The dilemma of the "Seven Sisters" in the US stock market: outperforming the market, but major institutions are not buying it

Since 2023, the "Mag 7" of the US stock market (including Apple, Microsoft, Google, Amazon, Nvidia, Meta, and Tesla) has been the most outstanding assets in the global market, with a cumulative increase of up to 160% from the beginning of 2023 to date, outperforming the broad market index by 130%. Furthermore, the profit growth of the Mag 7 continues, with profits expected to increase by 38% in the first quarter of 2024.

However, large US mutual funds have relatively low positions in the Mag 7. Their holdings are lower than the market value of the Mag 7 in the FTSE US Index.

HSBC pointed out that the light position of the funds is mainly due to regulatory requirements, unrelated to the fundamental factors of the Mag 7. It is expected that as more funds tend to transform and seek more relaxed regulatory conditions, the inflow of funds into the Mag 7 will continue to increase.

The Mag 7 is great, but the fund positions are not as heavy

A survey of the holdings data of 150 of the largest US funds (managing assets exceeding $19 trillion) by HSBC shows that the weight of the Mag 7 in the FTSE US Index is 28%, but they only account for 18% of these funds' investment portfolios.

The 10% allocation gap severely drags down performance: according to HSBC's calculations, since 2023, due to the light positions in the Mag 7, the net drag on fund performance has exceeded 2.3%.

However, unusually, although the holdings are relatively low compared to the market value weight of the Mag 7, the Mag 7 are already the heaviest stocks in these funds' portfolios. Whether from the total weight of the funds or the proportion of funds with exposure, except for Tesla, the other six of the Mag 7 are among the top 10 stocks held in the FTSE US Index.

At the same time, these seven companies are also the most sold-off stocks. All seven companies have made it to the top 10 list of most reduced holdings in the FTSE US Index, with Apple being the most heavily reduced.

Will more funds flow into the Mag 7 in the future?

What's going on?

HSBC believes that this structural reduction is largely due to regulatory factors and does not reflect investors' fundamental views.

According to the US "Investment Company Act of 1940," mutual funds must maintain "diversification" of positions, with the total weight of positions exceeding 5% not exceeding 25% of total assets.

For example, if a mutual fund holds stocks of Apple, Microsoft, and Nvidia from the Mag 7, each with a 5% position. However, due to rapid price increases, a few months later, the original 15% position of total assets has exceeded 25%. Once the regulatory threshold of 25% is exceeded, these funds cannot purchase stocks of Apple, Microsoft, and Nvidia.

However, an increasing number of diversified mutual funds are starting to transition to non-diversified funds. After the transition, the fund's position can be exempt from the diversification requirements of the "1940 Investment Company Act,". The transformation requires shareholder approval and may be viewed negatively by potential clients However, due to the increasing concentration in the US stock market, more and more funds are inclined to transform. For example, in 2021, T Rowe Price reclassified some of its large-cap growth funds as non-diversified funds; in 2023, Fidelity followed suit.

HSBC believes that more funds will explore this path in the future, thereby driving more funds into the "Seven Sisters".

Analysts also point out that as artificial intelligence becomes more advanced and complex, as research and investment index growth increases, and as barriers to entry increase, the moats established by the "Seven Sisters" will become entrenched and become even scarcer high-quality assets.