A Safer Way To Play The FANG Stocks

| About: First Trust (FDN)
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The First Trust Dow Jones Internet Index Fund has only 33% of its assets allocated to these stocks.

That allows investors to enjoy some of the upside of these risky stocks, but also not get killed on the downside.

The rest of the index has more mature, reliable, and generally profitable stocks that tempers volatility.

Back in 1999, it was the "Four Horseman" - Microsoft (NASDAQ:MSFT), Cisco Systems (NASDAQ:CSCO), Dell Computer, and Sun Microsystems. Today, it's the "FANG" stocks - Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and Alphabet (NASDAQ:GOOGL). Both groups were given names by Jim Cramer. Both groups soared to amazing heights. Alas, the Four Horseman crashed in 2000, and many believe the same fate will befall the FANG stocks.

The FANG stocks appeal to the best and the worst elements of the stock market. On the one hand, they are growth stocks (although NFLX isn't really growing net income), they are sexy, they are "the future". On the other hand, they trade at outrageous valuations.

Momentum investors love them. Value and conservative investors shake their fingers, warning of a crash.

Sentiment on these stocks can turn around instantly, sometimes even because of a little nugget in an earnings report. All is well if you are riding the wave up, but get caught in a wipeout, and you could permanently impair your capital.

At one point, Netflix lost 80% of its value and is presently 28% off its high. Amazon has had numerous large corrections. FB and GOOGL haven't had their reckonings…yet.

Is there a way to get in on some of the price appreciation without exposing yourself to massive declines? Yes. There are a few ways to approach these stocks that offer less risk and less reward, but still allow you to get in on the action without massive downside risk.

Have a look at the First Trust Dow Jones Internet Index Fund (NYSEARCA:FDN). This ETF owns the FANG stocks as follows: 10.3% Amazon, 9.94% Facebook, 4.88% Alphabet Class A, 4.83% Alphabet Class B, and 4.61% Netflix. So about a third of the ETF is invested in FANG. However, it holds 35 other stocks that compose the remaining two-thirds of the ETF, and those other stocks act as a diversifying hedge. They dampen the big moves up for the FANG stocks but also temper the losses.

As you can see from this chart which goes back beyond May 1, 2012 (when FB went public), you capture some of the upside of the FANG stocks but with substantially less volatility. Just as an example, looking at the correction that took place from December through March:

FDN fell 27% and is since up 30%
AMZN fell 30% and is since up 20%
FB fell 14% and is since up 16%
NFLX fell 38% and is since up 20%
GOOGL fell 12% and is since up 6%

FDN was subject to the drag of AMZN and NFLX as they are the two largest holdings, but the less volatile FB, GOOGL, and basket of 35 other stocks blunted larger losses. However, the recovery is where these other 35 stocks really help FDN, since it has recovered more than any of the FANG stocks. That's because those other stocks have established, mature businesses for the most part.

That's just focusing on this one correction. It's the longer term chart that matters, and it clearly shows the benefits.

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.