The New Zealand stock market has something to teach U.S. investors about the risks and rewards of a top-heavy market. That’s because New Zealand’s market is dominated by a handful of large companies. In fact, it is one of the top stock markets in the world.
think MSCI New Zealand IMI 25/50 IndexThe tool’s creators say it is “designed to measure the performance of the large-cap, mid-cap and small-cap segments of the New Zealand market.” 1 company, Fisher & Paykel Healthcare FPH;
It accounts for almost a quarter of the index. In the S&P 500 SPX,
In contrast, the largest stock weight — Microsoft MSFT,
— is 7.3%.
And Fisher & Paykel is no fluke. Auckland International Airport AIA, his second largest company in the MSCI New Zealand Index;
Weight is 22%. In contrast, the index weight of the second-largest S&P 500 stock — Apple AAPL;
— is 6.5%. The top five companies in the New Zealand index account for more than 60% of the index, and the top five companies in the S&P 500 account for about 25%.
New Zealand’s stock market has not always been dominated by large corporations. However, the distribution of its market capitalization has been highly skewed throughout its history. For example, a century ago, the country’s economy “was built on several primary products, particularly wool, meat, and dairy products,” according to UBS’s World Investment Returns Yearbook.
To understand the impact of a skewed distribution, consider how much of a difference a skewed distribution would have made in the relatively evenly weighted United States. According to Morningstar, the market-cap weighted S&P 500 index, dominated by the largest companies, has returned 23.2% in total over the past year. By comparison, the equally weighted version of the S&P 500 has a return of 6.4%.
The skew in the market capitalization distribution works in both directions. Sometimes they can lead to impressive performances, as in the long-term case of New Zealand. According to the UBS Yearbook, the country’s stock market has had the best returns in the world since 1900, as seen in this graph.
However, such concentration tends to lead to lagging market performance, and this has been the case in New Zealand in recent years. The iShares MSCI New Zealand Exchange Traded Fund ENZL has lagged the Vanguard Total World Stock ETF VT by 24 percentage points over the past year and about 9 percentage points over the past five years.
Investment Implications: When investing in a market-cap weighted index, know what you’re buying. You might think you’re buying a piece of every company in an index, when you’re essentially investing in a few large companies that dominate that index. That’s not necessarily a bad idea, but it’s a completely different investment than buying the same size pieces of hundreds of companies.
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. Contact him at mark@hulbertrateds.com.
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