By Rick Bookstaber
If you are in an S&P 500-ish portfolio, you probably think your exposure to technology is around 25%. That’s the percentage you get when you force the constituent companies in the index into 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 “holding the market”, well, you’re not. You are really into tech whole hog.
To regain some semblance of diversification and sidestep any tech bubble, you need to make adjustments to the holdings in the S&P 500-related indexes /zigman2/quotes/210599714/realtime SPX -1.04% .
One way is by holding sector-specific ETFs with a more toned-down holding in tech. Or by adjusting away from an index with a market-cap weighting toward one that weighs each component equally.
The five largest stocks make up over 20% of the S&P 500’s market cap, and they are all technology-related: Meta Platforms (Facebook’s parent), Alphabet /zigman2/quotes/205453964/composite GOOG -3.29% (owner of Google), Microsoft /zigman2/quotes/207732364/composite MSFT -2.36% , Apple /zigman2/quotes/202934861/composite AAPL +2.44% and Amazon /zigman2/quotes/210331248/composite AMZN -8.43% . (You might think Amazon doesn’t belong, but more on that below.)
If the 500 stocks were equally weighted, these five would only be 1% of the index.
The GICS sector definitions are a blunt instrument for dealing with tech exposure. GICS puts a company into one and only one of 11 sectors, based on its main line of business. But large companies are rarely in just one business line.
Look at Amazon. GICS classifies it as a consumer discretionary stock. But anyone who follows Amazon knows it’s more than a platform for online retail. It has cloud services, media distribution and a chain of brick-and-mortar grocery stores. The difference between the 25% and the 40% weighting comes from GICS being incomplete metric.
Speaking of cloud services, look at Equinix /zigman2/quotes/208927761/composite EQIX -2.65% . GICS treats it as a real-estate company in the Specialized REITS sub-industry. But its main business is running data centers. Shouldn’t it count as part of your technology exposure?
So before thinking about portfolio restructuring, we need to get a good handle on tech exposure, and to do that we need to think along the dimensions of space and time:
Look at the sector space. Companies might have a primary line of business, but if they are a decent size they likely will have more than one business line that is material to their earnings. So we can’t simply pull out the largest earnings source and ascribe the entire company to that sector. Technology exposure will be higher than what is represented by the one company/one sector approach if companies that are not primarily in technology have secondary business lines that compete with the main business lines of companies that are.
No doubt there are technology companies embedded in other companies in almost every sector. So to get a read on the tech exposure of a portfolio, drill down into a company’s product lines and get a sense of what each does, whom it sells to and what resources it uses.
Look at sectors over time. Every now and then the definitions of sectors need to be rejiggered because some industries morph over time. For example, in 2018, GICS moved a bunch of companies to a newly christened Communications Services sector. When that happened, your nominal tech exposure changed. Information Technology exposure in the S&P 500 dropped, not for any economic reason, but because firms like Facebook, Netflix /zigman2/quotes/202353025/composite NFLX -0.27% and Alphabet moved from Technology into the Communication Services sector.
The same thing happened in other sectors. Media companies like Disney /zigman2/quotes/203410047/composite DIS -2.21% and Comcast /zigman2/quotes/209472081/composite CMCSA -2.77% shifted to the Telecommunications sector.
These changes are inevitable, but the companies were still doing what they had been doing. So investors need to reach out to the new sector and count some part of the companies there in your overall tech exposure.
Going back to Amazon as an example, this chart shows a breakout of business lines, based on an analysis by Syntax’s Affinity tool, which employs this drill-down approach. Amazon is a consumer-focused company, but it has many businesses, and each of its businesses — maybe we should think of them as sub-companies, just like we have sub-industries — has some exposure which counts toward technology, indicated by blue in the exhibit.
Do this for all the companies in the S&P 500, add them up and you end up with an exposure of over 40%.
Even if we get the sector exposures right, sectors are only part of the picture. You also need a factor-based approach to risk. A tech company that is large and cash-rich with a supply chain anchored in China will respond differently in many scenarios from one that is low-cap, leveraged and fully U.S.-resourced. So reach deeper to get a handle on sector exposure and reach more broadly to assess exposure to countries (like China), and styles (like size and leverage).
Some good news: The tech sector has changed markedly since 2000, the last time it grew to over 30% of the S&P 500’s market cap. (As the tech bubble burst, the S&P slumped 40% over the three subsequent years; the even-tech-heavier Nasdaq Composite plummeted 70%.)
Today, the tech sector is even a bigger proportion of the S&P 500, although this is mitigated because now it is comprised of many more stable companies. (Unlike in the dot-com era, this time around they have earnings!). And it also is more diverse. In 2000, hardware was two-thirds of the tech sector’s market cap but now it is only about one-third. The largest now is software, at about 50%, and fintech has grown from close to nothing to represent 10% of tech’s weight.
So yes, more mature and more diverse. But still, over 40%.
Rick Bookstaber is co-founder and head of risk at Fabric. He previously held chief risk officer roles at Morgan Stanley, Salomon Brothers, Bridgewater Associates, and the University of California Regents and served at the U.S. Treasury in the aftermath of the 2008 crisis.