Are Funds Barreling Out of Tech and Into Energy?
Conventional wisdom says so; we take a closer look.
Fund Spy
In the late 1990s, when oil prices were hitting historical lows, energy stocks were simply considered too prosaic for all but the most diehard value fans. And even many of the most respected value managers took a pass on these shares because of concerns that managements at these companies were poor allocators of capital. As such, the diversified domestic category with the largest allocation to energy stocks was large-cap value, with the typical fund keeping just over 9% of its assets in the group. Lucky for them! Energy stocks have since soared, boosted by rising prices for oil and natural gas. And while concerns remain about how companies will redeploy all those profits, conventional wisdom holds that more and more managers have gotten interested in energy stocks. In particular, there's speculation that growth managers, who all but ignored these stocks in the late 1990s, are in love with the sector. A Closer Look
But is that really what's happening? For the answer, we examined the energy weightings of funds in the nine diversified domestic categories, looking at their year-end allocations beginning in 1998 and lasting through 2004. To make it more interesting, we also examined the hardware and software allocations of funds in these categories to see if money had been flowing out of technology, potentially because managers were instead shifting that money to energy. The results were interesting, if a little surprising. Among large-cap funds, value-oriented offerings didn't see much of a shift in their overall allocation to energy. In fact, at the end of 2004, the typical large-value fund had seen its overall weighting to energy rise by just 1 percentage point in the past six years. This likely implies that as stock prices have risen, the category's managers have been doing some selling. And while large-growth funds have seen their energy weightings double, it's still only a bit more than 4% of assets, so it isn't nearly as significant a trend as many make it out to be. What's more significant is that large-growth funds have seen their allocation to tech hardware stocks fall from more than a quarter of assets to approximately 15% of assets. Some of that is due to depreciation, but it also confirms that large-growth funds have cooled a bit on the group. This lack of enthusiasm is also mirrored on the value side, where tech stocks remain scant, a sign that valuations in the sector still aren't low enough for this category's managers. The trends are more pronounced in the mid-cap area, where value, blend, and growth funds alike have meaningfully ramped up their energy exposure in the past few years. Mid-growth funds, for instance, had less than 2% of assets in energy stocks at the end of 1998 and now have more than tripled that exposure. Meanwhile, value funds have seen their exposure rise from approximately 5.6% of assets to more than 8%. On the tech front, mid-growth and mid-blend funds have meaningfully reduced their exposure to the group, while mid-value funds are not really doing anything dramatic. The trends are very similar in the small-cap arena, although it is worthwhile to note that even after cutting back their tech exposure dramatically, small-cap growth funds continue to devote a fifth of their assets, on average, to the sector. So, what's the takeaway from all this? First, at least for now, the trend to higher energy weightings, while apparent, isn't nearly as pronounced as many believe. While it's clear that mid- and small-growth funds retain more of a speculative, performance-chasing flair than the other diversified categories, growth funds in general seem to have toned down their acts. Secondly, for those who remain fascinated with tech, these numbers are a reminder that investors' persistent attention to the sector is increasingly disproportionate to the weightings it is now accorded in portfolios. My guess is that's a good thing, as it's a sign that growth managers in particular are acting more rationally than they were a few years ago.
But is that really what's happening? For the answer, we examined the energy weightings of funds in the nine diversified domestic categories, looking at their year-end allocations beginning in 1998 and lasting through 2004. To make it more interesting, we also examined the hardware and software allocations of funds in these categories to see if money had been flowing out of technology, potentially because managers were instead shifting that money to energy. The results were interesting, if a little surprising. Among large-cap funds, value-oriented offerings didn't see much of a shift in their overall allocation to energy. In fact, at the end of 2004, the typical large-value fund had seen its overall weighting to energy rise by just 1 percentage point in the past six years. This likely implies that as stock prices have risen, the category's managers have been doing some selling. And while large-growth funds have seen their energy weightings double, it's still only a bit more than 4% of assets, so it isn't nearly as significant a trend as many make it out to be. What's more significant is that large-growth funds have seen their allocation to tech hardware stocks fall from more than a quarter of assets to approximately 15% of assets. Some of that is due to depreciation, but it also confirms that large-growth funds have cooled a bit on the group. This lack of enthusiasm is also mirrored on the value side, where tech stocks remain scant, a sign that valuations in the sector still aren't low enough for this category's managers. The trends are more pronounced in the mid-cap area, where value, blend, and growth funds alike have meaningfully ramped up their energy exposure in the past few years. Mid-growth funds, for instance, had less than 2% of assets in energy stocks at the end of 1998 and now have more than tripled that exposure. Meanwhile, value funds have seen their exposure rise from approximately 5.6% of assets to more than 8%. On the tech front, mid-growth and mid-blend funds have meaningfully reduced their exposure to the group, while mid-value funds are not really doing anything dramatic. The trends are very similar in the small-cap arena, although it is worthwhile to note that even after cutting back their tech exposure dramatically, small-cap growth funds continue to devote a fifth of their assets, on average, to the sector. So, what's the takeaway from all this? First, at least for now, the trend to higher energy weightings, while apparent, isn't nearly as pronounced as many believe. While it's clear that mid- and small-growth funds retain more of a speculative, performance-chasing flair than the other diversified categories, growth funds in general seem to have toned down their acts. Secondly, for those who remain fascinated with tech, these numbers are a reminder that investors' persistent attention to the sector is increasingly disproportionate to the weightings it is now accorded in portfolios. My guess is that's a good thing, as it's a sign that growth managers in particular are acting more rationally than they were a few years ago.
And even if you believe that energy stocks remain cheap, the fact that value funds continue to own them in about the same proportion that they did in the late 1990s means that their energy weightings are one of the contributing factors to rising portfolio valuations among many of these funds. The practical implication, of course, particularly when it's viewed in the context of the recently strong performance of these funds, is that value-fund investors should at least ratchet down their return expectations a notch or two. Chances are that the recently wide disparity in returns between the two groups isn't likely to persist to the extent that it has since the late 1990s.
And From The Department Of Irrelevance...
Turns out that we weren't the only ones writing about Buffett last week. In fact, I saw several worthwhile pieces about the Oracle's latest annual letter. However, I did come across one article that put me off. The article, "Trade Like Warren Buffett," actually references a book that's also been released on the topic. The gist of the argument is that Buffett has made money by more than just buying and holding stocks and that investors should also learn by looking at what he's done in merger arbitrage, distressed debt, and so on. That may be true as far as it goes, but I do think that putting the focus on them takes away from his central buy-and-hold message, which has more relevance for investors. As such, while this kind of thing makes for interesting reading, I think that's about where its usefulness ends.