Underweighting the Magnificent Seven Paid Off for These Funds

In recent years, the "Magnificent Seven" – Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla – have dominated the U.S. equity market, accounting for a significant portion of its returns. However, some funds that underweighted these companies managed to outperform those that held them, demonstrating the importance of diversification and risk management. This article explores the strategies employed by these funds and the factors that contributed to their success.



The Old Mutual Global Managed Alpha Equity Fund is one such fund that underweighted the Magnificent Seven. Despite being underweight to six of the seven companies, the fund produced an outperformance of 1.3% in a challenging environment. This was achieved by maintaining a broadly diversified portfolio and avoiding the "herd mentality" of increasing exposure to these technology-oriented stocks (Global Managed Alpha Equity and The Magnificent Seven, January 31, 2024).

The fund's systematic approach to factor investing played a crucial role in its success. The proprietary systematic model evaluates six broad market drivers or factor buckets: value, growth, quality, momentum, size, and volatility (risk). This approach allows the fund to tilt toward or away from these factors depending on the forecasted return drivers, resulting in an over- or underweight exposure to the underlying shares, countries, and industry sectors within tight risk parameters (Global Managed Alpha Equity and The Magnificent Seven, January 31, 2024).

Vanguard's analysis of the Russell 3000 Index over the past 24 years reveals an interesting pattern. In the early years of the study, it was more important to avoid the worst detractors, as they weighed on the market more than the top contributors helped it. However, in the latter years, it has been more beneficial to hold the top contributors than to avoid the biggest detractors (Vanguard, as of December 31, 2023).

The net impact of not holding the stock market's top contributors and detractors is a function of how large-caps perform relative to small-caps. When large-caps underperform, the gain from not holding the biggest detractors tends to exceed the loss of not holding the top contributors. Conversely, when large-caps outperform, the loss from not holding the top contributors tends to exceed the gain from not holding the biggest detractors (Vanguard, as of December 31, 2023).



The primary factors driving the underperformance of the Magnificent Seven in the given period were slowing earnings growth and large tech stocks struggling. The largest companies in the S&P 500, including the Magnificent Seven, were expected to post an 8.5% year-over-year increase in profits for 2024, but this growth was slower than expected. Additionally, the typically high-performing S&P 500 technology sector lagged the broader index in January by the widest margin since 2016, with four of the Magnificent Seven trading below their 50-day moving averages (Morgan Stanley's Global Investment Committee Weekly report from February 10, 2025).

To capitalize on these trends, funds could have increased exposure to cyclical equities like financials, energy, domestic manufacturers, and consumer services. These sectors were beginning to show the lagged effects of monetary-policy easing, with the Federal Reserve's rate cuts in the fourth quarter of 2024 starting to stimulate parts of the economy (Morgan Stanley's Global Investment Committee Weekly report from February 10, 2025). Additionally, funds could have diversified across credit and spread products, especially asset-backed securities, and real assets, select hedge fund strategies, preferred securities, and emerging market debt to mitigate the risks associated with the underperformance of the Magnificent Seven (Morgan Stanley's Global Investment Committee Weekly report from February 10, 2025).

In conclusion, underweighting the Magnificent Seven paid off for funds that maintained a broadly diversified portfolio, employed a systematic approach to factor investing, and capitalized on trends in the market. By understanding the factors driving the performance of the Magnificent Seven and the broader market, investors can make more informed decisions about when to hold or avoid these top contributors and detractors.