The stars perfectly aligned in 2016 as investors descended on Omaha in late April to hear from the “Oracle of Omaha” just as Apple’s (AAPL) disastrous earnings release crossed the wires and sent the stock plummeting roughly 11% in one week, wiping out more than $60 billion in market capitalization.
Despite Warren Buffet’s track record, most money managers disagree with his aversion to technology stocks, his penchant for hoarding cash or his pithy quotes. But as the debacle surrounding Apple’s Q1 earnings release makes clear, the true genius of Buffet’s folksy sounding wisdom is his ability to capture timeless truths, and it is why we think ETF investors need to ponder this old gem: “Only when the tide goes out do you discover who’s been swimming naked.”
Educating investors is a big part of what we do at our firm and is why last month we talked to you about how investors continue to be disappointed by commodity funds — because they fail to grasp how their basic structure works against their ability to replicate the underlying asset’s performance. Would you be surprised to know that holders of multi-billion-dollar technology funds have the same problem?
When historians talk about this bull market, they’ll likely call it the “Apple Decade,” as that innovative little computer company once left for dead exploded higher to join the S&P 500’s elite group of stocks that at one time or another made up more than 4% of the index. From Jan. 1, 2003 through the end of last April, Apple was up a staggering 9,787% compared to a mere 178% for the S&P 500. Only a handful of companies have ever been large enough to make up 4% of the market and their subsequent performance tends to be fairly depressing, but that didn’t matter to analysts in the anemic post-Lehman world where so much of the S&P’s earnings came from Apple that they took to quoting them “ex Apple.” The big problem for today’s investors is that tremendous performance coincided with the widespread adoption of the ETF, which could hurt their returns for years to come.
Most ETFs employ the same market capitalization-weighted systems, which have been the mainstay of equity indexes for decades, but when used with a more limited universe of stocks (at least compared to a broader market like the S&P 500) a long-term outperformer can very easily grow to drastically outweigh the rest of the portfolio. At its peak in Q1 2015, Apple had a market cap of more than $760 billion (about 2× that of Berkshire Hathaway) and made up 4% of the broader S&P 500. Apple made up an even larger portion of the leading technology funds. During its great-run up from 2009 to 2014, the company outperformed the other top holdings for most tech funds, Microsoft and Google, by double-digits nearly every year. At the stock’s apex in 2015, the Technology Sector Select Fund (XLK) had an allocation of close to 18% in Apple while the iShares Technology Sector Fund (IYW) position was more than 20%.
Now that the tide of positive investor sentiment is receding it could take years for Apple to bottom after such a powerful move (see “Apple’s sauce”). Why that should matter to investors is because unless another large holding in these funds can start to deliver explosive upside potential (unlikely at this late stage in the second longest bull market ever) to counteract Apple’s drag on the portfolio, tech funds could lag the market for years to come.