In a year of extreme climate challenges, Canada experienced one of its worst wildfire seasons, with more than 5.3 million hectares scorched. This followed an even more intense 2023 season, which saw 15 million hectares burned. As devastating as these fires were, the damage was noticeably mitigated in areas where controlled burns had cleared out dry brush.
Controlled burns – intentional fires set to remove flammable underbrush – are a pro-active strategy to prevent larger, uncontrolled wildfires. Though sometimes costly and at times controversial, controlled burns have proven critical in limiting potential devastation by eliminating the fuel that feeds massive fires.
This principle isn’t limited to forest management. It extends into public policy and investing. In Canada, years of underfunded health care and aging infrastructure resemble the “dry brush” waiting to ignite, as such systems often go unattended until a crisis erupts. Deferred action is costly, as we saw during the pandemic, when resource shortages demanded reactive, high-cost solutions. The same mindset applies to investing, where regular portfolio rebalancing functions as a controlled burn, pro-actively managing risk before it builds up.
Today’s markets reflect similar risks of concentration. The Magnificent Seven tech giants (Apple, Microsoft, Alphabet, Amazon.com, Nvidia, Meta and Tesla), are known for their market-leading performance. By October, 2024, these seven companies commanded more than 30 per cent of the S&P 500’s total weight, a concentration that surpassed the dot-com era’s 21-per-cent peak. To underscore the impact, consider that the other 493 companies in the index returned 8 per cent in 2023; include these seven stocks, and that return jumps to 26 per cent.
The equal-weight S&P 500, which minimizes the impact of large-cap stocks, underscores this disparity. As of the end October, 2024, it posted a 14-per-cent gain, compared with a 22-per-cent gain for the traditional index. This trend reveals an unhealthy dependency on a few tech giants, raising concerns that broader market health may be significantly overestimated.
Beyond tech concentration, shifts in IPO and private capital trends reveal potentially deeper market challenges. IPO activity has risen slightly from last year, with 76 IPOs raising US$15-billion by mid-2024, yet it remains far below 2020-2021 peaks, highlighting that companies and investors are still cautious. Meanwhile, private capital is expanding fast: Direct lending alone is projected to jump from US$17.2-billion in early 2023 to US$61.5-billion in 2024, reflecting confidence in private markets but also raising questions about risk distribution and concentration, particularly in illiquid investments.
Much like controlled burns in nature, portfolio rebalancing helps manage concentration risk, which is important before the next market downturn. When tech stocks dominate, portfolios become skewed, exposing investors to potential volatility if these giants falter. Rebalancing, while less exciting than chasing growth stocks, instills a “sell high, buy low” discipline, locking in gains from high-value stocks and reinvesting in undervalued assets. Research shows regular portfolio rebalancing can boost returns by more than half a percentage point annually. Other studies reveal that, without it, a balanced 60/40 portfolio could drift to a riskier 80/20 mix over time, emphasizing why regular portfolio maintenance matters.
Kodak’s story serves as a powerful reminder of the dangers of ignored concentration risks. The fact that the company pioneered digital camera technology and held valuable patents wasn’t enough to convince the firm not to cling to its legacy film business. When digital technology took off, Kodak was unprepared, eventually declaring bankruptcy in 2012. Today’s tech-heavy portfolios face similar risks: Overreliance on one sector can leave investors vulnerable to sudden shifts. Kodak’s downfall illustrates the importance of taking small, pro-active steps to maintain balance and avoid unnecessary risk.
For today’s investors, the current market landscape raises critical questions: How dependent is your portfolio on high-growth tech stocks? Are your allocations aligned with your long-term goals? As their year-end planning begins to take shape, investors may want to consider their own “controlled burns,” strategically harvesting tax losses to offset realized capital gains, in consultation with their advisers. As hedge fund investor Rob Arnott notes, “In investing, what is comfortable is rarely profitable.” Just as controlled burns safeguard against wildfires, these regular, intentional adjustments, although uncomfortable, may well be the key to maintaining long-term profitability in an unpredictable world.
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