Catherine Yoshimoto
- The Technology industry has surged in 2023, led by the dominant tech giants known as the "Magnificent Seven," increasing concentration risks for cap weighted indexes.
- Regulated Investment Companies (RICs) are subject to security concentration limits, making capped indexes a potential solution to ensure diversification.
- FTSE Russell has launched capped indexes to address concentration risks, offering alternative solutions for RICs and trimming the weights of the tech giants in industry indexes.
After an abysmal 2022, the Technology industry has staged a remarkable comeback in 2023. The tech giants that have become known as “the Magnificent Seven” have led the rally, considerably outpaced other US large cap companies and propelled their already mega market caps to new heights.
However, for cap weighted indexes, outsized market cap growth can lead to higher security concentration. And for Regulated Investment Companies (RICs), the Magnificent Seven rally puts some cap weighted indexes at risk of exceeding concentration limits—underscoring the need for capped indexes.
2023 has been a year of tailwinds for tech giants
A hawkish Fed interest rate policy took its toll on large US tech companies in 2022, sending the Russell 1000 Technology industry plummeting -34.6%. But a perceived less aggressive Fed stance in 2023—combined with the prospect of growth in AI—has been a reversal of fortune for US tech giants, and the industry has surged 53.5% year-to-date as of July 17, 2023.
While these trends have been a boon to many US companies, the biggest gains have been concentrated among the largest mega caps: Apple, Tesla, Nvidia, Microsoft, Alphabet, Meta, and Amazon. Known as the Magnificent Seven, in 2023 these companies have expanded their dominance in cap weighted US equity indexes, which can be problematic for investment companies with concentration limits.
The rally has pushed some limits
Several types of common investment companies and funds are subject to security concentration limits, designed to ensure diversification. For example, Regulated Investment Company (RIC) capping rules require that all companies that have a weight greater than 5% in aggregate are no more than 50% of the index, and that no individual company in the index has a weight greater than 25% of the index.[1]
If we examine some of our cap weighted Russell US Indexes, we can observe how the recent Magnificent Seven gains have impacted their index weights—and how as a result, some are approaching the RIC concentration limits. As shown, the aggregate weights of constituents with a weight greater than 5% in the Russell Top 50 index, Russell Top 200 Growth Index, and Russell 1000 Growth Index are all nearing the 50% RIC concentration limit.
Aggregate weights in cap weighted indexes of constituents >5%
Source: FTSE Russell as of July 12, 2023. Past performance is no guarantee to future results. Please see the end for important disclosures.
Capped indexes for addressing concentration risk
In accordance with the FTSE Russell Policy for Benchmark Methodology Changes, we’ve consulted with clients and external committees on the treatment of larger constituent weights in the index, and general feedback has been that market cap weighted indexes such as our Russell US Indexes should reflect the market, so should remain uncapped. However, market trends such as the 2023 Magnificent Seven rally shed light on the needs of clients who require capping methodologies applied to the indexes. To address these needs, we’ve launched various capped indexes based on the standard market cap weighted indexes.
For example, as the Russell 1000 Growth and Russell Top 200 Growth indexes approach concentration limits, the Russell 1000 Growth 40 Act Daily Capped Index and Russell Top 200 Growth 40 Act Daily Capped Index can be alternative index solutions for RICs. We created these indexes in consideration of the definition of a “diversified company” per the Investment Company Act of 1940, applying a methodology that ensures all companies that have a weight greater than 4.5% in aggregate are no more than 22.5% of the index.
Capping can be a humbling experience for the Magnificent Seven
A closer look at our Russell 1000 ICB Industry Capped Indexes offers a magnified view of the impact of capping the Magnificent Seven. As shown, our capping methodology trimmed the weights of each of the tech giants considerably in their respective industry indexes.
Magnificent Seven: Capped vs. Uncapped
| Constituent | ICB Industry | % Weight in Russell 1000 ICB Industry Index | % Weight in Russell 1000 ICB Industry Capped Index | Difference |
|---|---|---|---|---|
| Apple Inc | Technology | 22.43% | 18.77% | -3.67% |
| Microsoft Corp | Technology | 19.88% | 16.71% | -3.17% |
| Alphabet Class A and Class C | Technology | 10.48% | 9.21% | -1.27% |
| Nvidia | Technology | 8.26% | 4.54% | -3.72% |
| Meta Platforms Inc | Technology | 5.42% | 3.97% | -1.45% |
| Amazon.com | Consumer Discretionary | 19.11% | 13.34% | -5.77% |
| Tesla | Consumer Discretionary | 12.17% | 9.17% | -3.00% |
Source: FTSE Russell as of July 12, 2023. Past performance IS no guarantee to future results. Please see the end for important disclosures.
In essence, while our cap weighted indexes are an accurate reflection of the current market, markets can move in uneven ways, spurring demand for capped indexes. Please see our capped index methodology for more information.
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