The tech bubble – Cover story
Paradoxically, the prominence of tech stocks in default portfo- lios is partly fuelled by the ambition to implement ESG criteria into portfolios. To reduce their carbon footprint, some DC pro- viders, including Nest, have opted for passive funds with a cli- mate tilt. But by trying to reduce exposure to heavy carbon emitters, they increase their exposure to tech giants with a rel- atively low carbon footprint. For Wesbroom, it is important that all elements of ESG funds – environmental, social and governance – are considered. Tesla, for example, might score well on the E side, but perhaps a not as well on governance, while Apple might score poorly on its social standards. Perhaps the most challenging part of any bubble is that exiting the market too early comes with a price tag. DC funds with heavy exposure to tech have until now fared extremely well. Nest’s flagship 2040 retirement fund, for example, booked an annualised return of 9% during the past year mainly due to its tech exposure, while funds that have opted out of tech have underperformed the benchmark.
Diversification
One key challenge for investors in this game of musical chairs might be to establish what events could burst the bubble. For Pilcher, regulation and the introduction of anti-trust meas- ures in the US could be a factor to keep an eye on. “Prices will struggle if we see a combination of regulatory involvement, where hitherto there has been little regulation. “And there is the possibility that we might see anti-trust focus on some of those stocks,” he adds. “If we were to see poor exe- cution, or if we were to see a change in business leadership within some of those sectors. All these factors could affect share prices.”
Deciding when to opt out of tech stocks is a challenge for open defined benefit (DB) schemes which tend to be heavily invested in equities, but often with the benefit of being actively managed. Border to Coast’s Booth acknowledges that the local govern- ment scheme pool, which has most of its portfolio invested in shares, has also benefited from the tech surge. Nevertheless, at the end of 2020 the pool adopted a more cautious stance. “Within our internally managed funds, we are taking profits on outperforming stocks and rotating them back into cheaper stocks,” he says. “As part of that, the scheme has taken profits out of some large cap tech stocks. In contrast, financials could be an area to increase exposure to in 2021.” This caution is replicated by Local Pensions Partnership (LPP), which has actively underweighted some tech stocks in its £8.26bn global equity fund. While Microsoft still accounts for its largest holding at 3.3%, its most underweight positions are Apple, Amazon and Tesla. As such, the fund has marginally
under-performed its benchmark, the MSCI World, during the past two years. A bet that could pay off if the tech bubble were to burst.
While not all investors are convinced that a correction is around the corner, many DC schemes are starting to take a more cau- tious stance. Anders Lundgren, Nest’s head of public markets and real estate, says that diversification will play a bigger role for Nest. “We have been experiencing very high valuations in some sec- tors, but this needs to be seen in the context of the unprece- dented fiscal and monetary response to the pandemic. “As developed market equities become more crowded, and given the likelihood that markets will continue to be turbulent, we want to help find areas that can continue to deliver the per- formance we want.
“This includes increasing our exposure in private markets, such as private credit and unlisted infrastructure equity. US infrastructure is set to receive a significant boost under Biden and being able to invest more in green infrastructure should help in the transition towards a low carbon economy. We believe now is the right time to be diversifying into these asset classes,” Lundgren says. For Nico Aspinall, The People’s Pension’s chief investment officer, it remains important to remember that many tech firms have booked significant profits in the past year. “While the price of tech stocks could currently be inflated, their revenue growth has been impressive during the past year. Eve- rybody will be watching to see how quickly their profits can maintain pace with expectations and, crucially, whether the Federal Reserve makes significant increases to the discount rate.
“The current low-rate environment has also supported high valuations. It would be hard to see an upside for these stocks, but that doesn’t mean they will crash in price, suggesting they were in a bubble,” he says. But Aspinall also stresses that DC schemes have to think beyond a purely market-cap approach. “At The People’s Pen- sion we include an equal-weighting approach for the largest stocks alongside market cap. We expect it to protect us as the rally becomes more diversified and if the froth comes off the top tech stocks. “We also use factors to diversify by investing in size, which means tilting towards smaller companies, and value, where we tilt towards under-valued stocks. These measures complement factors which might make us more exposed to big tech, such as momentum, when we tilt towards companies with high share price growth. “You cannot get away from the fact that a balanced approach to constructing portfolios and a long-time horizon are key,” he says.
Issue 101 | March 2021 | portfolio institutional | 23
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