It has not been a great start to the week for the technology sector, with large-cap tech stocks dragging down equity indices across the globe.
With the current media focus on the industry behemoths, suitably arranged into fun acronyms (“FANGs” and so on), investors in the U.S. tech sector might be concerned about the risks of over-concentration. But is the tech sector the right part of the market to be worried about?
Certainly, the risks of concentration are present in tech: the top five issues account for a shade under half of the total S&P 500 Information Technology index. As we have argued previously, more concentrated portfolios can have unfortunate characteristics. Equal-weight indices can help investors manage sectoral concentration risk; they tend to limit a portfolio’s exposure to single issues, and logically outperform as concentration decreases from higher to lower levels. Should the overall level of concentration within sectors mean-revert, then the current level of concentration – when compared to historical norms – offers a potential guide as to whether an equal- or cap-weighted strategy may be more effective at generating returns.
Which makes it important to notice that the present level of concentration is not unusual for the tech sector. By the “top-five” measure, the S&P 500 Information Technology index is neither more, nor less concentrated than was typical over the past decade.
In fact, another sector is displaying far greater warning signs. Concentration in the consumer discretionary sector, while less dramatic in absolute terms, is reaching unusual levels relative to recent history.
Just one issue (Amazon) presently accounts for over 21% of the sector, while the next four (Home Depot, Comcast, Disney and NetFlix) account for another 23%. Accordingly, while tech may retain the headlines, investors worried about unusual levels of concentration may be better off applying their discretion in other sectors – and perhaps worrying about the CHANDs, not the FANGs!
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