It’s hard for advisors to pick a basket of tech stocks that can beat the market when much of the gains are concentrated in the giant tech names everyone owns, including Alphabet and Apple .
Within the 26.9% return of the Standard & Poor’s 500 index last year, several of the megacap names had stellar results, including Alphabet, up 65.3%, Nvidia , up 125%, Apple , up 33.8%, Broadcom , up 52%, and Advanced Micro Devices , up 57%. Most of the fund world, as a result, just loads up on the household tech names everyone already owns, with little else to show for stock-picking innovation.
Where there was an advantage in 2021 for some funds was supplementing those giant holdings with less-obvious picks, such as Lam Research , the maker of chip equipment, which rose 53% in 2021, and Arista Networks , the competitor to Cisco Systems in networking, which almost doubled.
A good example of an ETF that simply approximates the weighting of tech giants in the broader market is the Vanguard S&P 500 (ticker: VOO). The fund’s biggest holdings of late are Apple, Microsoft , Amazon , Alphabet, and Tesla, which combined make up about a fifth of the portfolio.
What makes this very plain-vanilla index fund interesting as a tech investment is that, by virtue of buying more of the winners as they climb in value in order to approximate the index, it has been loading up on Arista Networks , both last year and for many years prior, as well as Lam Research . Those were fortuitous developments.
Despite an unremarkable return last year of 27%, VOO gets a “Gold” rating from Morningstar , mostly because of its stable year-in, year-out performance profile. The five-year annualized return of 18.38% is better than the average for its category, “large blend,” according to Morningstar, and just slightly below the index average of 18.55%, that being the Morningstar US Large-Mid Cap index.
Morningstar notes that VOO’s expense ratio, 0.03%, tends to be the difference between this fund and the S&P 500. It’s worth noting that the beta is very low, at 1.05, and the dividend yield is a healthy 1.29%.
You can find lots of ways to get a little bit of alpha above the S&P’s tech performance with funds that emphasize more of the best-performing names, and you can also find ways to get a lot more alpha by paying higher expenses.
Two fine choices with returns just above the S&P are the Vanguard Information Technology (ticker: VGT) and State Street’s Technology Select Sector SPDR (ticker: XLK) Both topped the S&P 500 last year, XLK returning 33.7% and VGT, 29.5%. The two have very similar multi-year track records. VGT is up 44% over a three-year period and XLK is up 42.6% over that same time.
Both have a giant chunk at the moment in Microsoft and Apple, with the VGT having about 39% of the portfolio split between the two and XLK having slightly more at 45%. The holdings other than that are remarkably similar.
Both funds are inexpensive, with VGT charging a tenth of a percent and XLK an eighth of a percent. The most interesting difference is that the XLK has a higher dividend yield than the VGT, 0.79%, versus 0.68%. The XLK is, however, also a bit more volatile, with a beta of 1.66 versus 1.6 for VGT.
Morningstar gives the higher nod to VGT for its strong “process” of picking investments, and also for Morningstar’s high regard for Vanguard itself. VGT gets a “Gold” rating versus “Silver” for XLK despite very high marks on most measures for the latter.
You may also want to consider a cousin to XLK, SPDR S&P US Technology Select Sector UCITS ETF (ticker: SUSTF), which has a slightly higher three-year return. SXLK tends to have been more aggressive in buying up winners last year, such as Apple and Microsoft, which added a bit to returns.
The important thing about all three, VGT, XLK, and SUSTF, is that they tend to do best in periods of up to three years. Looking at five-year returns, the outperformance is fairly slight relative to the index, Morningstar US Technology.
Considering chips. Beyond those simple sources of alpha, some of the most robust returns last year came from really loading up on chip stocks in a banner year for the group. The question becomes, do they continue to outperform in 2022?
Right now, the outlook from companies such as Lam Research is stellar, though the group is still a cyclical one, and it’s entirely possible a downturn could develop later this year.
A fine example of adding to the broad index is the ProShares Ultra Technology, (ticker: ROM) which has bolstered the concentration in FAANG stocks with top semiconductor performers such as Nvidia , AMD and Broadcom .
With an expense ratio of 0.95%, it’s in the top quartile for expenses of all funds I looked at. It may be worth it, given the fund has a very healthy 5-year return of 61%, four times the Morningstar US Technology index.
Another semi maven is the ProShares Ultra Semiconductors (ticker: USD). As with its ProShares tech cousin, USD, it also has a very solid track record, with a five-year return of 57% and 10-year return of 44.6%. The fund had had a banner year in 2021, up 104%, trouncing its benchmark index, the Morningstar US Market. That’s mainly a consequence of having astutely built positions in the top semiconductor names over many years, including Nvidia, Broadcom, and AMD.
USD has the same ultra-pricey expense ratio, 0.95%. Both ROM and USD have relatively high volatility, 1.56 and 1.93, respectively.
The danger, again, is that after more than doubling last year, and a 68% rise in 2020, and a doubling in 2019, if the wildly hot semiconductor market cools in 2022, USD could revert to its pattern of down years after a run of up years. If you want to take a focused bet that chips will hold up better than their cyclical past, ROM or USD are among the better vehicles to make that bet.
New tech ETF. There are additional funds to keep an eye on as well. One is the iShares Cloud 5G and Tech fund (ticker: IDAT). The fund only got started in mid-June of 2021 and produced a 19% gain in that time. Morningstar assigns the fund a “Silver” rating, regarding it as having a “sound investment process,” although with such a short track record, that remains to be seen.
What is intriguing is that IDAT has many of the top names at the moment outside of FAANG, including Arista and Nvidia, but also Fortinet , a cyber-security firm that was up 142% last year. Apparently, the fund does know something about picking winners, which would be nice, as it has a 0.47% expense ratio.
Time will tell if this name is like another iShares vehicle with a longer track record, the iShares Exponential Technologies fund (ticker: XT). That fund has many of the same holdings but had a mediocre year, rising just 15.4%. However, over a 3-year and 5-year period, XT has beaten its benchmark, the Morningstar US Market, by a little more than one point.
That’s not what you call tremendous tech-driven alpha, so one would hope IDAT turns out a bit better.
Certainly, it pays to keep an eye on one of the highest-profile funds in tech or any other sector, ARK Investment Management’s ARK Innovation fund (ticker: ARKK). It was a high-flyer in 2020, rising 157%. In 2021, it crumbled by 24%.
Cathie Wood, ARK’s CEO, has insisted on betting on what she terms the winners of disruption, including Tesla, which soared in 2021, but also Zoom Video and Roku, both of which tanked last year, bringing down her average.
Morningstar notes that the fund’s five-year track record is still solid, at 39%, annualized, which is almost double the average return for its fund category, mid-cap growth.
ARKK is on a July-ending fiscal year, so, technically, it’s only mid-way through the year. We’ll see if ARKK’s dogs can turn into darlings come July.
With all of these funds, bear in mind that the last time the funds’ biggest names, such as Apple, had a so-so year, was in 2018, and it was worse than the broad market. The S&P 500 dropped 6.24% that year, while Apple declined by 6.79%. The XLK managed to fall just 3% and had a total return of only -1.66%.
Hence, if you think tech’s largest names are bound for a cooling off this year, something modest like XLK might be your safer bet in 2022.
Tiernan Ray is a New York-based tech writer and editor of The Technology Letter, a free daily newsletter that features interviews with tech company CEOs and CFOs as well as tech stock news and analysis.
