Are index funds too tech heavy? Are index funds blindly driving tech higher?

[joe189man]

MMM just had a post about socially responsible investing and it it he shows that the majority of the two index funds he talks about, VTI and ESGV are both heavily weighted to tech stocks - especailly the big ones like apple, microsoft, facebook, netflix, amazon, google etc. This sparked a question i have had for a while now, with the current focus on index investing and folks blindly putting money into them, will this trend artificially inflate asset prices for these and other similar companies? In effect are the biggest getting bigger (more investment) solely because they are big and a greater percentage of the index? This process feels like it is creating a bubble of sorts without considering underlying business fundamentals? On some level buying index funds feels like, in a weird analogy, buying the same groceries without price shopping or thinking about what you need.

If yes, should we be worried or is there nothing to fear?

or am i barking up the wrong tree?

[MustacheAndaHalf]

VTI holds 3,500 stocks while ESGV holds 1,500 stocks.  They do not push up the price of the largest companies, but rather buy at market weight.  Apple is 5% of the U.S. stock market (!), so 5% of VTI is Apple stock.  Also, VTI is market cap weighted, so when Apple goes up it doesn't need to do anything.

Do you have any examples of "creating a bubble of sorts without considering underlying business fundamentals"?

A "bubble" tends to mean prices inflated beyond reason.  When retail stores and malls locked down, Amazon took their customers.  That's not a bubble - that's real sales shifting to Amazon.

[joe189man]

VTI holds 3,500 stocks while ESGV holds 1,500 stocks.  They do not push up the price of the largest companies, but rather buy at market weight.  Apple is 5% of the U.S. stock market (!), so 5% of VTI is Apple stock.  Also, VTI is market cap weighted, so when Apple goes up it doesn't need to do anything.

Do you have any examples of "creating a bubble of sorts without considering underlying business fundamentals"?

A "bubble" tends to mean prices inflated beyond reason.  When retail stores and malls locked down, Amazon took their customers.  That's not a bubble - that's real sales shifting to Amazon.

no examples,

Index funds just buy stocks at what every ratios they are setup under. if they buy more tech stocks because of the weighting structure how can that not have an effect on the individual stock price overall? we have millions of people buying index funds that are buying tech stocks at much higher percentages than other companies, doesn't that increase the scarcity of the number of general shares available and increase the price of that stock?

[Abe]

That'd be true if people were preferentially buying tech companies at a higher rate relative to their current value than other stocks. By definition, broad index funds (not tech-weighted, which are a small fraction) don't prefer one over the other.

Company A is worth $1000 market capitalization, Company B is worth $500, Company C is worth $500. If you invest $10 into a fund that weights these per market capitalization, then $5 would go into Company A, $2.50 each into B and C. 5/1000 = 0.5% increase in market cap for A. That is the same % increase for B and C.

If 100% of stocks were invested this way, then yes you could have a scenario where all the money goes into company A over time. But only about 50% of the stock market total value is invested in this manner. https://www.wsj.com/articles/index-funds-are-the-new-kings-of-wall-street-11568799004 The other 50% sees A as being over-valued potentially, and is buying to B and C (or not, if B and C are doing poorly).

[MustacheAndaHalf]

Do you have any examples of "creating a bubble of sorts without considering underlying business fundamentals"?

no examples,

Index funds just buy stocks at what every ratios they are setup under. if they buy more tech stocks because of the weighting structure how can that not have an effect on the individual stock price overall?

Vanguard S&P 500 was originally setup over 40 years ago.  If as you said it only buys the "ratios they are setup under", how does it buy new stocks like Google or Facebook?

Index funds do not buy anything at a higher percentage than the market.  During Covid-19, the big tech stocks gained an average of about +50% in 12 months, leaving the rest of the market behind.  That's why tech stocks have such a large weight in the market: they have grown much faster than other stocks.

[Radagast]

As Abe demonstrates, the answer is "no." You own an equal percentage of every company on the market (which passes Vanguard's liquidity screen). There is no bias whatsoever. If you had less tech, you would own a lower percentage of the stocks of tech companies than of other companies. A capitalization weighted index fund can drive the entire market higher, but not any subcomponent relative to another subcomponent. 

[ChpBstrd]

I would think actively managed funds are driving index funds to be more tech heavy.

[hodedofome]

Tech is the only thing growing, so all the money is going there. Yes it's getting more expensive but the only alternative is to buy a business that's in decline because of the growing tech companies...

There are some non-tech companies which are still doing fine like Home Depot, Lowes, Sherwin Williams, Costco, Dollar General, Chipotle, Lululemon, Fortune Brands, etc. But a lot of companies are going obsolete or not as necessary as they used to be. There's a big rotation going on now.