associated Press in May, the 10 biggest large-cap growth funds that didn’t own Apple had an average year-to-date ranking in the bottom 79% of the peer group.
One conclusion: If you’re analyzing a large-cap growth fund, it’s essential to look past recent performance since so much of its one- and three-year return figures might be derived from its weighting in Apple.
What It Means for Apple
All of this leads to the question of whether Apple is “overowned.” Such claims have been rare thus far because Apple has delivered the goods in terms of both its business execution and its stock price performance. Still, its near-universal presence in growth funds is indicative of a very crowded trade.
In the short term, the stock could find continued support from lagging managers who capitulate and bring Apple up to a market weighting. Also, Apple’s initiation of a dividend might result in its presence in value funds rising from the current low level.
Still, those who own Apple need to be aware that a sizable percentage of the stock’s shareholder base is made up of managers who own it for reasons other than its fundamentals. This won’t be an issue as long as the company can keep the growth engine rolling … but a hint of bad news could have a disproportionate impact on Apple’s share price.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.