Big Tech Stakes Equal Big Risk

Tech stocks are hot. While the sector took a hit in the downturn of late 2018, the technology-fund Morningstar Category has been the strongest performer of any in Morningstar’s database over three, five, 10, and 15 years. The category has also bounced back of late; it was one of the best performers in 2019 through Oct. 17 with a 24.6% gain.

Tech valuations may not be at March 2000 levels, but owning a big stake in the sector now may represent a significant risk. Let’s take a closer look at some of the heaviest tech investors among diversified U.S. equity funds.

Fidelity OTC FOCPX Expect this fund to consistently hold a lot of tech; it's benchmarked against the tech-heavy Nasdaq Composite Index. Indeed, the fund's lightest tech stake in the past decade was 47%, based on Morningstar's sector definitions. That said, the fund's tech weighting at the end of August 2019 was 60.4%, higher than at any other point over that period according to Morningstar data. Given the sector's strong run, this may not represent great timing.

Moreover, lead manager Chris Lin just took the helm in October 2018 following the sudden departure of predecessor Gavin Baker. While he’s an experienced tech investor, he hasn’t run a diversified fund before--a big reason why the fund currently has a Morningstar Analyst Rating of Neutral. Sonu Kalra, who managed the fund in the 2000s, stepped in as a comanager when Lin joined the fund, but that’s expected to be a temporary arrangement, as Kalra is primarily occupied with managing Fidelity Blue Chip Growth FBGRX.

Artisan Small Cap ARTSX This small-growth fund hasn't always loaded up on tech stocks, but its weighting in the sector has steadily risen over the past decade to 52.1% in September 2019 from 24.2% in 2009 (with a 54% peak in 2018). That big shift coincided with Craigh Cepukenas (a comanager since 2004) taking on the lead role in 2009 when he joined another Artisan team best known for running Artisan Mid Cap ARTMX.

Because this is a small-cap fund, its tech holdings aren’t the usual suspects. Cepukenas has been enthusiastic in recent years about the prospects for specialized software companies. Indeed, four of the six tech stocks within the fund’s 10 largest holdings at the end of June were software firms. That’s a lot of exposure to a single industry, and it’s helped power the fund’s very strong recent returns. The team has done a pretty good job of managing downside risk over time, and three of its charges (this fund, Artisan Global Opportunities ARTRX, and Artisan Mid Cap) each earn Silver ratings. But investors could experience significant volatility here if small-cap software firms take a turn for the worse.

Amana Growth AMAGX This Bronze-rated fund is managed according to the principles of Islamic law, which means virtually all financial firms (among others) are off-limits. As a result, other sectors tend to have larger-than-average weightings in this fund, and tech has been the primary beneficiary in recent years--from 25.9% nearly a decade ago, the fund's weighting rose to a peak of 50.3% in August 2018 before sliding down to a still-hefty 41.4% at the end of September. Of the fund's 10 largest holdings (which constituted 43% of assets), five were tech names, including such stalwarts as Adobe ADBE, Apple AAPL, and Cisco CSCO.

The fund held up well in the 2007–09 bear market, primarily because of a large cash stake at the time, though cautious stock selection also played a role. The fund isn’t taking a lot of price risk relative to its large-growth peers--the fund’s price/earnings ratio was recently below the category average--but a tech-led market downturn would clearly inflict some pain here.