Why has tech become such a concentration risk and what can be done about it within a multi-asset fund? asks Anthony Rayner, fund manager, Premier Miton Macro Thematic Multi Asset Team, Premier Miton Investors
The massive success of a small number of large US technology stocks throws up some important questions when constructing global multi-asset portfolios. A cursory glance at the anatomy of a US equity index, and in fact a global equity index, illustrates how high concentration risk is now. Before we look at our strategy for managing concentration risk, it’s worth looking at why concentration risk is so high.
The internet, mobile technology and, more recently, artificial intelligence represent only some of the genuine tech innovations over recent years. However, it’s much more than the innovations which have propelled big tech to where it is today.
Extraordinarily low interest rates for an extended period provided vital access to cheap capital at a time when many of these companies were growing, needed to invest in R&D and, in many cases, also allowed the acquisition of potential competitors. Additionally, low rates have contributed to the growth in market capitalisation, as future profits have been discounted back at lower discount rates and therefore supported valuations.
Big tech has also benefited from the prolific growth of passive investing, an approach which rewards market capitalisation rather than profit per se, especially important in the early days when profits were sparse. In addition, big tech’s tendency for significant share buybacks has provided a fairly consistent bid for share prices.
More recently, lockdown benefited many of these companies, as nations went on-line. In more recent years, many of these companies turn a massive profit and here they frequently benefit from opaque tax structures, tax havens and creative accounting practices. In terms of regulations more generally, the progress in tech has been so fast-moving that regulators are often trying to catch up.
Another element which has powered their growth is quite distinctive: many users end up working for the business but are unwaged. For example, users that create and share content, traffic information uploaded when using navigation apps, etc. Not only are they unwaged but they contribute to something else, which is not unique to tech, called the network effect: the more members join, the better the experience and the more valuable the business becomes to users, and shareholders.
There is a debate around whether or not these companies are in fact monopolies, some are clearly more so than others. Either way, whether they are monopolies or simply big conglomerates, they benefit from many advantages typical of monopolies. For example, from economies of scale, high barriers to entry and their lobbying power.
Monopolies have always used their power for their benefit and in some ways it will be no different here, except they have an additional power, that of information, communication and big data. In this way, their influence is often very powerful. It’s not listed but just look at the importance of the Elon Musk owned Space-X Starlink satellite communications in Ukraine. More generally, there is a risk to truth, and therefore democracy, with the algorithmic nature of information generation and information gathering.
In short, there are some amazing positives brought by big tech, but some significant negatives too, which are confusing for regulators, users and investors alike, which brings us to concentration risk.
In managing global multi asset funds, we are very alert to the main risk in our funds, which is often equity risk and, currently, this is concentrated in a specific sector, style and geography. A typical approach might be to use long duration bonds to diversify equity risk but as we believe that inflation will be higher for longer, we don’t think long duration government bonds will be the diversifier of equities that they sometimes have been in lower inflation episodes.
As a result, we look to diversify within equity and beyond government bonds. Within equity, we do like some of these tech businesses, however, we have exposure to a select basket of stocks, rather than big positions in individual positions. We also have exposure away from large cap, especially in mid cap, and not just in the US. In addition, we have built positions in Japan and India, which tend to diversify Western equity. In corporate bonds we generally have exposure to short duration and good quality credit, in order to limit interest rate risk and credit risk, and these characteristics tend to be less equity like. We also have some exposure to a commodity basket, including, gold, energy and agricultural commodities, as well as some property.
This information should not be relied upon by retail clients or investment professionals. The views provided are those of the author at the time of writing and do not constitute advice. These views are subject to change and do not necessarily reflect the views of Premier Miton Investors. The value of investments may fluctuate which will cause fund prices to fall as well as rise and investors may not get back the original amount invested. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
