Is now the time to trim exposure to ‘overvalued’ tech stocks?

After a decade of extraordinary performance, questions are being asked about how much further the rally can go

IA

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Despite the current pressure on valuations of leading US technology stocks, more than two out of five professional investors plan to up their tech weighting in the next 12 months, according to research.

A study of hedge funds, wealth managers, IFAs, fund managers and institutional investors by the ETP provider GraniteShares, revealed that just 24% plan to cut their tech weighting in the next year, while 23% are maintaining their exposure.

Additionally, some 47% of those professional investors believe retail investors should be upping their weighting, and just 23% said they should be decreasing their exposure to tech.

The performance of tech in the last decade has been extraordinary. Over 10 years to 25 June versus a return of 287.3% from the S&P 500 and just 83.1% from the FTSE 100, the Nasdaq 100 is up 733.3% in sterling terms as Facebook, Apple, Amazon, Alphabet, Netflix, Microsoft have risen to become mega caps.

Is now really the time to be upping weightings?

Concerns about inflation and action from central banks to tighten monetary policy to stop economies overheating, as well as worries about tech stocks being overvalued, has hit the prices of stocks this year.

Then there is the small matter of what has become known as the “concentration conundrum”. Namely, the performance of the large cap tech stocks has been so dominant in the last 10 years that in July last year in the first time in history the six largest stocks in the S&P 500 – all of them technology companies – accounted for 25% of the total index.

The end result is that an investor in global equity indices now has far more exposure to Microsoft than to the smallest 27 countries within the index.

Despite this, some 75% of those professional investors questioned by GraniteShares said now is a good time to buy large tech stocks for those who take a medium term over one to three years.

Market rotation tempts some investors back

“The short-term outlook for US tech stocks may be cloudy and commentators are talking about a tough summer for the sector,” says Will Rhind, founder and chief executive at GraniteShares. “Professional investors are however increasing their exposure to the sector and are very confident about the medium term and long-term outlook.”

For Ryan Hughes, head of active portfolios at AJ Bell Investments, the switch from growth to value in recent months has arguably made parts of the tech sector attractive again as prices have paused for breath.

“The long-term structural growth story behind technology companies is clear to see, but as 2020 progressed, there was much talk that these stocks had become too expensive,” he says.

“The market rotation has perhaps done enough to tempt some investors back to the sector and if we look at Apple, its PE ratio has fallen from 40 to 30 over the past six months,” he adds.

Hughes says that while it’s hard to argue that tech companies are cheap, paying 30 times earnings for the likes of Apple, Alphabet and Facebook is perhaps a little easier to justify for the long-term growth that these companies can deliver.

“However, investors will need to be confident these companies can meet these lofty expectations as there is little margin for error when trading at these levels,” he adds.

Artificial intelligence route reduces stock concentration

While remaining positive on US technology, Justin Onuekwusi (pictured), head of retail multi-asset funds at Legal & General Investment Management (LGIM) believes advisers should take steps to diversify their client portfolios. So how can this be achieved?

One way LGIM’s multi-asset team has reduced stock concentration in funds is to introduce artificial intelligence (AI) stocks.

“There are a number of funds and ETFs that allow investors to get access to the tech sector without taking excess stock concentration risk,” Onuekwusi says. “One such area we think is particularly attractive is AI, which is at the heart of the tech sector.”

For Onuekwusi, AI is where many individual tech themes overlap, such as Big Data, autonomous vehicles, smart home, cloud computing and the Internet of Things.

“At the same time, AI stocks have similar characteristics as the technology sector, in that they tend to have lower leverage, be longer duration in their earnings growth and have lower labour costs than the wider US market,” he adds.

For more on international financial planning, please visit international-adviser.com

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