Tech

The five biggest tech companies now make up 17.5% of the S&P 500 — here's how to protect yourself

Key Points
  • Apple, Microsoft, Alphabet, Amazon and Facebook now account for 17.5% of the S&P 500, creating risk of overexposure to passive investors.
  • Financial advisors are coming up with an array of strategies to make sure their clients are diversified while not missing out on tech.
  • Investors have been flocking to ESG (environmental, social and governance) investments as screening tools improve.
Apple CEO Tim Cook, Microsoft CEO Satya Nadella and Amazon CEO Jeff Bezos in the State Dining Room with President Trump.
Chip Somodevilla | Getty Images

The S&P 500 is supposed to represent a broad cross section of large U.S. companies, giving index investors an attractive way to diversify their money while betting on the domestic economy.

That's no longer the case.

With Big Tech earnings kicking off this week, the industry's dominance is greater than ever: the five most valuable U.S. companies — Apple, Microsoft, Alphabet, Amazon and Facebook — now account for 17.5% of the S&P 500. That means investors passively putting money into the most popular exchange-traded fund, the SPDR S&P 500 ETF, are heavily, and perhaps unintentionally, wagering on U.S. tech companies.

In a report earlier this month, Morgan Stanley equity strategist Mike Wilson wrote, "a ratio like this is unprecedented, including during the tech bubble."

The bet has served passive investors well. The S&P 500 climbed 31% last year, its best performance since 2013. Apple, which accounts for 4.9% of the index, soared 86% in 2019, while Microsoft, which makes up 4.6% of the benchmark, jumped 55%. When you get those sorts of gains from two companies that comprise almost 10% of a group, there's little reason to complain.

"As more of these winners reach this mega-cap status, they dominate the end investments," said Scott Acheychek, president of REX Shares, a firm that develops thematic exchange-traded products. "I constantly pound the table and beg people to know what you're investing in, what's inside your product and what you're looking for."

The bull market, which has stretched for longer than a decade, can't last forever. Whether its trade issues, political uncertainty, or an external shock like the coronavirus or an unforeseen war, the market will inevitably hit the skids after such an extended rally. Tech stocks tend to be the most volatile, so the same dynamic that's led to such outsized gains could result in particularly large losses.

Additionally, tech companies face unique threats as regulators in the U.S. and Europe scrutinize what they view as anti-competitive practices.

CNBC spoke with an assortment of financial advisors and industry experts for suggestions on how investors can realign their portfolios to avoid such heavy exposure to Big Tech. Here are some strategies:

Equal weighting vs. cap-weighted investments

The S&P 500 is weighted by market cap, which is why the big five tech companies have such a dramatic influence. The index's entire market value is $27.3 trillion. Apple and Microsoft each have market caps of more than $1 trillion, with Amazon and Alphabet close behind at more than $900 billion apiece.

But S&P also offers a way to value each component equally, whether it's Apple or beauty products maker Coty, which is worth a fraction of 1 percent of the iPhone maker. The S&P 500 Equal Weight Index gives every stock a 0.2% weighting, removing the risk of big losses (or chance of big rewards) based on the performance of Apple and Microsoft.

"If financial advisers are uncomfortable with tech weightings, they can use equal weighting," said Craig Lazzara, managing director and global head of index investment strategy at S&P Dow Jones Indices. "The products we have reflect reality just fine."

There hasn't been a large outcry for the equal weight strategy for good reason. On a one-year, three-year, five-year and 10-year basis, the cap-weighted option has performed better. As of last year, according to the website ETF.com, the SPDR ETF was the most actively traded security in the category, while an equal-weight equivalent didn't crack the top 15.

Marguerita Cheng, a certified financial planner and the CEO of Blue Ocean Global Wealth, said she has recommended that clients in retirement accounts, which allow for rebalancing without tax implications, shift some money into equal-weighted funds. They offer a good way to broaden exposure and reduce some risk, she said, though Cheng acknowledged that clients need to understand the implications.

"If you do equal weighting, the downside is you may not make as much money," she said. "It's important for people to know why a fund is underperforming."

