Large Cap Commentary – December 2012
Academics and investors have debated for years active versus passive investing. Many claim that ‘beating the Index’ is difficult, if not impossible, especially over the long term. Running a concentrated portfolio of 30 – 35 of the best stocks, Argent Capital obviously believes there are opportunities to better a benchmark.
Implicit in the debate between passive (or Index investing) and active investing is safety and risk. Proponents of index investing point to the level of risk that active investment managers must incur in order to beat their benchmark. To be sure, in order to outperform a fund manager has to deviate from the benchmark. That difference, referred to as ‘tracking error’ equates to risk in the minds of many.
Oftentimes, lost in this debate is consideration of the constituents of the index itself. In other words, what exactly is being bought when an individual buys that safer alternative – an index fund? One aspect of index investing that is frequently overlooked is that indices are price-driven investments. In other words, stocks or sectors that rise in value on a relative basis become a larger percentage of an index over time. Letting your winners run can be a great way to invest. That adage, however, comes with some very relevant caveats. The first caveat is a winner at what price? The second caveat is how much of the winner do you want to own?
Recall the late 1990s we had the Internet Bubble. At its zenith, the technology sector represented over one third of the S&P 500 Index as a whole. At the same time the valuation of S&P500 was close to 30X forward twelve month earnings versus today’s valuation of 13X forward earnings. What that meant for an index investor in the late 90s was that he or she was buying a concentrated position in technology at a time when the valuation of the market was quite high. For Argent Capital the index during the Internet Bubble did not represent favorable odds and, as a result, we were underweight technology.
Today, we see some similarities in the case of Apple’s (AAPL) stock. AAPL represents the largest single stock at nearly 4% of the S&P 500 Index and over 7% of the Russell 1000 Growth Index, more than twice the weight of the next largest stock. According to Morningstar, a mutual fund industry information provider, 12.5% of all mutual funds count AAPL as their single largest holding. While we at Argent Capital own AAPL we are cognizant of what outside investors may do as they consider their portfolios and their exposure to AAPL. Further, for us, AAPL does not represent our largest holding.
Therein lies the power of managing an active, concentrated portfolio. We are not forced by index composition or investor perception to own any particular stock or particular weighting in an industry sector. Argent’s selective investment process guides us toward stocks and industries that represent favorable odds for our investors, and to avoid or underweight those stocks or industries that do not. We believe we have flexibility that will help us protect our clients that other investment professionals do not.
As always, we appreciate your interest in Argent Capital Management.
Senior Portfolio Manager
Views expressed herein represent the opinion of the portfolio manager as of the date above and are subject to change. Argent portfolio managers may recommend the purchase or sale of these and other securities for their client’s accounts. A list of all stocks recommended by Argent during the past year is available upon request. Past performance is no guarantee of future results.