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Managing FANG Risk

Understanding the risks of owning the hottest stocks in the market.

Facebook (FB) got kicked in the teeth today after news broke that personal information of 50 million people may have been accessed for political reasons. The other FANG stocks (no matter how you define them) were all down as well, more than the S&P 500 but not as much as FB.

The chart captures Facebook, the iShares Technology ETF (IYW) and the S&P 500 for all of 2017. Obviously Facebook outperformed IYW but how much FB would you be likely to own versus a sector fund. An equal weight to tech right now would be 25% of an equity portfolio. If all you own is an S&P 500 index fund you have 25% in tech. If all you use is sector funds and you equal weight tech you're 25% in IYW or another tech fund (repeated for clarity).

In that context there is nothing crazy about 20% in IYW or even 30% (I think 30% is too much for any sector but it is not reckless). But how much are you going to have in Facebook or some other FANG stock or high flyer from another sector or theme? I am conservative on this point, initiating positions in individual stocks at 2% or 3%. A 5% position is not reckless but at some point not far above 5% I think you do start to approach reckless. I would say 10% in one stock is way too much.

But initiating a 10% position in FB at the start of 2017 would have delivered 550 basis points to the portfolio in 2017. A mere 10% in IYW would have delivered 371 basis points to the portfolio, an underweight 20% in IYW would have delivered 742 basis points and an equal weight 23% would have delivered 753 basis points to the portfolio.

If you're a good enough stock picker that you owned FB for part of your tech exposure and the other tech stocks you picked also all beat IYW then this may not resonate but 10% in FB is much riskier than 23% in IYW. According to MacroAxis, FB has almost double the standard deviation of IYW and I might suggest that FB's standard deviation might be muted thanks to how much Facebook has gone up and the mostly subdued volatility in the last couple of years but that is counter factual. Obviously IYW avoids single stock risk.

Social media and the like have a very trendy or faddish nature to them, not like Iomega many years ago or Fitbit and GoPro more recently but creative destruction seems to move a little quicker than the way things use to be. Maybe it's some sort of accelerated version of Moore's Law. Was today's news on FB the beginning of the end? That's not a bet I would make but some form of slow obsolescence down the line if something comes a long that turns FB into MySpace? Sure it is possible.

The ETF offers access to these names of course and will offer more access to them if they continue to outperform and less if they start to fade. Where the S&P was recently criticized as being a momentum fund, it is the tech sector from which a disproportionate portion of that momentum comes from.

In terms of building a portfolio and thinking about what your volatility will be I would argue that you may not need to own FANG stocks individually when they are so well represented in every tech ETF (other than Amazon which is in discretionary ETFs). Maybe save the volatility for names that are not heavily weighted in the big sector funds.

IYW is a client holding.