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Finding 'Tech' Stocks in a Fund Is Not That Simple

While the five largest U.S. publicly traded companies may refer to themselves as "tech" companies, they're not technically "tech" stocks, which makes finding the right funds to invest in them challenging.

Analyst expectations for third-quarter earnings have improved in October. As of Oct. 22, the Capital IQ consensus forecast for S&P 500 earnings growth was 30%, up from 24% at the beginning of the month. Some of this was driven by optimism within the information technology sector, with analysts projecting 31% growth for the quarter, an increase from the prior 28%. According to Sam Stovall, chief investment strategist at CFRA, since this secular bull market began in early 2009, the S&P 500 has recorded actual quarterly EPS growth that exceeded analysts' expectations in 47 of 48 quarters, missing only in Q2 2020. While some large-cap companies have already reported results, this is a big earnings week. AT&T, JPMorgan Chase and Honeywell are among the prominent companies that have posted third quarter updates, and the five largest companies in the S&P 500 Index—Apple, Amazon, Facebook, Alphabet and Microsoft—will offer details on their financials this week and likely provide guidance. The members of this quintet are often referred to as “technology” stocks, which we think creates confusion for ETF investors.

Index providers S&P Dow Jones Indices and MSCI maintain the Global Industry Classification Standard (GICS) structure for classifying companies into sectors across global benchmarks. In the GICS framework, Apple, Amazon, Facebook, Alphabet and Microsoft are not in the same sector but rather spread across three sectors.

Facebook and Alphabet were moved in 2018 to the communication services sector, while Amazon was never a tech stock in the index world. Investors can find Apple and Microsfot as the two largest ETF holdings in technology sector ETFs Vanguard Information Technology (VGT) and Technology Select Sector SPDR (XLK) as well as mutual fund Vanguard Information Technology Index Fund (VITAX), representing more than 37% of combined fund assets. However, investors need to look elsewhere to find the other three mega-cap companies.

The shift into the S&P 500 communication services sector closely aligned Alphabet and Facebook with the Communication Services Select Sector SPDR (XLC), joining AT&T and Disney. Amazon has always been a consumer discretionary stock and can be found in Consumer Discretionary Select Sector SPDR (XLY), with Tesla and Home Depot. While actively managed mutual funds and ETFs can and do mix and match stocks across sector classifications, index-based funds have rules that must be followed for tracking purposes.

Investors should be focusing on growth funds, not sector funds. Invesco QQQ Trust (QQQ) tracks the 100 largest non-financial companies trading on the Nasdaq and is also often referred to as a technology ETF. However, the ETF has just 49% of assets in companies classified as information technology stocks by GICS, with 19% and 18%, respectively, in communication services and consumer discretionary, and more modest stakes in health care, consumer staples, and industrials. Yet, QQQ has 40% of assets in the five major growth companies that are reporting results this week. Many other growth-focused, index-based ETFs and mutual funds also have hefty representation in the five companies, including iShares S&P 500 Growth ETF (IVW), Vanguard Growth ETF (VUG), and Vanguard Growth Index Fund (VIGAX).

While providing ETF ratings and mutual funds independently from one another, both methodologies used by CFRA incorporate holdings-level analysis, as we believe what is inside a fund matters—not just its past performance. Conclusion It is easy to think you know what is inside an ETF, given they often track well-known benchmarks and are labeled with common terms. However, CFRA believes investors need to look closely so they position their portfolios to fit their objectives.

Todd Rosenbluth is the director of ETF and mutual fund research at CFRA. Learn more about CFRA's ETF research here.

TAGS: Mutual Funds
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