The official daily temperature is a molly-coddled version of reality.
Gauged by meteorological instruments hidden from the elements behind a ‘Stevenson Screen’, the numbers confidently quoted by TV weather-explainers everywhere often jar with lived experience.
Met services have recently taken to hedging the scientifically pure Stevenson-screened temperature with a ‘feels like’ version in deference to human sensibilities.
The ScienceABC website says the ‘feels like’ alternative “is a calculated figure that considers several different factors apart from the temperature of the surrounding air”.
“It gives people a better understanding of how they would feel if they actually went out in an area where the temperature had been recorded by some meteorological instrument.”
And investors similarly deserve a more real-world risk indicator than the traditional market capitalisation-weighted indices, according to a recent Scientific Beta paper.
The study, authored by Scientific Beta index director, Daniel Aguet, notes, for example, that the standard US S&P 500 cap-weighted (CW) benchmark has always overstated the ‘effective’ market diversification.
Based on the relative exposure to each company from 1970 to this June, Aguet estimates S&P 500 index investors held the equivalent of “an equally-weighted portfolio of just 114 of the largest stocks of the US universe” – or 22.8 per cent of the total.
“As of June 2023, the effective number of stocks of the US 500 CW plunged to 63, an extreme level only reached during the 1970s,” the Scientific Beta study says.
Since the emergence of the so-called ‘magnificent 7’ US mega-cap stocks over the last couple of years, the true diversification temperature of the cap-weighted index has slid to a 40-year low.
During the first six months of 2023 alone, the seven large companies – a group including Apple, Microsoft and newcomer, Nvidia – outperformed the broader index by almost 50 per cent while representing a quarter of the total market capitalisation.
“… the Magnificent 7 contributed to almost 70% of the performance of the US 500 CW index in 2023, while the 493 remaining stocks, which represent 75% of the market capitalisation of the index, contributed to only 30% of its performance,” the report says.
Scientific Beta, now majority owned by the Singapore stock exchange, emerged out of the 2012-established French academic investment research house, EDHEC-Risk Institute, to offer factor-based indices and associated funds.
Mike Aked, senior investment specialist for Scientific Beta in Australia, said the current concentration of US market returns in a handful of large companies might be an historical outlier but it is not unique.
“All such episodes in the past have mean-reverted,” Aked said.
Aguet found, for example, that periods of concentrated stock out-sized returns in the past have invariably been followed by net aggregate higher levels of underperformance.
“… over the long-term, the 5% largest cap [stocks] underperformed the CW by -0.6%,” the study says. “This observation should come as no surprise to investors, since the asset pricing literature has demonstrated a reward for small cap rather than large cap stocks.”
In the interim, well-diversified factor portfolios continue to lag the broader cap-weighted US equities benchmark as the big guns continue to hold sway.
But Aked said even if investors have a justification for allocating to companies that “have a low correlation to the economic cycle” such as the seven current faves, they are paying too much for the privilege.
“Being overweight these names now carries more risk,” he said, which implies investors in cap-weighted passive funds could be in for what feels like a cold shock as the market temperature reverts to the mean.