Index heavyweights: When one company dominates

One New Zealand company now represents 20% of the NZX 50 index. For those looking to passively invest in the domestic market, this represents a significant concentration risk from a portfolio perspective. While concentration is not just a New Zealand phenomenon, having a single company influence such a big part of the overall market is certainly an anomaly. In these instances, investors need to balance performance benchmarking with sensible portfolio construction.

Indices are a proxy

In New Zealand, when we hear about the performance of our market, it is the NZX 50 index which is being referenced. For each market around the world, there tends to be a key index which is used as a proxy for market performance. In the US this is the S&P 500, in Australia it’s the ASX 200, and in the UK it’s the FTSE 100. While all have nuances in terms of their calculations, an index is essentially a statistical measure that tracks the performance of a defined group of companies. Market indices are often used for performance benchmarking but also dictate how passive investors funds are deployed.

Market concentration

Market concentration is becoming a concern in a number of markets, particularly where large technology companies have become a major part of a market index. While the New Zealand market doesn’t have many AI-exposed companies where concentration has been prevalent, we have still evolved into a highly concentrated market.

While our sector concentration is not as high as other markets, we think investors should be aware of what sits underneath the surface of the NZX 50 index.

How is the NZX 50 defined?

The NZX 50 is our primary benchmark. It measures the performance of the 50 largest and most liquid companies listed on the NZX, weighted by their free-float market capitalisation.

The NZX 50 is unique for a number of reasons, not least of which is that it is a gross index, meaning that its return calculations include the benefit of dividends, not just share price growth. Our index is also free-float adjusted, while this is less unique, it does mean that many of our largest companies have an index weighting which is not truly reflective of their size. For example, Meridian (MEL), Mercury (MCY), and Genesis (GNE) are all majority owned by the Crown and therefore have a free-float of less than 50%. Without this Crown ownership, their weighting would increase significantly.

There are a number of other listed companies which have the same free-float adjustment, although these others (such as Air New Zealand, Vector and Port of Tauranga) are not as significant given their smaller index weightings to begin with.

Our market in a nutshell

Despite there being 50 companies which make up the overall index, only a few names dictate the overall performance of the NZX 50 index. This is because our index is being dominated by a few large companies, in particular Fisher & Paykel Healthcare (FPH) which now makes up almost 20% of the market.

Figure 1 below shows our largest index constituents, with our largest dozen companies accounting for ~75% of the overall index. Thought of in another way, the remaining 38 companies make up just 25% of the market.

Index performance implications

Having a company which makes up so much of our market weighting means that the performance of the benchmark becomes less about the broader constituents, and more about the daily moves of the biggest names.

As Figure 2 shows, the majority of the index performance for the third quarter has been driven by FPH, dwarfing the index-weighted movements of remaining 49 companies in the index. A more subtle observation beyond the obvious FPH move is that of Auckland Airport (AIA). Over the quarter to date, AIA is the 17th best performing stock in the index (based on pure share price performance), but it has the
second largest positive impact on the performance of the NZX 50 index over this period, simply because it has a large index weighting.

Of the dozen biggest share price rises over the past quarter, only two are featured in Figure 2, given the rest all have very small weightings in the index. Another way to think about it is that if most companies in our market have a strong day, month or year, our index could still record a negative performance if powerhouses like FPH, AIA and Infratil (IFT) experience share price declines.

Passive… aggressive

The beauty of the equity market is that it isn’t static. There is a very famous Benjamin Graham quote which goes “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”

Share prices in the short-term can move based on investor opinions, news flow, or technical factors. However, in the long term, prices eventually adjust to reflect a company’s true value as investors weigh up fundamentals and base decisions on evidence rather than near term speculation.

While we are not suggesting that some of our largest companies are unfairly valued, it’s worth reminding ourselves that markets, businesses, competition, and risks can all shift, leading to a change in market leadership. Adding a layer of pragmatic portfolio construction should go some way to helping mitigate risks.

While Fisher & Paykel Healthcare is a fantastic business, and one we invest in, should an investor be allocating 20 cents of every dollar invested in New Zealand to just one company? We think not. Just because the index says so, it doesn’t mean you should.

Index concentration can also be exacerbated by the prevalence of index/passive funds. At the risk of upsetting the passive investing disciples, it’s worth noting that many passively invested funds do not consider concentration risk, they simply invest mechanically, based on index weighting. This flow of passive money can become a self-fulfilling prophecy, especially in relatively illiquid markets. The largest constituents attract the largest portion of each dollar invested, increasing demand for their stock and leading to further share price rises. These share price rises then drive a higher weighting when it comes to index calculations, continuing the cycle.

Change is the only constant

Below we use two examples to show that index leadership can change over time (Figure 3), and in some instances, can change in the blink of an eye (Figure 4). Overall, index weightings are a useful proxy for our listed companies, but don’t reflect a pecking order of the best to worst investment propositions, therefore your investment into our market should not be apportioned religiously in line with these weightings.

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