The New Zealand stock market has something to teach US investors about the risks and rewards of a weighty market. This is because the New Zealand market is dominated by a few large companies. In fact, it is one of the most heavily stock markets in the world.
Consider the MSCI New Zealand IMI 25/50, which its creator says is “designed to measure the performance of the large, mid-cap and small-cap sectors of the New Zealand market”. One company, Fisher & Paykel Healthcare FPH,
It represents nearly a quarter of the index. In the S&P 500 SPX,
In contrast, the weight of the largest stock — Microsoft MSFT,
– 7.3%.
And Fisher & Paykel is no mere fluke. The second largest company in the MSCI New Zealand index, Auckland International Airport AIA,
Its weight is 22%. In contrast, the index weight of the second largest stock in the S&P 500 index – Apple AAPL,
– 6.5%. The five largest companies in the New Zealand index represent more than 60% of the index, while the five largest companies in the S&P 500 index represent about 25%.
The New Zealand stock market has not always been dominated by large companies. But the distribution of its market value has been severely skewed throughout its history. A century ago, for example, the country's economy was “built on a few primary products, most notably wool, meat and dairy products,” according to the UBS Global Investment Returns Yearbook.
To estimate the impact of a skewed distribution, we only have to look at the size of the difference caused by this distribution in the United States, with its relatively equal weight. The market-cap S&P 500 index, dominated by its largest companies, generated a total return of 23.2% over the past year, according to Morningstar. This compares to a return of 6.4% for the equal-weighted version of the S&P 500.
Skewed market capitalization distributions work in both directions. Sometimes it can lead to impressive performance, as was the case in New Zealand over the long term. The country's stock market has had one of the best returns since 1900 of any market in the world, according to the UBS Yearbook, as you can see in this chart.
However, such a focus can just as easily lead to underperformance in the market, and this has been the case in recent years in New Zealand. The iShares MSCI New Zealand ETF ENZL has lagged the Vanguard Total World Stock ETF VT over the past year by 24 percentage points, and over the past five years by about 9 percentage points.
Investment Implications: Know what you are buying when you invest in a market capitalization-weighted index. You may think that you are buying portions of all the companies included in this index, when in fact you are essentially investing in a few large companies that dominate this index. This isn't necessarily a bad idea, but it's a very different investment than buying equal-sized pieces of hundreds of companies.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to audit them. He can be reached at mark@hulbertatings.com
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