Apple’s Fall Underscores Misunderstood Risks in Mutual Funds

Most investors assume (because that’s what mutual fund companies tell them) that mutual funds are relatively safe investment vehicles, because they are well-diversified – they own a bunch of different investments, so the risk is spread over these many investments and no single investment accounts for a large percentage of the total fund value.   A little-known fact is that very few mutual funds distribute their investment capital evenly over the various investments.  Instead, they tend to focus the majority of their money in their top 10 holdings.  They do this because they believe these top 10 positions to be the best opportunities, and they feel incredible pressure to outperform their benchmark index and their competition.  The result, however, is that the risk in these mutual funds is much higher than one would expect.

The recent collapse of Apple, which lost $40 billion+ in market value yesterday, underscores this problem.  just 27 mutual funds account for about 13% of the total outstanding shares of Apple, according to Factset data.  The largest single holding of Apple stock is with Fidelity Contrafund, FCNTX , at 12.1 million shares, making up 7.17% of its portfolio, according to Factset.  Apple’s stock accounts for 3.6% of the S&P 500, 10% of the Nasdaq Composite and 15% of the Nasdaq 100, giving it an outsized effect on these broader market indexes and the index funds tied to them.

If the typical mutual fund owns 200 or more positions, then one would expect that they should have, on average, about 0.5% of the funds total value in each position.  Here’s a look at funds with at least 15% of their portfolios concentrated in Apple stock based on data compiled from Factset:

Holder Name Ticker % Port
Russell US Dynamic Equity Fund RSGAX  23.77
Putnam Global Technology Fund PGTAX  21.13
Fidelity Select Computers Portfolio FDCPX  19.75
iShares Dow Jones US Technology Sector Index Fund IYW  19.74
JNL/Mellon Capital Technology Sector Series 19.33
ProFunds Variable Prod-Technology Fund 18.86
Fidelity VIP-Technology Portfolio 17.2
Fidelity Information Technology Central Investment Portfolio 16.95
Fidelity Advisor Technology Fund FADTX  16.66
Upright Growth Fund UPUPX  16.66
Fidelity Select Technology Portfolio FSPTX  16.6
NASDAQ Premium Income & Growth Fund QQQX  16.57
SPDR Series-Technology Select Sector SPDR Fund XX:IXT  16.53
Vanguard Information Technology Index Fund VGT  16.13
Huntington Variable Rotating Markets Fund 15.4
ICON Information Technology Fund ICTEX  15.31
DWS Technology Fund KTCAX  15.28
PowerShares QQQ Trust QQQ  15.22
USAA Nasdaq 100 Index Fund USNQX  15.06

I don’t have to tell you the negative impact that Apple has had on the value and performance of these funds this week.  Those investors that own these funds will get a shock when they receive their January statements.  The moral to the story is that mutual funds can be a lot more risky than they seem.  Further, risk should be understood as the chance of losing money, and not simply volatility (we like upside risk).  When funds hold 15% or more in any stock, even one that is supposed to be as good as Apple, bad things can and do happen (we saw this in vivid relief this week with Apple).  Investors should look at the top holdings of any mutual fund they are considering to understand the concentrations that fund has in any individual stocks, and should understand the added risk that these concentrations add to the fund, before buying.

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