Party Like It's 1999: Could These Tech-Heavy Mutual Funds Be Headed for a Crash?

Tech and communication stocks like Facebook and Apple have had a really good year — and could be taking up way more space in some of your mutual funds than you realize.

On average, the tech and communications sectors make up about 34% of U.S. large blend funds, according to Morningstar. That's slightly shy of their 39% share of the S&P 500.

But that hasn’t stopped some fund managers from upping the exposure even more, in some cases well above benchmarks. The tech and communication sectors make up nearly 48% on average of U.S. large growth funds, according to Morningstar.

Seeing as tech has dominated the market in recent months, it's understandable how bulking up funds with these stocks could be appealing.

Morgan Stanley Institutional Discovery, for example, invests 65% of its portfolio in tech and IT, writes Morningstar’s Katherine Lynch. At Nuveen Large Cap Growth fund, it's 55% (with Apple and Microsoft alone accounting for nearly 24%) and at Fidelity Advisor Leveraged Company Stock C fund, tech and IT made up more than 51% of holdings. In all, 190 active stock mutual funds and ETFs have more than 50% of their assets in just these two industries. (Morgan Stanley, Fidelity and Nuveen didn't immediately respond to requests to comment.)

While it’s paid off for some — the Morgan Stanley fund is up 92% on the year compared to 12% for mid-cap growth stocks overall, according to Morningstar — it also means your investments could be risky if you aren’t aware of what portfolio managers are doing.

A bubble?

Twenty years ago, active managers were also exposing their portfolios to a lot of tech. And some of them got burned.

In the late 1990s, investors piled money into internet-based companies, leading to ballooning tech stocks valuations. The Nasdaq Composite skyrocketed more than 500% between 1995 and 2000. But by 2002, the bubble burst, tech stocks like Cisco and Intel dove over 80% and we entered a bear market.

"It was probably our turn to pay the piper," fund manager David Alger told The Wall Street Journal in 2000 after his tech-heavy Spectra Fund fell over 30% after 15 years of positive returns.

It doesn’t look like 2020 is going to be a repeat of the dot-com bubble, but the historical context does indicate that it’s fair to have concerns about your fund being really overweight in the technology sector. As the saying goes, you don’t want to have all your eggs in one basket.

“If you trip and that basket gets turned upside down, all your eggs are broken,” says Rafael Resendes, portfolio manager and co-founder at Applied Finance Capital Management. He adds that Apple may be extremely profitable, but what happens if tomorrow someone develops new technology that displaces the iPhone, like the iPhone displaced the BlackBerry?

What You Should Do

If you’re worried about there being too much tech in your mutual funds, do some research. One tool to determine whether your investments are diversified enough is with Morningstar X-Ray. Enter mutual fund's ticker symbol and you'll receive a report that shows you a breakdown of the types of stocks it owns, including sectors, regions and more. (Here’s a sample). You can also compare also compare each fund's allocations to a benchmark, so, for instance, you can see what percentage of a fund's holdings is tech or energy stocks compared to the S&P 500.

You should also consider whether or not you have both U.S. and non-U.S. equities, a mix of small-, medium- and large-cap stocks and a blend of value and growth, Morningstar strategist Alec Lucas says.

His example of a well diversified portfolio is American Funds Smallcap World Fund, American Funds New Perspective Fund and American Funds American Mutual Fund. The first two are global funds, the first has small- and mid- cap stocks while the second has large-cap and third is more defensive, meaning it focuses on dividend-paying companies with investment-grade ratings and the ability to hold cash or bonds.

And remember that just seeing a lot of tech in a fund doesn’t necessarily give you all the information you need. The Morgan Stanley Institutional Growth’s June portfolio included only Amazon of the five big tech names, and “leaned toward less-established names that the team thinks have long growth runways, especially in the IT services and software industries,” Lucas wrote. In other words, while the fund has focused heavily on tech, it hasn't necessarily blindly followed investing fads.

“The kind of tech exposure you’d get in that fund is different than one you’d get in a fund that is systematically overweighting some of the biggest constituents,” he says. If the fund manager is skilled at picking stocks, then over longer periods of time, their results should be superior to the benchmark’s, Lucas adds.

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