I have recently come across the term 'Fab Five' in articles on various financial news websites. This phrase refers to the five mega cap tech companies that have kept S&P 500 afloat thus far in 2015: Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Google (GOOGL and GOOG), Facebook (NASDAQ:FB), and Netflix (NASDAQ:NFLX). These stocks jointly account for over 8% of S&P 500 market capitalization and have contributed positive 1.6% to the index return whilst the remaining 495 constituents combined for negative 5.6% (see the chart from Google Finance below). These results made me wonder how the 'Fab Five' stocks fit into a typical portfolio and what risk characteristics they possess.
For the analytical purposes, all statistical measures have been obtained from a freely available investor resource InvestSpy. FB was the last one out of the 'Fab Five' to IPO on May 18, 2012, thus historical data for other stocks have been truncated to this date.
To start with, let's take a look at the correlation coefficients:
The figures in the table above are quite remarkable as pretty much all the coefficients are sub 0.50. Not only are the 'Fab Five' stocks little correlated to SPDR S&P 500 ETF (NYSEARCA:SPY) but they appear to be independent from their peers as well. The least correlated pair is AAPL and NFLX with a coefficient of a mere 0.04. The highest correlated pair is GOOGL and AMZN, although the coefficient of 0.47 is still very low. To put this in perspective, as shown in one of my previous articles, correlations between sector ETFs rarely fall below 0.70.
It is also useful to look at other risk characteristics:
As can be seen from the table above, volatility levels of the 'Fab Five' members differ significantly. NFLX is by far the most volatile stock with 57.2% annualized volatility, whilst GOOGL was least volatile. However, even at 24.0% GOOGL was almost twice as volatile as the SPY ETF in the same period.
Although the last few years were pretty stable for the broader market, wider fluctuations among the 'Fab Five' members meant that their maximum drawdown levels were well beyond that of SPY at only 11.9%. Even AAPL, which had the lowest beta coefficient and relatively contained annualized volatility suffered a maximum drawdown of 43.8%. What this means in practice is that, for example, in a simplified portfolio with 50% invested in SPY and 50% in FB risk contributions will be of completely different magnitude. The table below illustrates that 87% of volatility in such a hypothetical portfolio would come from the holding in FB and only 13% from SPY.
Summing up the observations above, it appears reasonable to include the 'Fab Five' members in your portfolio as low correlations make them attractive holdings. At the same time volatility inherent in these stocks is way above average, thus the size of the positions has to be carefully managed. The last three years have been great but if the trend reverses, the impact on portfolio returns can be not so fabulous.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.