Institutional investors are limiting portfolio diversification through overexposure to a selected group of U.S. technology stocks, says Alec Murray, senior vice-president and head of equity client portfolio managers at Amundi Asset Management.
Since the beginning of 2023, he says, public equities have offered strong returns largely due to the performance of a concentrated group of technology companies sometimes referred to as the ‘Magnificent 7’ — Alphabet Inc., Amazon.com Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp. and Tesla Inc.
A report by investment management and advisory firm Meketa Investment Group found at the end of 2023, the seven technology companies accounted for 22 per cent of the Russell 3000 index. The dependence on returns from these assets provides a unique challenge for investors looking to retain a healthy diversification in their equities portfolio, says Murray.
“The challenge for institutional investors is as you think long term about returns in equities globally, how do you diversify your exposure so you’re not overly reliant on a narrow group of stocks? Historically, we know that at times that can reverse.”
The risk associated with relying on the Magnificent 7 group is similar to what institutional investors experienced with the dot-com bubble in the late 1990s, says Murray. Indeed, a 2023 report by Franklin Templeton noted some institutional investors are “revisiting value-style equities, as many are overallocated to growth given the prominence of the ‘Magnificent 7’ in major U.S. equity market indices.”
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The Meketa report argues that while there are financial similarities between the technology leaders of today and those at the forefront during the dot-com bubble, companies in today’s marketplace have a higher ratio of long-term debt to capital due to lower interest rates over the last decade. “Hence, the top 10 companies today have less funding stress and are better positioned to weather short-term cash challenges than their counterparts during the dot-com era.”
Murray says the long-term outlook for the technology segment remains strong thanks in large part to the growth of artificial intelligence, which is creating a tailwind for the U.S. equities space. “If you look across the software universe, you already see a number of companies that are integrating AI into their product suites, which should power innovation and growth for those companies but also for the US economy in the years to come.”