Passive investors may be far more exposed to the AI trade than they realize. New data brings into sharp relief the risk that investors are, perhaps unknowingly, putting all of their eggs into the U.S. technology basket.
Warnings about tech-sector concentration are nothing new, but the problem is intensifying just as the risks surrounding the artificial intelligence boom are multiplying.
If you take into account the tech sector’s share of the S&P 500 market cap – which is within a whisker of June’s record high – as well as the communications services sector and other big tech-centric companies, the broader tech universe now makes up more than half of the index’s entire US$70-trillion market value. The U.S. stock market has rarely been this concentrated and narrow.
Investors buying an index-tracking fund may think they’re gaining exposure to the top U.S. banks, retailers, energy firms and healthcare giants, as well as the famed tech and AI behemoths. But tech is now so dominant in the index that what they’re buying increasingly resembles a tech fund with a few other sectors added on for appearance’s sake.
Passive investing itself arguably exacerbates the problem by pushing more money into already crowded trades – and passive investment flows have long dwarfed their active counterparts. U.S. equity funds currently hold over US$16-trillion in assets under management, based on funds that report at least weekly, according to Société Générale, and roughly 70 per cent of that is now passively managed.
These passive funds have attracted cumulative inflows of almost US$3-trillion since 2019, while investors have pulled around US$1-trillion from actively managed funds, SocGen analysts note.
Even the concentration within the passive fund universe is rising rapidly. The three largest listed passive S&P 500 index exchange-traded funds (ETFs) – State Street SPDR, iShares Core, and Vanguard’s VOO – have nearly US$2.7-trillion in assets under combined management. It’s a near-constant, one-way flow.
This concentrated bet is fine when tech is on the up, as has been the case for much of the past few years. The rising tide has – for the most part – lifted all boats. But it’s not all plain sailing for the AI revolution right now, with safety concerns and doubts over the technology’s long-term economic viability recently bubbling to the surface. If these waters suddenly turn choppy, the pain will be felt far and wide.
And more Americans than ever are in this boat. According to Federal Reserve figures released earlier this month, equities now account for almost 47 per cent of U.S. households’ financial assets and 34 per cent of total assets. Both are record-high levels.
“We are not calling time on the AI cycle, but positioning has grown too concentrated for comfort, and the reward for looking beyond the crowded trade has rarely been clearer,” WisdomTree’s Aneeka Gupta argued last week.
Ameriprise’s Anthony Saglimbene echoed this on Monday, stressing the importance of “understanding the concentration of technology in your portfolio and diversifying inside and outside of that tech exposure.”
But diversifying out of tech is easier said than done. AI’s footprint in all markets is expanding, whether that be in investment-grade credit, emerging markets or private markets. What should investors do? Everyone likes to think they will get to the exit in time, but history has proven that not everyone does. The stampede, if and when it comes, could be fierce.