Managing concentration risk in a portfolio’s tech allocation

Many investors watching the recent strong performance of the technology sector may be worried about the outsized effect on their portfolios if the sector falls out of favour.

But investors can adjust their allocations in a way that allows them to still reap the benefits of the booming industry, says Robertson Velez, portfolio manager at CIBC Asset Management.

“In my view, it’s not so much about overconcentration in tech, but about managing the risk in that concentration and achieving better returns,” Velez said.

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There are a few reasons tech has been so successful in recent months, Velez said. This includes strong balance sheets that allowed major firms to be “much less negatively impacted by rising interest rates” and the surge in generative artificial intelligence (AI), which he described as “a technological revolution on the same scale as the internet or smartphones.”

The major tech companies, known as “The Magnificent Seven,” have been crucial in driving this success.

“The technology sector has had a very strong run [and] a significantly higher return over the broader benchmark,” Velez said.

Given this strong performance, Velez made the case for maintaining exposure to technology in a 60/40 portfolio while encouraging a more selective approach in investment decisions.

“If most of the returns are generated by these stocks that are focused on innovation, why not increase the exposure to the higher growth sectors?” he said.

He noted that 70%–80% of tech investments today are linked to generative AI. Companies such as Nvidia are leading in this area, he said, not just because of their hardware, but also due to their software, which is crucial for running AI applications.

Velez said he expects further growth potential for Nvidia, especially as more businesses update their data centres with advanced computing technologies.

Beyond Nvidia, Velez named other tech firms that support AI, such as ASML, a semiconductor supplier, and Broadcom, a semiconductor and software firm. He also pointed out that software leaders such as Microsoft are integrating AI to better utilize data, and that consumer tech giants such as Apple and Alphabet are finding new ways to use AI on a large scale.

Velez acknowledged the risks that come with investing in technology: “The downside, of course, is that higher returns come with higher volatility,” he said.

Regardless, Velez remains bullish on tech and emphasized the need to choose the right companies that are at the forefront of technological innovations like AI.

“I think the important question to ask is not so much which sectors will outperform, but rather which stocks within each sector will outperform,” he said.

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