Why is Shopify in top 10?
Why is Shopify in the top 10?
TSX 60 are the most important 60 companies in Canada and Shopify [SHOP] is one of them. What we fail to understand is why SHOP after falling near 90% is not at the bottom of the weightage list among the Canadian 60 components list. Why is it in the top 10? And why does it weigh 2.6% and not near 0.26%, the weight allocated to First Service [FSV], the lowest ranked and least weighted stock among the Canada 60?
Source: Google Finance
These questions have a bearing on your investment’s ability to generate [conserve] long-term wealth. Hence you need to not only question why something goes into your portfolio but also how much of your Canada 60 portfolio is allocated to a certain stock. 80% of the money in a few stocks, makes it concentrated, non-diversified portfolio, and if this concentrated portfolio continues to overweight stocks that have fallen 90%, you should ask, Why?
Our courage to ask ‘How Much’ comes from our awareness that a 2.6% allocation will lose more value than an allocation of 0.26% if the respective component falls by 90%. And by the way, this 2.6% weight was near 7% just a few months back. You don’t have to be a genius to figure out that pension money invested in a portfolio not so overweight on a rocket that crashed would have done better. The component weight dragged your portfolio into the red for the year 2022. How something so obvious regarding weight and allocation is not featured in the ETFs, in the top XIU.TO, which manages $ 10 billion of Canadian investors’ money [some of it is definitely in their pension]? What happened?
The answer is simple. Your ETF has no way of fixing this weight, it does not make the decisions, as it is replicating an Index. In simpler words, BlackRock’s iShares can’t fix the design challenge. The methodology of the underlying Index is based on a biased algebraic equation written by Ernst Louis Étienne Laspeyres, a German in 1871. The method was adopted because of its calculation convenience. The method blindly and religiously follows Size. Bigger the Size, the bigger the weight.
This is why the more things become popular, the more the method overweights, and the more it overweighs the respective components, the harder it is for the method to rectify the imbalance. So something like SHOP, once it reaches an extreme valuation, will end up becoming 8-10% of your Canadian 60 passive portfolio. And in case something goes wrong [which generally happens], one single disproportionately values stock is enough to destroy your multi-year, patiently earned gains and get your pension back in red. Your ETF, unfortunately, is a derived instrument, saddled with all the inefficiencies that come along with a flawed Index creation methodology, which has not been questioned for nearly 75 years, since S&P 490 components benchmark became the leading Index in 1957.
Canada is a smaller market compared to the U.S. and hence stock darlings can hog the limelight, attention, popularity, Size, and hence weight, faster. A vicious cycle. This is not the first time this chaos has happened. Let us remind you of another darling stock. Valeant, in 2015 passed Royal Bank of Canada [RBC] as Canada’s largest company by market value. The TSX 60 Index took 5 years to recover after peaking in 2015. We are not suggesting any forecast here. Nobody can forecast. We are talking about how poor benchmark design has led to a generation of lost wealth for global investors and continues to hurt our pensions and portfolios.
Bug detection is a science and art form. Once you find a bug in an 1871 methodology, you have found a gold mine. In the not-so-distant future, starting 3rd January 2023, we will release our Exceptional & Rich Indexes along with their GitHub code base, so that you can understand how a new Indexing method can improve on the old method and be used to design new ETFs or Electronic Investment Funds to reduce risk and improve returns on passive long term investments.
Bibliography
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Valeant passes RBC as Canada’s largest company by market value, Bloomberg News, July 2015
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The rise and fall of Valeant Pharmaceuticals, CBC News, March 2017
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Pal, M., “The S&P 500 Myth”, SSRN, July 2022
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