The AI euphoria continues on the stock market. In indices such as the MSCI World and the S&P 500, the concentration of US technology stocks is very high. How to better diversify the risks when investing.
American technology stocks are once again shining with brilliant price gains this year. Chip manufacturer Nvidia is once again at the forefront, with a gain of 171 percent since the beginning of the year.
But the price increases of Facebook group Meta (+45 percent), Netflix (+44 percent), Google parent company Alphabet (+28 percent) and Amazon (+22 percent) are also impressive. The shares of technology giants Apple and Microsoft also gained around 15 percent and 19 percent in value this year, respectively.
Great potential for artificial intelligence expected
Artificial intelligence (AI) is considered the main driver of the continued strong performance of American technology stocks. “Investors continue to have a lot of faith in AI,” says Chris Iggo, Head of Core Investments at Axa Investment Managers. Like management consultants, he believes that AI could increase economic output worldwide by trillions of euros. Activities that currently require a large proportion of the workforce will be automated by AI. “Technology is changing the world, it is making it more productive,” says Iggo.
In recent years, American technology stocks have consistently earned more than the market as a whole, he continues. This is unlikely to change for the time being. “We are only at the beginning of the application of AI,” he says. The momentum in technology stocks from the USA remains very strong.
High weighting in ETF on the MSCI World
Many savers and investors use well-known stock market indices such as the MSCI World global stock index or the US leading barometer S&P 500 for wealth accumulation and retirement planning. To do this, they use financial products that reflect the development of these indices – so-called exchange-traded funds (ETFs) or index funds. In recent years, they have profited massively from the run of US technology stocks.
The seven most important stocks in the MSCI World at the end of May this year were all American tech stocks. Microsoft had a weighting of 4.5 percent in the world stock index, followed by Apple with 4.3 percent and Nvidia with 4.2 percent. Another concentration risk in the barometer is generally stocks from the USA, which alone have a weighting of 71 percent. US and tech stocks also have a very high weighting in other world stock indices. These include, for example, the MSCI All-Country World Index, the FTSE All-World, the S&P Global 1200 and the Dow Jones Global Titans Index.
Tech stocks dominate stock exchanges and indices
It could, of course, happen that US technology companies dominate important stock market indices in the long term – in the Swiss standard value barometer Swiss Market Index (SMI), for example, this is also the case with Roche, Novartis and Nestlé.
But what happens if the big tech companies can no longer meet the extremely high expectations of investors? Then their stock prices are also likely to go down. If this were to happen, savers and investors who hope to gain broad diversification from their investments in common global stock indices would feel the impact. “The overweighting of US technology stocks and US stocks in global indices is not healthy for investors,” says Ali Masarwah, partner at the fund platform Envestor.
Risk of a crash or lower returns
The risk is not necessarily a crash of American technology stocks. It could also happen, for example, that these stocks’ outperformance is followed by a longer period of lower returns, says Masarwah.
Historically, the composition of the top stocks in the MSCI World has changed significantly. According to a study by the pension fund consulting firm PPCmetrics, for example, Apple and Microsoft were already among the top five stocks in the MSCI World in 2014, but the oil company ExxonMobil, the pharmaceutical company Johnson & Johnson and the American bank Wells Fargo were also there at that time.
One risk for US technology stocks, for example, is politics. The more dominant and larger the technology companies become, the greater the likelihood of regulations or even tech giants breaking up into smaller units, says Iggo. On Friday evening, it was announced that the EU Commission may sue Apple for the US tech giant hindering competition in its app store.
Other companies pay for Nvidia revenue
It should also be noted that Nvidia’s huge revenues are due to investments by other companies in the indices, the market says. This revenue from Nvidia is therefore based on massive expenditures that, at least in the short term, reduce the profits of other companies.
It is still unclear what the future profits will be from the use of new technologies. The euphoria arises from expectations that technology companies will continue to grow disproportionately strongly and be profitable.
What investors can do against concentration
If you are not comfortable with the very high weighting of tech stocks and the USA in the world stock indices, you can give other regions and sectors a higher weighting in order to better diversify the risks.
Masarwah recommends not looking for a “one-product solution” when it comes to wealth creation and private pension provision. Many investors have previously believed that this is exactly what is possible with regular payments into an ETF on the MSCI World. However, the financial expert considers this to be too simple.
High weighting in US stocks can be avoided
His tip is to invest in ETFs when saving for shares and to invest 80 percent of the money in standard stocks and 20 percent in small caps. For example, the standard stocks could be covered by 60 percent shares from industrialized countries and 40 percent from emerging market stocks. For the sake of simplicity, indices from the provider MSCI are also used here.
To avoid the high weighting of the USA in the MSCI World, one could use an ETF on the MSCI World ex USA index – i.e. the MSCI World without US stocks – instead of the MSCI World. The desired proportion of shares from the USA can be determined by investing in the MSCI USA index. Another option would be to add ETFs on European or Japanese stock indices to the MSCI World.
Emerging markets index dominated by technology stocks
There are also concentration risks in emerging market stock indices. This is evident from a look at the composition of the MSCI Emerging Markets barometer. At the end of May this year, 27.2 percent of this was invested in China, 18.1 percent in India and 18.1 percent in Taiwan. The most important stock was the semiconductor manufacturer Taiwan Semiconductor with 8.6 percent, ahead of the Chinese internet company Tencent with 4.2 percent and the electronics manufacturer Samsung with 3.5 percent. Technology stocks therefore have a high weighting here too.
The market is saying that investing in an ETF on the MSCI Emerging Markets is less effective at spreading the risks of investing in stocks. The stocks with the highest weightings in the MSCI Emerging Markets are closely linked to the big tech stocks in the US leading index S&P 500.
Envestor partner Masarwah advises investors to map their portfolio share of blue chips from emerging markets with an ETF on the MSCI China index and an ETF on the MSCI Emerging Markets ex China barometer. This way, you can prevent concentration risks in Chinese stocks and technology stocks and spread the risks of your investment more widely.