The rise of giant tech stocks means greater ‘concentration risk’ for investors

The meteoric rise in tech stocks has resulted in an imbalance in certain market indices and, consequently, in some investors’ portfolios.

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  1. Rob Morgan

Large technology stocks such as Amazon, Microsoft and Google-owner Alphabet have risen strongly this year, building on previous outperformance. Investors have been quick to reposition portfolios to reflect the new business trends in a world of social distancing, home working and online entertainment. The disruption of Covid-19 lockdowns has resulted in a quickening and broadening of the digital revolution and has presented a clearer view of how the world will further integrate technology into daily life.

The Nasdaq 100 index, representing many high growth American companies, has risen by over 25% in 2020 so far, compared with a still-impressive rise of around 5% in the S&P 500. There’s a substantial representation of the fast-growing areas of technology in the main US indices, and their strong performance stands in contrast to others. Notably, the FTSE 100, which contains no large internet or technology businesses, is down around 15% over the same period despite a strong rebound from the March low.

The meteoric rise in tech stocks has resulted in something of an imbalance in certain market indices and, consequently, in some investors’ portfolios. Just five tech stocks (Apple, Alphabet, Facebook, Microsoft and Amazon) account for around 22% of the S&P 500’s total market value. Those same stocks make up a remarkable 46% of the Nasdaq 100 index. It’s not just in the US. The Asian technology ecosystem has resulted in similarly lopsided equity indices with two giant internet and e-commerce businesses, Tencent and Alibaba, accounting for over 30% of the MSCI China Index.

Investors using passive investments, also known as trackers, that aim to mimic the performance of these indices should be aware of the high sector and individual company weights. It would be unusual for an active manager to have a position size of more than 6% or 7% in an individual company and there is normally a hard limit at 10%.

This concentration doesn’t necessarily pose a problem. After all, a strategy of ‘running winners’ as they get progressively bigger can be effective in boosting returns. However, it means investors are more reliant on a smaller number of business and should momentum reverse then it might leave them exposed. It’s certainly something to bear in mind.

What could go wrong for the tech giants? The stock market seems to have already decided who will be the long-term winners from the coronavirus crisis and the levels of expectation – and share price valuations are high. Any disappointments in terms of company earnings announcement could send share prices lower.

Another threat comes from governments desperate to raise money to pay for efforts to keep coronavirus at bay. The largest companies with the most significant revenue are likely to enter their crosshairs, especially if they are seen to have ‘done well’ from the crisis. Taxation and regulation could ultimately impact earnings. The tech giants are mature companies with vast earnings and great resilience but the more they grow, the greater the risk of political backlash.

Finally, monetary stimulus through ultra-low interest rates means investors see less difference between the value of money today and the value of money in the future, which essentially serves to make future profits more valuable. This is particularly important for the technology sector where tomorrow’s profits for many companies are expected to be a lot greater than today's. A scenario where inflation rises and interest rates creep upwards would likely be detrimental to share prices.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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