If you’re in an S&P 500 portfolio, you probably think your technology exposure is around 25%. This is the percentage you get when you force the constituent companies of the index to adopt a rigid industry classification taxonomy such as the widely used Global Industry Classification Standard (GICS).
But in reality, it’s not 25%. It’s somewhere north of 40%.
So if you think you are broadly diversified by “taking the market”, well, you are not. You are really into the whole tech hog.
To regain some semblance of diversification and avoid any tech bubble, you must adjust the holdings in the SPX indices linked to the S&P 500,
One way is to own industry specific ETFs with a more muted stake in the technology. Or by moving away from an index with a market cap weighting towards an index that weighs each component equally.
The top five stocks represent over 20% of the S&P 500 market cap and are all tech related: Meta Platforms FB,
(parent of Facebook), Alphabet GOOG,
(owner of Google), Microsoft MSFT,
and Amazon AMZN,
(You might think Amazon doesn’t belong, but more on that below.)
If all 500 stocks were weighted equally, those five would only represent 1% of the index.
The definitions of the CIGS sector are a blunt instrument for dealing with technological exposure. GICS classifies a company in one and only one of the 11 sectors, according to its main sector of activity. But large companies are rarely in one line of business.
Look at Amazon. GICS ranks it among consumer discretionary stocks. But anyone who follows Amazon knows it’s more than an online retail platform. It has cloud services, media distribution, and a physical grocery chain. The difference between the 25% and 40% weighting is that GICS is an incomplete metric.
Speaking of cloud services, check out Equinix EQIX,
GICS treats it as a real estate company in the specialized REITS sub-sector. But its main activity is the operation of data centers. Shouldn’t that count as part of your tech exposure?
So, before thinking about a portfolio restructuring, we need to have a good grasp of the technology exposure, and in order to do that, we need to think about the dimensions of space and time:
Look at the space of the sector. Companies can have one main line of business, but if they are of a decent size, they are likely to have more than one line of business that is important to their profits. So we can’t just extract the biggest source of revenue and assign the entire business to that industry. The technology exposure will be higher than what is represented by the one company / one sector approach if the companies that are not primarily in technology have secondary lines of business that compete with the main lines of business of the companies that are not primarily in the technology sector. are.
There is no doubt that there are technology companies integrated with other companies in almost every industry. So, to get a feel for a portfolio’s tech exposure, explore a company’s product lines and get a feel for what each does, who it sells to, and what resources it uses.
Look at sectors over time. From time to time, industry definitions need to be rethought, as some industries change over time. For example, in 2018, GICS moved a bunch of companies to a newly baptized communications services industry. When this happened, your nominal technology exposure changed. Exposure to information technology in the S&P 500 fell, not for economic reasons, but because companies like Facebook, Netflix, NFLX,
and Alphabet has moved from technology to the communications services industry.
The same has happened in other sectors. Media companies like Disney DIS,
and Comcast CMCSA,
moved to the telecommunications sector.
These changes are inevitable, but companies always did what they did. Investors should therefore reach out to the new sector and count a portion of the companies there in your overall technology exposure.
Returning to Amazon as an example, this chart shows a breakdown of industry sectors, based on analysis from Syntax’s Affinity tool, which uses this exploration approach. Amazon is a consumer-focused company, but it has many companies, and each of its companies – maybe we should think of them as sub-companies, just like we have sub-sectors – has some exposure that counts for technology, indicated by blue in the exhibit.
Do this for all the companies in the S&P 500, add them up and you get over 40% exposure.
Even if we get the right sector exposures, sectors are only part of the picture. You also need a factor approach to risk. A tech company that is large and cash-rich with a supply chain anchored in China will react differently in many scenarios than a small-cap, leveraged, fully US-funded company. So go further to get an idea of sector exposure and more broadly to assess exposure to countries (like China) and styles (like size and leverage).
Some good news: The tech industry has changed dramatically since 2000, when it last reached over 30% of the S&P 500 market cap. (When the tech bubble burst, the S&P fell 40% over the next three years; the even heavier tech Nasdaq Composite fell 70%.)
Today, the tech sector makes up an even larger proportion of the S&P 500, although this is mitigated as it now includes many more stable companies. (Unlike the dot-com era, this time around they have income!). And it’s also more diverse. In 2000, hardware made up two-thirds of the tech industry’s market capitalization, but now it’s only about one-third. The biggest thing now is software, at around 50%, and fintech has gone from next to nothing to 10% of the weight of technology.
So yes, more mature and more diverse. But still, more than 40%.
Rick Bookstaber is Co-Founder and Chief Risk Officer at Fabric. Previously, he held risk director positions at Morgan Stanley, Salomon Brothers, Bridgewater Associates and the University of California Regents and served in the US Treasury in the aftermath of the 2008 crisis.