In this edition of ‘Stock Teasers’ we are going to be looking at a submission to /r/CanadianInvestor on Reddit where the user asks what a good hedge to US tech stocks is. Let’s dive in!

Below we can see the user’s submission where they highlight that their portfolio is overconcentrated in US technology stocks.

Source: Reddit

With the recent run up that US tech stocks have had; many investors may be finding themselves in this scenario. The graph below displays the performance of the NASDAQ-100 which comprises the 100 largest tech stocks in the US. Since January 2023, the Index has returned over 70%, which is evidently a significant outperformance compared to the other major stock market indexes displayed. While many investors have capitalized on these gains, their portfolio weightings have naturally shifted towards tech. Additionally, many of the most attractive new investment opportunities have been coming from US tech due to the significant AI tailwinds in the market. 

Hedging Options

One of the frequent replies in response to the user’s post was to utilize value stocks as a hedge. We agree with this thought process, and it ties into the importance of diversification in a portfolio. Tech stocks are generally classified as ‘growth’ stocks, which are characterized by trading at high multiples, not paying dividends, and the goal is capital appreciation. Due to these characteristics and the consumer focus of technology companies, they typically perform poorly in a recessionary environment.

So, in order to hedge tech stocks an investor would want to have an efficient allocation towards stocks with the opposite traits. Value stocks would fit the bill here, typically being stable, mature companies that trade at low multiples, and which pay dividends at regular intervals. In a recessionary environment, there is typically a shift towards value investments due to the stability they provide. Therefore, by incorporating an offsetting allocation towards value stocks into a portfolio that may be too heavy in technology, there will be some degree of ‘hedging’ in the event of a sector downturn in tech.

Stocks in defensive sectors specifically would also be good to target as a hedge. Defensive sectors are those that are seen as ‘recession-proof’ and will perform similarly no matter the market conditions. Defensive sectors typically have companies with ‘value stock’ characteristics. Sectors such as: energy, consumer staples, and utilities are commonly thought of as being defensive. Utilizing an ETF in one/multiple of these sectors would be an efficient way to manage one’s portfolio.

Conclusion

US tech has been one of the great stories over the last year due to the significant tailwinds that have arose. While many investors have had big wins so far, the risk of the sector should not be understated. The technology sector in general is quite risky due to the characteristics of its constituents and investors should be comfortable with the volatility they are signing up for. Investors should always practice diligent portfolio management with diversification at the top of mind. This includes ensuring that one has an appropriate allocation to what may seem to be ‘boring’ investments in defensive and value stocks. A well-balanced portfolio is one of the best ways to hedge against risks from individual sectors and is a core principle of portfolio management.

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