Navigating market concentration wisely

Investors have a habit of nicknaming groups of stocks that define a market era, whether it’s FAANG, the Nifty 50, or the Four Horsemen of the late 1990s. Today, of course, we have the Magnificent 7: Nvidia, Meta Platforms, Amazon, Microsoft, Alphabet, Apple, and Tesla. 

These are the leaders in their respective industries, which include semiconductors, digital commerce, software, and electric vehicles. Their profit acceleration in recent years has attracted growth investors, resulting in this handful of stocks playing an outsized role in leading U.S. equity benchmarks like the Nasdaq-100® Index, which Invesco QQQ ETF (QQQ) tracks.

That’s why investors may hear a lot about concentration risk in the market. The fear is that well-known indices like the Nasdaq-100 and S&P 500® Index may be top-heavy and lack diversification.

Although it certainly makes sense to be aware of risk, successful long-term investing requires avoiding the distractions caused by negative headlines. Examining cold, hard data can sometimes help dispel biases and potentially misleading narratives.

Over the past decade, the profit share of the five largest companies has jumped to 30.7% from 18.9% in terms of the percentage of the 100 highest-earning U.S. companies, according to Morningstar.¹ Therefore, it could be argued the market is doing what it’s supposed to do: assigning greater value to the most profitable companies.

Also, there have been periods in history when profits were even more concentrated in the biggest winners. For example, there were stretches in the 1960s and 1970s when the five largest companies had even larger profit share percentages than they currently have today.¹

QQQ’s resilience over the years

It’s also important to remember that the Magnificent 7 doesn’t have a monopoly on innovation. The Nasdaq-100, which QQQ tracks, contains dozens of other leading companies from other dynamic industries.

In fact, QQQ’s exposure to innovation has made it tough to beat over the last 25 years. Since its March 1999 inception, QQQ has delivered an annualized return of 9.9%, outperforming the 8.0% annualized return of the Russell 3000® Index, a benchmark considered representative of the U.S. stock market.²

Standardized performance – Fund performance shown at NAV. Performance data quoted represents past performance, which is not a guarantee of future results; current performance may be higher or lower than performance quoted. Investment returns, and principal value will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. An investor cannot invest directly in an index. Index returns do not represent Fund returns. Invesco QQQ's total expense ratio is 0.20%.

This historical performance can be attributed to QQQ’s exposure to growth-oriented companies within the Nasdaq-100. While the current narrative centers on the dominance of the Magnificent 7, it's essential to recognize that these companies have earned their positions through sustained innovation, technological advancements, and significant contributions to the economy.

For example, consider Microsoft and Apple, two of the largest holdings in QQQ. Both companies have continually reinvented themselves, expanding their product lines and services to maintain relevance and drive growth. Similarly, Alphabet, Google’s parent company, has diversified its revenue streams beyond advertising, venturing into areas like cloud computing, artificial intelligence, and hardware.

Innovation as a long-term strategy

Although QQQ can be miscategorized as a technology fund, the ETF provides exposure to companies that are leaders in other sectors like healthcare, consumer discretionary, and industrials. The emphasis on innovation is not a passing trend but a fundamental strategy that has helped to deliver strong performance.

Companies that prioritize innovation and R&D spending often lead the way in technological breakthroughs and game-changing services. This is because they can adapt to changing market conditions, introduce new products and services, and capture emerging opportunities. QQQ provides access to a portfolio of such forward-thinking companies.

Key takeaways

• In the world of investing, simple narratives and catchy nicknames often capture attention, but they can also lead to oversimplifications.
• While concerns about concentration risk in QQQ shouldn’t be ignored, they should also be viewed in the context of history and fundamental drivers like profits.
• The Magnificent 7 may be prominent today, but QQQ's exposure to innovative companies has been a consistent theme throughout its history, and it continues to provide access to the next wave of market-leading advancements.