Tech stocks were at the forefront of the post-financial crisis bull market and have continued to thrive during the coronavirus crisis, but strategists at Legal & General Investment Management think investors need to consider what happens if they start to underperform just as dramatically. 
When markets sold off in February, the ‘FAAANM’ stocks – or Facebook, Apple, Amazon, Alphabet, Netflix and Microsoft – were far less affected than other sectors as swathes of the population relied on technology to help them through spending their work and leisure time at home.
The stocks also continued to soar when equities picked up and, as the chart below shows, the FAAANMs were up an average of 22 per cent in the opening half of 2020, while the rest of the S&P 500 was sitting on a 6 per cent loss.
Source: LGIM, Bloomberg, as at 30 Jun 2020
Joseph Firth, an investment specialist at Legal & General Investment Management, said: “The FAAANM stocks were already the very largest in the index, so their continued outperformance relative to the rest of the market means that the weight of these six stocks in the S&P 500 is now over 25 per cent for the first time in history.
“We still like tech, but over the longer term we are concerned by that concentration in so few stocks.”
Investors often use for a market capitalisation-weighted approach to equity allocation, as this is seen as cost-effective and transparent method that provides a broad exposure to countries, sectors and companies around the world.
However, Firth pointed to the below chart, which is a visual representation of allocations within the MSCI AC World index – a popular benchmark with global equity strategies. It shows that the biggest 20 US tech companies now account for 20 per cent of global index.
Source: LGIM, MSCI, as at 30 Jun 2020
“The increased concentration in market-cap indices over time means that an investor now has more exposure to Amazon than to the smallest 25 countries within the index,” the investment specialist said.
“In addition, despite the index covering 49 countries and nearly 3,000 individual stocks, one-fifth of its total investments now lies in just 20 US stocks, with the performance of Apple and Microsoft more important than the whole of the UK and German equity market.
“We believe that this is a concentration conundrum for investors and being exposed to so much idiosyncratic risk is undesirable. Therefore, we opt for broader diversification relative to a market-cap weighted approach and reduce exposure to the largest region, sector and stocks.”
Among the ways that Legal & General Investment Management is diversifying away from US tech exposure is to reduce weighting to the US in favour of areas like emerging markets. In addition, the asset manager has increased exposure to more defensive equity sectors like infrastructure and forestry.
The group has also increased exposure to some specific areas of tech, adding artificial intelligence into portfolios to express a positive view on tech while diversifying away from the biggest US technology stocks.
Legal & General Investment Management expects the market backdrop to stay supportive of tech for the near term. The firm has previously noted how factors such as the digital revolution, greater adoption of technology and companies making greater use of tech to cut costs in an uncertain macro environment will continue to buoy tech stocks.
However, it believes investors cannot ignore the possibility that these six stocks could eventually underperform to the same extent that they have outperformed in recent years.
Firth concluded: “There’s no doubt that our more diversified approach has not always paid off due to the unbelievable performance of the FAAANM stocks.
“But these companies do face significant risks, and the recent grilling of the company chief executive officers by the US Congress about their potentially anticompetitive practices was a good example of this. Whilst the outcome didn’t move share prices, it is a reminder that techlash – restrictive regulation of the largest US tech firms – would be a real challenge to the unquestionable optimism that’s currently priced into these stocks.”