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For example, BlackRock’s Technology Opportunities Fund was blocked from buying more shares in Apple, Microsoft and Nvidia © Reuters

Many of the largest US investment funds are being blocked from buying more shares in popular stocks due to diversification rules, as they struggle to keep up with indices that are increasingly dominated by a few massive tech groups.

Major asset managers and mutual fund specialists such as Fidelity, BlackRock, JPMorgan Asset Management, American Century and Morgan Stanley Investment Management have run into strict regulatory limits that determine whether a fund can be categorised as “diversified”.

The trend is a further sign of how a lopsided rally powered by just a handful of big companies is creating unexpected issues for investors and index providers, and follows news that even the Nasdaq 100 — the index most closely associated with high-flying tech groups — will be rebalanced to reduce the dominance of the largest groups such as Apple, Microsoft and Nvidia.

The S&P 500 has added 18 per cent so far this year, but seven large tech stocks have accounted for the majority of the gains.

Mutual funds that register with the Securities and Exchange Commission as “diversified” cannot put more than 25 per cent of their assets into large holdings — with a large holding defined as a stock that represented more than 5 per cent of the fund’s portfolio at the time of investment. 

Funds are not punished if the value of their existing large holdings naturally rises past the 25 per cent limit, but once it is hit they cannot buy any more of the affected stocks.

At the end of May, Fidelity’s $108bn Contrafund, for example, could not buy any more shares in Meta, Berkshire Hathaway, Microsoft and Amazon, because they made up a combined 32 per cent of its portfolio. 

BlackRock’s Technology Opportunities Fund was blocked from buying more shares in Apple, Microsoft and Nvidia, while JPMorgan’s large-cap growth fund was over the limit for Microsoft, Apple, Nvidia, Alphabet and Amazon.

The recent rally means that even funds that merely mirror major benchmarks such as the Russell 1000 Growth Index would exceed this limit.

The SEC said in 2019 that it would not enforce the more stringent 25 per cent limit on passive investment funds that breach the guidelines while tracking an index, but the restrictions make it harder for active managers to make bets.

“If rules are not being enforced, it usually means the rules didn’t make sense,” said Rob Arnott, chair of $130bn asset manager Research Affiliates. “What happens to anyone who wants to go slightly overweight on companies that are already large in the index?

“I personally think valuations have gotten way ahead of themselves . . . [but] suppose you think Apple and Microsoft’s future prospects are stupendous?”

Some asset managers such as T Rowe Price have chosen to recategorise many of their funds as “non-diversified”. This allows them to make more concentrated bets, but requires shareholder approval and may put off potential clients who assume a non-diversified fund is highly risky.

Stephen Cohen, a partner at law firm Dechert, said the most likely outcome for any fund that inadvertently broke the rules would be for the SEC to force them back into compliance. However, funds that lost money while in breach could also be exposed to legal action from investors.

“A plaintiff would argue that the fund didn’t get shareholder approval to become non-diversified, and as a result made a material misstatement in its registration statement which caused harm to shareholders,” Cohen said.

BlackRock, Morgan Stanley, JPMorgan, Fidelity and American Century all declined to comment.

Nasdaq’s changes, which were announced earlier this month and come into effect next Monday, underline how index providers are facing similar pressures to diversify their holdings. The Nasdaq 100 will be updated next week because it passed a separate, looser regulatory threshold that required the combined weight of large holdings to be less than 50 per cent.

The combined weighting of the six largest companies on the Nasdaq 100 will be reduced from 50 per cent to 40 per cent so any funds that track the index can continue to meet the requirements to be a regulated investment company.

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