To Our Investors and Friends,
The S&P 500 Index (S&P 500) expanded by 3.1% in July as the chances of a soft landing of the economy improved, and the market advance was much broader than during the first half of the year. Oil jumped 16% to $82 a barrel as concerns of a recession diminished. The 10-year Treasury bond increased 16 basis points in the month, ending at 3.97%, while the 2-Year Treasury was up 1 basis point, finishing 89 basis points above the 10-year. For the first time this year, the market widened and small companies performed better than large companies. The Russell 2000 Value Index increased 7.6% and the Russell 2000 Growth Index appreciated 4.7%. Larger companies lagged slightly as the Russell 1000 Value Index moved up 3.5% and the Russell 1000 Growth Index appreciated 3.4%.
The significant volatility in individual stocks and the entire market is partially the result of a major reallocation of equity exposure from actively managed funds to passive funds since the end of the financial crisis in 2009. By 2022, assets in passive investment vehicles exceeded assets in actively managed investment vehicles for the first time. Market pundits believed that investors lost faith in active management and moved to passive to get market exposure at low fees. Be careful what you wish for. To avoid one problem, investors have most likely created an even bigger one. It is a myth that the S&P 500 ETFs and all those ETFs like it are passively managed. They are in fact lower turnover, more diversified strategies that are regularly adjusted, i.e., actively managed.
As shown in the table above, there are some very surprising characteristics of these ETFs that most investors likely do not appreciate. In the large cap ETFs, a large percentage of total assets is highly concentrated in just a handful of stocks. If this concentration is not by design, it is a recipe for disaster. Turnover in large cap strategies is so low that poor-performing positions can hurt returns considerably, especially in a market that begins to favor smaller market cap companies (as we saw this month).
The smaller cap strategies don’t have a concentration issue but do have a turnover issue. A high turnover means that index changes are more likely tied to market sentiment than actual appreciation of individual names. We believe many active managers are so influenced by this turnover that they have been relegated to chasing the index instead of investing in businesses.
We don’t think that the index approach is the right approach in a rapidly changing economy. We believe investors will regret their moves into these low turnover, highly diversified strategies as the average company fails to keep up with the digital age. At Kingsland Investments, we are actively managing concentrated strategies focused on capital appreciation. We spend our time seeking out the best businesses the market has to offer, and then owning them as they grow into much bigger companies. We will hold the stocks in these companies for many years if they continue to offer great appreciation potential. This allows us to enjoy the benefits of compounding, which has the potential to result in significant gains over time.
All the best to you,
Arthur K. Weise, CFA
The views expressed are those of Kingsland Investments as of August 1, 2023, and are not intended as investment advice or recommendation. For informational purposes only. Investments are subject to market risk, including the loss of principal. Past performance does not guarantee future results. The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse. Past events and trends do not imply, predict or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index.