As a capitalization-weighted index, the S&P 500 is dominated by the largest companies. In the S&P 500, the largest 50 stocks account for over half the index’s value. One could make the argument investing in a S&P 500 index fund is not radically different than investing blindly in the Nifty Fifty stocks half a century ago.
|Weight in Overall Index
|Top 5 stocks
|Top 10 stocks
|Top 50 stocks
Source: Morningstar Direct. SPY holdings as of 11/16/2021
The problem with such an approach is that it forms a positive feedback loop. The more successful the strategy is, the more people engage in it. The more people who engage in the strategy, the more successful it becomes. Such a strategy will work…until it doesn’t. This kind of herding sows the seeds of its own destruction.
So how did the Nifty Fifty perform when the tables turned?
The S&P 500 lost over 40% during the bear market of 1972-74; many Nifty Fifty stocks did worse. Usually, growth stocks fare poorly in bear markets when valuations matter. The Nifty Fifty with the highest price/earnings ratios fell tremendously from their peaks.
|Loss off 1972-73
Source: “The Nifty Fifty Revisited”, Jeff Fesenmaier and Gary Smith, Pomona College
Of course, there are some differences between the Nifty Fifty and the S&P 500-craze we are seeing today. It could be argued that conditions in today’s markets make the potential problem worse. There was no single, official list of the “Nifty Fifty” stocks and no index based upon the fifty. Mutual funds were much less prevalent and ETFs were non-existent. 401(k) plans didn’t exist yet.
Today a whole infrastructure exists to funnel trillions of dollars into the S&P 500 that did not exist 50 years ago. If and when this strategy reverses, the impact might be much more wide-spread and harmful.
So what is the relevance of revisiting the “Nifty Fifty” craze? Half a century later, what lessons can be learned that apply to passive investing in the S&P 500 today? As students of history, we believe there are three takeaways:
Sometimes it takes years or even decades for a complete market cycle to occur, but our strategy was designed for a long-term time horizon. Moreover, the Defined Risk Strategy was built using lessons learned from history. If you look back far enough, we believe the old saying “there is nothing new under the sun” rings true.
Marc Odo, CFA®, FRM®, CAIA®, CIPM®, CFP®, Client Portfolio Manager, is responsible for helping clients and prospects gain a detailed understanding of Swan’s Defined Risk Strategy, including how it fits into an overall investment strategy. His responsibilities also include producing most of Swan’s thought leadership content. Formerly Marc was the Director of Research for 11 years at Zephyr Associates.
Swan Global Investments is an SEC registered Investment Advisor that specializes in managing money using the proprietary Defined Risk Strategy (DRS). Please note that registration of the Advisor does not imply a certain level of skill or training. All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance that future performance will be comparable to past performance. This communication is informational only and is not a solicitation or investment advice. Further information may be obtained by contacting the company directly at 970-382-8901 or www.swanglobalinvestments.com. 346-SGI-121621.