Is Being Overweight Deadly For Your Portfolio?

rogernusbaum had a lengthy article listing out ten “hidden
gem” ETFs
. Who knows if they are hidden gems or not but there are some
interesting ideas as well as other talking points that arise from the list. One
of the ETFs featured was the Goldman Sachs Hedge Industry VIP ETF (GVIP) which
owns stocks favored by hedge funds.

I have no doubt that Goldman has plenty of research that supports
why this is a viable strategy, so I don’t want to dig into that, if that
interests you, great, take the time to learn about it. But I did want to
address one thing which was GVIP’s huge exposure to tech which according to is 41%. Such a large weighting in an ETF of favorite hedge fund picks makes
sense due to tech’s strong performance this year.

Let’s say an investor does like the idea underlying GVIP and
they put 10% of their portfolio into it. Totally unrelated to their interest in
GVIP, let’s say the same investor is interested in Taiwan for whatever reason
and they put 10% into iShares Taiwan ETF (EWT). That fund has 56% in technology.
Finally let’s say this same investor wants to have a slight overweight to the consumer
discretionary sector and puts 15% into Consumer Discretionary SPDR (XLY) (client
holding) versus the 12% weighting that sector has in the S&P 500. 15% versus
12% wouldn’t be that extreme.

At this point only 35% of the portfolio has been allocated
and just over 12% of it is already in tech. The GVIP and EWT numbers are self-evident
and XLY has a 16% weighting to Amazon (AMZN) which has traded like a tech stock
and I would argue is going to continue to do so. That 12% is about half of the S&P
500’s weighting in tech.

Although all three themes expressed by the funds are
different and seemingly diverse, the portfolio is well on its way to being very
overweight the tech sector. This doesn’t have to be a negative, but it is poor
portfolio management to not realize what the weightings are and then get caught
off guard for not realizing how much was in a given sector.

This is exactly what happened going into the financial
crisis as many funds were extremely overweight in financial stocks and
investors thought they were more diversified than they actually were.

Addressing this issue comes down to the simplest of
spreadsheet work. ETFs of course allow you to see what they own every day
current to yesterday’s close. There is no reason an investor needs to let
unintended overweights build up other than laziness.

An investor intending to be overweight a sector is a
different matter altogether. Ending up 40% in tech is a very big bet but that
doesn’t mean it has to be wrong, something like that would have been very right
in 1999 and 2017. Putting that much in one sector is risky however. There are
several examples in market history where market excess was expressed through
sector weighting distortion. In addition to financials in 2007 and tech in
2000, energy grew to 30% of the S&P 500 Index back in the 1980’s.