Specialized tech investing

Acheychek of REX Shares says that investors are more excited than ever about tech, and they're demanding more ways to get into the sector without having to pick a stock or two.

Netflix, Tesla and Nvidia are all hot tech stocks outside the big five, and China's Alibaba and Baidu aren't in the S&P 500 because they're not domiciled in the U.S. Acheychek recommends a basket called FANG+, which combines those five names with the big five stocks and gives each a 10% weighting.

Late last year, REX introduced an exchange-traded note, which is similar to an ETF but structured like a bond instead of equity, to track FANG+.

"If you want to make a tech play, make a tech allocation, you should trade a pure tech product," Acheychek said. This index is "10 of the biggest names that people know. It's providing exactly what people want," he said.

Big Tech's outperformance
CNBC

Other thematic products have popped up in recent years, including a number of ETFs focused on cloud computing, providing exposure to companies like Salesforce, Twilio and Shopify. In 2018, Bessemer Ventures took its 5-year-old Bessemer Cloud Index and partnered with Nasdaq to create a benchmark index "designed to track the performance of emerging public companies primarily involved in providing cloud software to their customers."

Paul Pagnato, CEO of wealth management firm PagnatoKarp, said that one of his strategies is to combine passive management with fund managers who are actively focused on the leaders in emerging areas like genomics, 3D printing, autonomous vehicles, the cloud, connected devices and financial technology.

Rather than reducing allocation to technology, Pagnato wants to provide greater access to companies and areas that aren't fully represented in the S&P 500.

"We've chosen to invest in an actively managed ETF manager that has deep expertise in these disruptive innovations," said Pagnato, whose firm overseas $4.8 billion. "The clients are getting tech exposure, but they're getting diversified within the technology space."

The evolution of ESG

Last year, investors flocked into funds focused on sustainable energy and corporate governance, or a category called ESG — environmental, social and governance. According to a November blog post from Jon Hale, head of sustainability research at Morningstar, some $17.7 billion had flowed into open-end funds and ETFs focused on sustainability in 2019, more than triple the amount for all of the prior year, which was a record at the time.

Shareholders are demanding that companies recognize the importance of environmental and social issues, and they're finding that they can target their investments without sacrificing returns, actually generating better-than-average results.

Christina Kramlich, a financial advisor, said her firm, Chicory Wealth, has built a portfolio of companies that rank high when put through ESG screening. Most of the companies are based in the U.S., because she said it's hard to find foreign companies that match the firm's preferences, and they're focused on limiting use and production of fossil fuels while improving internal diversity.

The firm can accomplish all that while keeping fees very low, one of the main attractions to passive management.

VIDEO3:4603:46
Invesco's Dan Draper on coronavirus and ESG investing

"I've always been very skeptical about using ESG screens, and now I'm really impressed and thinking the tools available for advisers and the general public are increasing," Kramlich said. With ETFs "the bloom is a little bit off the rose. It's time to get back to some basic fundamentals and knowing what you own," she said.

None of that suggests that the majority of investors and advisors are tossing out the S&P 500 as the best benchmark for achieving consistent returns on equities.

After all, Big Tech is getting bigger for a reason. The companies in that group have dominant businesses in fast-growing markets and are sucking up an increasing amount of both consumer and enterprise spending. Financial advisors are responsible for keeping their clients attuned to the new dynamics of the index, but that doesn't mean they're pushing them away from it.

"For how long have people been saying, tech is overvalued, tech is overvalued, tech is overvalued?" said Andy Stout, chief investment officer of Allworth Financial. "And it still continues to head higher."

Stout added that, based on earnings, the weighting of tech in the S&P 500 from a market cap perspective isn't far out of whack.

"We're not going to be taking any sort of large active bets to try and time the market, to try to get in or out of technology," he said. "More often than not, people get burned by that."

Correction: A previous version of this story incorrectly included Tesla among tech stocks in the S&P 500. The automaker is not in the index.

CNBC's Darla Mercado contributed to this report.

WATCH: The big tech fights to watch in 2020

VIDEO4:2504:25
The big tech fights to watch in 2020