The South African stock market is highly concentrated with a small number of stocks forming the bulk of the value. The 10 biggest stocks make up 60% of the market value. The biggest stock, Naspers, even after listing Prosus separately, makes up a whopping 18% of the market.
This concentration in the market can give a fund manager a competitive edge as there are fewer stocks to analyze and understand, but does raise the question of how much should you have invested in one stock? If Naspers is 18% of the market, should you own 18%?
As a stock becomes a larger portion of the market, so does its impact, as shown in the dark bars below, and if a stock is doing well, it is very tempting to potentially overexpose the portfolio as you can see the difference in returns between owning Naspers or not, as shown between the green and pink lines below.
Market concentration is not unique to the JSE, the big tech stocks FAAAMNs (Facebook, Apple, Alphabet (Google), Microsoft, Amazon and Netflix) currently make up 25% of the S&P500.
Our view is that a fund manager should never own more than 10% in one stock, as a share price shock (Steinhoff and Sasol are recent examples) can be devastating to a portfolio’s returns. While we like a portfolio manager to have high conviction in their stock picks, we will push back and question them if we feel they are overly exposed to one stock. This also further highlights the need to diversify globally as there are less than 350 local stocks but more than 40,000 investable stocks globally.