FAANG Weakness Problematic For Plenty Of ETFs

Reminding investors that nothing, at least not in financial markets, moves up in a straight line, the fabled FAANG quintet has recently encountered selling pressure.

FAANG membership consists of Facebook Inc. FB, Amazon.com, Inc. AMZN, Apple Inc. AAPL, Netflix Inc. NFLX and Google parent Alphabet Inc. GOOG GOOGL.

Fierce FAANG

As of June 9, Apple, Amazon, Facebook and both classes of Alphabet shares represented five of the top 10 holdings in the S&P 500. With the S&P 500 being a cap-weighted index, the dominance of FAANG in the benchmark U.S. equity gauge reminds investors that a slew of exchange traded funds will be affected by any further retrenchment faced by the FAANG stocks.

FAANG “had a bad day on Friday after research notes from Goldman Sachs, Deutsche Asset Management and others warned that these stocks were too expensive. Owning these five stocks, which together accounted for more than 40 percent of the S&P 500’s gains this year before Friday’s sell-off according to an article in this weekend’s edition of Barron’s, are an extremely crowded trade,” said AltaVista Research in a note out Monday.

Weighting by market capitalization is the most frequently used weighting methodology by ETFs and index funds. Advocates of cap-weighted indexes say the strategy gives investors exposure to the “whole market” while detractors say weighting by market value exposes investors to richly valued stocks. Additionally, detractors of cap weighting say the strategy leaves investors vulnerable when asset bubbles burst.

Everyone Has Bad Days

For now, it is not reasonable to say a couple of bad days for FAANG stocks means another tech bubble is coming, but it must be remembered that “as these stocks’ market caps grew, so too did their weight in most of the ETFs that hold them,” said AltaVista.

Alone, Apple accounts for over 17 percent of the iShares U.S. Technology ETF's IYW weight. IYW's total FAANG exposure is about 38 percent, highlighting why the ETF fell more than 3 percent last Friday. Amazon and Netflix are classified as consumer discretionary stocks, so they are not part of technology ETFs such as IYW.

Those stocks do, however, reside in broader market ETFs, such as the PowerShares QQQ QQQ. QQQ's FAANG exposure is about 34.5 percent, according to AltaVista data.

Although Apple is not a member of well-known internet ETFs, the FAANG allocations in those funds are still high. For example, the First Trust Dow Jones Internet ETF FDN, the largest U.S. internet ETF, has FAANG exposure of 32.7 percent.