The FAANG fallacy: A closer look at the risks of acronym investments

From the latest ‘Magnificent 7’, comprising powerhouses including Microsoft, Apple, Alphabet, Meta, Tesla, Amazon, and Nvidia, to variations like FAANG (the ‘N’ represents Netflix), MAGMA, and MAMAA, these acronyms represent market darlings in moments of time.

Even in Australia, we’ve had our own version with the ‘WAAAX’ – WiseTech, Altium, Afterpay, Appen, and Xero.

But the media’s love affair with their meteoric rise can mask a hidden risk: what goes up, doesn’t always stay up. Even within these seemingly invincible acronyms, companies can falter or simply fall out of favour due to factors such as disruption, mismanagement, or poor execution.

In this blog, we explore how today’s most buzzworthy investment choice can become tomorrow’s cautionary tale, and share some ETF ideas that can help investors navigate market shifts without getting burned by a single stock’s stumble or an entire acronym’s downfall.

The trend trap

During a rising market, when everything seems to be trending up and certain companies are taking off due to a novel idea or theme, it’s tempting to believe that this time is different.

But it’s precisely during times of exuberance that the allure of quick gains can overshadow prudent investing.

Lessons from the past: GE, Appen, BRIC

History is littered with the wreckage of once-unstoppable companies that were idolised by many investors at the time.

Consider General Electric, which fell victim to its own poorly timed acquisitions and unsustainable debt, forcing it to split. Its fall from grace as once the world’s largest conglomerate was marked by its expulsion in 2018 from the Dow Jones Industrial Average of America’s 30 most significant businesses¹.

Closer to home, Appen has lost nearly 99% of its value as its over-reliance on a few large clients led to its fall from grace². The company was removed from the S&P/ASX 200 in 2022³.

It’s not just individual companies that can fall victim to overhyped trends. Remember the BRICs (Brazil, Russia, India, China)? This catchy acronym once represented the hottest emerging markets, dazzling investors with their brief, initial outperformance (see chart below).

However, the allure of the story overshadowed key risks like political instability and challenging economic fundamentals in developing nations.

China’s slowdown, Brazil’s political turmoil, and the mass exodus from Russian assets due to Russia’s illegal war in Ukraine exposed the dangers of overexposure to specific emerging economies. The once-mighty BRICs have now become the “BICs,” delivering subpar returns compared to the broader global and emerging markets.

Today’s trending acronyms: Magnificent 7, FAANG, MAGMA, MAMAA

Facebook, Alphabet, Meta, Amazon, Microsoft, Nvidia, Netflix and Tesla have contributed to a significant portion of the growth in the Nasdaq 100 and S&P 500 indices over the last decade.

Bundling them together into a memorable acronym and focusing on past performance makes them seem like a sound investment thesis, but going all-in on the tech behemoths can expose investors to undue risk and volatility.

Just as BRIC obscured the differences in the economies in the constituent countries, FAANG and its variants can mask significant differences in the performance of individual stocks, as shown in the chart below.

Although focusing on a short period of time, the performance of the FAANG companies for the last 12 months illustrates significant divergence between them, with Apple gaining just 3.2%, while Meta soared over 120%. Netflix, bumped out of the FAANG club in favour of Microsoft to form MAGMA or MAMAA, is experiencing a resurgence and outperforming Microsoft, Amazon, and Alphabet.

These unexpected outcomes illustrate that investing in one or a few of these equities exposes investors to volatility, unpredictability, and the potential to wipe out gains in dramatic twists and turns.

What can we learn?

While it’s true that historically, these companies have made substantial contributions to index returns, it’s equally undeniable that it’s impossible to predict when companies are past their prime.

The data speaks volumes. Since 2015, nearly a third (around 180 companies) of the S&P 500 constituents have been replaced⁴, often due to economic shifts, disruption, poor management, or acquisitions by larger rivals.

Furthermore, the tables below show how radically different the list of the world’s largest companies has become since 2000, compared to recent history.

Largest companies by market capitalisation (1 January 2000)

Largest companies by market capitalisation (1 July 2022)

This is where considering ETFs that track entire markets and sectors, or invest in securities with defined criteria, makes sense:

• Built-in diversification: No need to stress over choosing individual winners. Index-tracking ETFs spread your investment across a range of companies, making diversification easier and reducing your exposure to any single company’s setbacks.
• Automatic rebalancing: Indexes aren’t static. As companies fluctuate within the index, underperformers are regularly swapped out for stronger contenders. This ensures your portfolio remains aligned with the economy’s evolution.
• Long-term focus: Index funds aren’t swayed by short-lived trends. They aim to track the overall market or companies (before fees and expenses) that meet defined criteria, capturing growth across various industries and sectors. This approach helps you weather the inevitable ups and downs of the market.