FAANG, BRIC and What Else?
28 February 2018
The financial media is drawn to catchphrases, acronyms, and buzzwords that can be sold as the new thing. FAANG (Facebook, Apple, Amazon, Netflix, and Google) is the latest of these.
But does this constitute an investment strategy?
For journalists, commentators, and marketers, acronyms like FAANG are useful. They fit easily into headlines and they appeal to a feeling among some investors that their portfolios should match the “zeitgeist” or spirit of the age. But, as we’ll see, investment trends tend to come and go. This is not to downplay the transformative nature of new technologies and the possibilities they present. Instead, as an investor, it is wise to recall that all those hopes and expectations are already built into prices.
The FAANG acronym became particularly popular in 2017, as returns from the five members of its unofficial club far outpaced the wider market. Exhibit 1 shows the total year-to-date returns of the FAANG members compared to the S&P 500.
Source: Dimensional Fund Advisors
Such is the public interest in the tech giants that the parent company of the New York Stock Exchange recently launched the NYSE FANG+TM Index. This index includes the quarterly futures contracts of the FAANG members, apart from Apple (hence only one “A”), plus another five actively-traded technology growth stocks. So, does this mean, as some media gurus suggest, that you should re-weight your portfolio around these tech names? After all, these companies fundamentally reshaped the traditional sectors of newspapers, television, advertising, music, and retailing.
For investors, there are a few ways of answering that question, none of which involve denying the significant influence that Facebook, Amazon, Apple, Netflix, Google, and other technology giants have on our lives. Firstly, market leadership is constantly changing based on a myriad of influences. This includes shifts in the structure of the global economy, commodities, technology, demographics, consumer tastes, and supply factors. Trying to build an investment strategy by anticipating these forces is like trying to catch lightning in a bottle.
In the 1960s, the then-often-quoted Nifty Fifty of solid, buy-and-hold blue-chips included such names as Xerox, Eastman Kodak, IBM, and Polaroid, all of which were disrupted in one way or another by newer, more nimble competitors in the following decades. By the late 1990s, the media was full of stories about the dot‑coms – companies that were building new businesses using the transformative power of the internet. A handful of those companies (Amazon, for instance) fulfilled their promise. Many others (retailer Boo.com, prototype social network TheGlobe.com, and pet supplies firm Pets.com were just three examples) crashed and burned.
In the mid-2000s, the focus turned to companies with a large exposure to the so-called BRIC economies, an acronym based on the fast-growing emerging economies of Brazil, Russia, India, and China. Several financial services companies even set up BRIC products, with mixed degrees of success. One investment bank argued that the superior growth for emerging economies justified a bias to stocks exposed to these markets. It ended up closing its BRIC fund in late 2015 after years of poor returns (“Goldman Closes BRIC Fund,” The Wall Street Journal, November 9, 2015.).
So, while individual sectors can each have their time in the sun, weighting your portfolio towards a currently favoured industry may not be a sustainable long-term strategy. Still, accepting that it is difficult to pick winning sectors does not mean you should exclude these zeitgeist stocks in a diversified marketwide portfolio. You can still own them. You just do so by casting a much wider net.
The more concentrated the portfolio, the more you are exposed to idiosyncratic forces related to individual stocks or sectors. Being highly diversified means you can still benefit from the broad trends driving technology, or whatever is leading the market at any one time, but you are doing so in a more prudent manner. To put it another way: by diversifying you are not only reducing the risk of placing too much of a bet on one sector, but also improving the odds of holding the best performers. Look at Exhibit 2, which shows what would have happened if you had excluded the top 10% and top 25% of market performers in a global portfolio from 1994–2016.
Source: Dimensional Fund Advisors
We’ve seen that even professional investors can find it tough to pick which sector will lead the market from year to year. It’s true that technology companies like Amazon and Facebook have performed well recently. But it is worth recalling that current prices already contain future expectations about those companies. We don’t know what future prices will be, because those will reflect information we haven’t received yet. Since no one has a reliable crystal ball, a better approach is to diversify. That way, we increase the odds of being positioned in the next big winning sector without chasing hot trends or latching on to cute‑sounding acronyms.
What is the best way to diversify effectively? To follow an evidence-based indexed strategy. As indices constantly change over time to include new companies and discard old or fallen ones, investing in such a manner ensures that the individual investor would not need to constantly try to buy the up-and-coming sectors or industries. All this work is handled automatically and ensures a stable, evergreen strategy.
The exhibit below shows how the investable universe has evolved over the years. In the 60’s and 70’s, a diversified investor was only able to access 1000 stocks from fewer than 20 countries around the world. Today, investors can buy more than 14,000 securities from over 70 countries, including rapidly growing countries from the Emerging Markets. For instance, GYC’s Everest Portfolios have a globally-diversified allocation comprising over 9,000 securities from 47 countries and representing 35 currencies. An undiversified investor focusing on a handful of securities would miss out on a huge opportunity set.
*Content adapted from “Outside The Flags – Catchphrase Investing” by Jim Parker, Vice President, DFA Australia Limited, Dimensional Fund Advisors Pte Ltd.
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