Index funds have been all the rage in recent years, with their low fees and easy format appealing to many investors. But mutual fund manager David Winters says they have gotten too popular — and are creating a bubble similar to the “Nifty 50”.
Winters recently told WealthTrack that the inherent flaw in many index funds is that they are weighted by market capitalization, meaning that they tend to hold a disproportionate amount of the stocks that have performed best. As people keep buying and buying index funds, it thus creates a cycle in which the top-performing stocks keep going up and up. Last year, for example, Winters says that Apple, Microsoft, Facebook, and Intel accounted for 20% of the S&P 500’s gain. That creates a situation in which many of the biggest, top-performing stocks become greatly overvalued, he says, and strong value stocks get ignored. At some point, he thinks the top-performer bubble will burst, wreaking havoc on index fund investors’ portfolios.
Winters says all of this has created a lot of opportunities in unsexy value stocks, and he talks about some that he is high on right now. He also is high on non-US plays, and says many investors have been too focused on American stocks. Winters adds that he doesn’t think investors need to avoid index funds altogether. But he thinks that going all in on index funds is a dangerous game.