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Will tech rally continue? Hedge funds say yes, but mutual funds say no

Technology has been Wall Street’s biggest standout of 2017,
accounting for nearly half of the overall market’s rise thus
far this year. The biggest question for investors, then, is
whether those gains are likely to continue.

As of right now, fund managers are split on the sector’s
prospects.

“Both mutual fund and hedge fund returns in 2017 have benefited
from high allocations to the information technology sector,”
Goldman Sachs wrote on Monday, referring to its own data, which
showed how tech stocks have single-handedly helped active managers
outperform in 2017
. However, “shifts in sector allocations
during [the first quarter] suggest different expectations” for
the future, the investment bank added.

“Although they remain overweight, mutual funds faded the tech
rally,” wrote the team of Goldman Sachs Group Inc.

GS,
+0.61%

analysts, led by David Kostin, the firm’s chief
U.S. equity strategist. “Managers reduced positioning in the
sector to 133 bp (1.33%) overweight versus their respective
benchmarks. However, hedge funds have continued to buy the
rally. Hedge fund managers increased net positioning in Info
Tech by 82 basis points, ending the quarter 352 basis points
overweight relative to the Russell 3000 (25% vs. 21%).”

The tech sector, as measured by the Technology Select Sector
SPDR ETF

XLK,
+0.30%

is up more than 18% thus far this year, more than
twice the 8.9% gain of the S&P 500

SPX,
-0.03%

The gains have come on the back of strong
outperformance by some of tech’s biggest names, including Apple
Inc.

AAPL, -0.87%

Facebook Inc.

FB,
+0.55%

Netflix Inc.

NFLX,
-0.04%

and Google-parent Alphabet Inc.

GOOGL,
+0.97%

which is up nearly 26% in 2017, while the rest of
have advanced more than 30%.

Some investors have raised concerns about valuations in the tech
space
. The tech ETF recently saw its biggest one-day outflow since
January
, while Apple received a rare analyst downgrade on
Monday
.

See also: Tech rally overdone? The case for buying
other stock sectors now

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According to Thomas Lee, a managing partner at Fundstrat Global
Advisors, the bullish view held by hedge funds may be the
correct one.

“FANG usually builds on year-to-date gains,” he wrote,
estimating that the group could rise another 20% to 40% in the
second half of the year. “Given the substantial top-line and
[earnings per share] growth, valuation risk/reward remains
favorable.”

The term FANG refers to four stocks—Facebook, Amazon, Netflix,
and Google—that are major players in the internet space
(Amazon, while heavily connected to trends in the technology
sector, is technically classified as a consumer-discretionary
name given its online retail business.). Apple, which has more
of a hardware focus, is sometimes included in such groupings
(when the acronym is expanded to FAANG).

Outside of the technology sector, mutual funds and hedge funds
have extremely different views on financials, according to
Goldman’s analysis.

The financial sector “is the most underweight sector among
hedge funds relative to the Russell 3000 (-500 basis points),
but it is the second-most overweight sector in
large-cap mutual fund portfolios (+198 basis points),” the firm
wrote (emphasis in original). “The 4 percentage point
difference in Financials’ allocation between mutual funds (14%)
and hedge funds’ net exposure (10%) is second only to
Materials, where mutual funds allocate 3% of assets compared
with hedge funds’ 7% net weighting.”

While financials were the biggest gainers in the immediate
aftermath of President Donald Trump’s election in November,
those gains have stalled lately. The group is up less than 1%
thus far this year.

The divergent views on financials are solidifying, the
investment bank added. “Large-cap mutual fund managers (core,
growth, and value) boosted their Financials’ overweight by 66
basis points vs. their respective benchmarks while hedge funds
increased their underweight by 52 basis points (relative to the
Russell 3000).”

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