This Stock, Unloved By The Pros, Could Keep Proving Them Wrong

If you’ve always wanted to wave a wand and see how all the highly paid US professional money managers are investing, well, abracadabra: Copley Fund Research collects and crunches data from the US mutual fund industry, and can give you a glimpse. And that could be kind of magical: knowing where those heavy-hitting investors are going big and where they’re shying away could help you decide what to do with your own portfolio...

Where are the big funds investing now?

One of the most interesting things Copley tracks is the top overweight and underweight positions from some 295 active US funds – collectively, they manage $3.2 trillion, all of them trying to beat the S&P 500.

Top overweighted and underweighted investments versus the S&P 500. Data is collected from 295 active US funds. Source: Copley Fund Research.

These are some big-name stocks that the pros are underweighting in their funds – i.e. holding position sizes that are below the S&P 500 index weight. And with the exception of Berkshire Hathaway, all these firms have had stonking years so far. No wonder, then, that 58% of professional fund managers are lagging behind their S&P 500 benchmarks this year.

I mean, just look at Apple alone: it’s the biggest firm in the S&P 500, commanding a whopping 7.7% of the index. But, according to Copley, the average weight that Apple holds in those pro funds is just 3.8%. Now, Apple has outperformed the S&P 500 by nearly 30 percentage points this year. And that has cost the average fund manager (with that nearly 4% underweight position) around 1.2 percentage points of relative performance. That mightn’t sound a lot, but in the professional investment world, it’s huge – a potential career-ender.

What’s perhaps even more puzzling is that the funds’ underweight position in Apple has actually become bigger over time.

The average professional fund manager’s relative position in Apple over time. Source: Copley Fund Research.

So what have the pros got against Apple?

My guess is: not very much. Most pro investors would concede Apple is an awesome company that makes fantastic products. They would probably also agree (because it’s a fact) that the firm has managed to sustain a high level of performance for much longer than people thought.

But there are two problems the pros do have with Apple, and the first is its sheer size. It’s not that Apple’s $3 trillion market value is likely to hold it back, it’s more that a weighting of nearly 8% of anything in a fund feels like too much risk in one company. Plus, the Securities and Exchange Commission (SEC) has actual rules on position sizes. If a fund classifies itself as “diversified”, then it’s not allowed to have more than 25% of its fund in position sizes of 5% or more. So if Apple is up to 8% of your fund, that’s going to eat up a fair chunk of that 25% budget.

The good news for you is you don’t have any clients to answer to, or SEC position size rules to follow. If you want to hold 8% of your portfolio in Apple, you can. Now, that’s not to say diversification isn’t important, but you’d still have 92% of your cash to achieve that. And if you look at it that way, 8% really isn’t that big of a deal.

The second problem the pros have with Apple is the pure strength of this rally (and the risk of looking like an idiot). Imagine you’ve watched the likes of Apple go up all year, but you’ve stuck to your guns and stayed underweight. You’ve probably crafted arguments as to why Apple’s stock might stumble. Maybe you’ve built a valuation case arguing that the stock looks expensive. Or perhaps you’ve convinced yourself that iPhone sales are about to hit the skids. Now imagine you decide the pain of losing relative performance is just too much, and you throw in the towel and buy the shares. And now imagine what would happen if Apple were to collapse. It’s a pretty common problem for institutional investors. Often, the fear of getting it wrong twice (for example, being underweight while the shares rally and then buying them up just before they drop) is so intense that it’s deemed worse than staying underweight and risking the shares rallying further.

What’s the opportunity then?

Here’s the thing. That 1.2% underperformance on average equates to a lot of pain for professional investors. They’re assessed every year on how they perform relative to that S&P 500 benchmark, and if they consistently underperform it, at best they’ll get a big fat zero at bonus time, and at worst, well, they’ll have their clients and bosses to answer to.

Now, everyone has a pain threshold, and if Apple – or the other high-flyers that fund managers are underweight in – maintains its momentum, the temptation to buy and close the underweight would get to be too much for some, if not most. That’s despite the risk of owning too much of one particular company or the fear of looking like an idiot. Sometimes, you’ve just got to stop your performance from bleeding away, no matter what. Other times, you might be instructed to buy, by your firm’s risk committee, your boss, or your clients.

And that means there’s a long line of fund managers that could potentially cave and buy these shares. Now, I’m not suggesting you go and throw all your cash into these underweighted stocks, but if you’re invested in them (and don’t care about whether you’re underweight or overweight a benchmark), you might think twice about selling them now. And if you’re nervously eyeing this year’s monster gains in Apple, Microsoft, Nvidia, and Tesla, it might help to put yourself in the shoes of those underperforming and underweight pro investors, and ask yourself what you’d do next. If the answer is you’d cave and buy in, then maybe that’s a sign for you to stick it out – for now at least.