Mutual funds are pouring over technology stocks, and it is not hard to understand why. U.S. Technology is among the top performing sectors so far this year – something which has translated into big gains for funds overweight in the sector. But, it also begs the question, are investors\u2019 appetite for tech stocks becoming too risky for them to stomach later?<\/p>\n
Tech Bull is Raging and Investors Are Cool about It<\/strong><\/p>\n According to a Bank of America Merrill Lynch report, large-cap active equity mutual funds reached a record-high overweight of 25% (+5.8 percentage points increase) in U.S. Technology sector relative to the benchmark in July (as reported by CNBC). This overweighting could well be a self-fulfilling cycle \u2013 the Technology Select Sector SPDR Fund (XLK) has climbed around +19% as of end-July since the start of the year, and mutual funds have probably been buying into the momentum by letting their positions grow in the sector, only to reinforce the tech rally.<\/p>\n Investors seem to be quite complacent about it too. Technology stocks have been trading with the implied volatility way below that of Utility stocks. That\u2019s rather surprising, given that Technology has some of the most volatile earnings among sectors and is potentially far more cyclical than companies supplying our day-to-day needs of gas and power. Is this than \u2018the calm before the storm\u2019 for tech stocks?<\/p>\n To be sure, U.S. Technology\u2019s fundamentals are on a strong footing. \u00a0The S&P 500 Technology earnings grew at a record +17% in Q1 2017 year-over-year, and the Q2 figure is estimated to come in at a solid +15% (according to the latest Zacks Earnings Trend report). But, question is – how much of funds\u2019 overweighting the sector is justified by fundamentals versus complacent momentum?<\/p>\n Are Funds Blinded by Tech\u2019s Momentum?<\/strong><\/p>\n When a sector experiences high returns and low volatility, many investors tend to underestimate risks and keep piling on the sector \u2013 more so, if the sector has had positive earnings growth in recent times. This could be a potential factor driving the current overweighting of tech by funds. And that makes these funds that much more vulnerable to pullbacks. That\u2019s because there is only so much room that\u2019ll be left for further price increases in overcrowded sectors or stocks. And when it gets too \u2018hot\u2019, investors will rush to exit all at once, thereby potentially competing away each other\u2019s returns. The less diversified a fund or portfolio is across different sectors, the more the downside risks from their overweight positions.<\/p>\n Bottom Line for Investors<\/strong><\/p>\n Whether or not mutual funds feel ready to taper off their tech exposure yet, it makes sense for investors to leverage the Technology\u2019s strong fundamentals without letting the \u2018herd mentality\u2019 get in the way. That is achievable through increased selectivity in tech investments and adequate portfolio diversification. Ultimately, fundamentals will drive long-term returns in any sector or security. But for the potential roller-coaster in between, adequate diversification across less-correlated sectors and asset classes is what will cushion the downside risks.<\/p>\n Having said that, we understand that not every investor may feel confident enough to rise above the crowd without the fear of losing out. More importantly, they may not be sure which strategy to adopt to maximize gains, in an environment of increasing integration between financial markets and rising economic\/policy uncertainties. That\u2019s why, at Zacks Investment Management, we leverage our in-house independent and unbiased research and tools to get a better in-depth understanding of fundamentals across sectors, countries and asset classes. We use this to build customized diversification strategies for every client to mitigate downside risks, while keeping in mind their individual financial goals and risk tolerance. If you want to understand which strategy suits your needs and time horizon, feel free to get in touch at 1-888-600-2783 for a free portfolio review. We\u2019ll be happy to answer your questions and also give you more details on our services.<\/p>\n In the meantime, check out our latest Stock Market Outlook report. This briefing discloses facts and forecasts on different macroeconomic indicators, asset classes and sectors, including our in-house ranking of sectors based on how \u201cattractive\u201d they are right now. Give this report a read to get a leg-up over other investors when it comes to making educated investing decisions. To get your free copy, click on the link below:<\/p>\n","protected":false},"excerpt":{"rendered":" Mutual funds are pouring over technology stocks, and it is not hard to understand why. 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