If 2017 was the year of the momentum and tech stocks, then 2018 could turn out to be the year things change. The first half of the year just seemed like more of the same in terms of momentum and tech stocks, but it seems that over the last month or so, active managers have been tweaking their strategies, preparing for a time when tech isn’t the only sector to soar. Portfolio managers are finally downshifting their FANG and Tech stock positioning while cranking up their exposures to Energy and Materials.
Perhaps this is an early sign that fund managers' expectations will finally come to fruition across the equity market. In fact, based on our coverage of BAML's update on active managers from a little over a year ago, the picture is looking quite a bit different.
Slashing exposure to Industrials
Bank of America Merrill Lynch strategist Savita Subramanian and team said in their Aug. 6 update on active managers' holdings that Industrials are out while Energy and Materials are in. They said over the last month, large cap active managers reduced their weighting in Industrials to nearly the lowest level ever recorded. The subsegment of Industrials which fell the most out of favor was Aerospace & Defense, which drove most of the decline in Industrials positioning among active managers. In fact, the overweight on Aerospace & Defense fell to the lowest level in at least 10 years.
Meanwhile, active managers boosted their positionings in Energy and Materials to their highest levels in over a year. Last month, positioning in Materials sat at its lowest level in five months, but now, positioning in the segment is at its highest level in 16 months. The BAML team found Chemicals to be the favorite subsegment of Materials.
Last year, active managers were dumping value stocks and piling in hard on tech stocks and FANG. Overweight tech stock positioning a year ago was at a record high.
FANG and tech stock positioning in moderation
BAML's latest update on active managers is also notable because it shows managers are finally easing up on the throttle in Tech. Active managers rotated out of Tech and also Consumer Discretionary and into cyclical sectors, increasing their exposure to cyclicals by the most in nearly one year.
Tech stock positioning is of particular interest because large cap active managers are finally showing signs of souring on the FANG stocks (Facebook, Amazon, Netflix, GOOGL/Alphabet). According to the BAML team, active managers reduced their relative weights in the FANG stocks again over the last month. Two years ago, they were at a 70% overweight, according to the firm, but after dialing back their positions recently, they're now at an approximately 50% overweight.
Even though active managers have been dialing back their tech stock positioning and FANG stock weightings, BAML still warns about crowding risks. The firm also explained that major funds were probably hit hard in July by the recent selloff in the sector.
Indeed, many of the second-quarter hedge fund letters we've reviewed have also shined a spotlight on tech stock positioning recently. Value funds in particular have struggled as tech stocks have soared, leaving them lying in wait for their day. Corsair Capital highlighted the way stocks have been running against typical expectations, based on macro factors like rising interest rates and the ongoing trade war. JHL and Lakewood both wrote about speculative investing, particularly in high-flying tech stocks which show no sign of slowing down.
Adding FAAANG and AANG into the mix
Most investors are familiar with the FANG acronym and even FAANG, but in their latest update, BAML added another one into the mix. After screening for Tech stocks with at least 20% sales growth; expectations of at least 15% long-term growth; and a market cap in excess of $65 billion, the BAML team got Adobe Systems and Broadcom in addition to the FANG stocks, which makes their new acronym FAAANG. Interestingly, they found that the "disproportionate overweight" in the FAAANG group was even greater than in the FANG names.
In analyzing tech stock positioning, the BAML team was able to determine who was buying the FANG stocks, and it wasn't long-only funds. They observed a narrowing in the spread between the relative weights of FANG and non-FANG stocks over the last year.
They believe the recent shift in the FANG stocks may be the result of managers covering their shorts rather than outright active buying. The reason is because short interest in FANG and FAAANG fell close to record lows of 1% of the float over the last year, and as much as things change, some things stay the same. BAML also said last year that most of the gains in the FANG stocks were driven by short covering. Clearly, FANG is still dishing out pain to short-sellers a year later.
The BAML team also weighed in on another new acronym: AANG, which consists of Apple, Amazon, Netflix and Alphabet. Looking at this group, they found that relative weighting in this group has tumbled significantly in the last two years.
Latest index rebalance now in the books
Every June, FTSE Russell rebalances the major stock indices in the U.S., and usually the biggest shifts can be seen in the Russell 1000 Growth and Value indices than in the Core index. According to the BAML team, after rebalancing the indices, value hedge funds are now the most overweight on Financials and Tech stock positioning. Interestingly, value managers were "moderately underweight" on Tech the previous month, BAML added.
Meanwhile, growth funds' positioning held mostly the same after the rebalancing, except for an extreme cut to Telecom positioning, which BAML attributes to Verizon's exit from the Growth index.
Another big change coming... to the S&P
The FTSE Russell rebalance isn't the only big change investors should watch out for. The S&P 500 will be changed dramatically so that Tech doesn't dominate the index as much. In less than two months, two of the FANG stocks—Facebook and Alphabet—will exit the S&P's Tech sector and join the new Communications Services sector.
Even though this is being done to make Tech look less dominant, the reality is that Tech will remain strong. On paper, it will look like Tech weightings in the S&P are dropping, but in reality, some of the most popular names are simply being re-filed under a new group. The change will certainly impact the holdings in some major funds after it goes into effect.