10 shares to diversify your ISA portfolio

This ISA season coincides with an unusual moment for tech shares, and now could be an opportunity to buy, says stock screen expert Ben Hobson.

Last year’s sell-off revealed some yawning differences between stock markets in the UK and the US. But with the outlook improving on both sides of the Atlantic, this ISA season could be the ideal chance for British investors to look to US shares for diversification ideas that can’t be found at home.

• Invest with ii: Open a Stocks & Shares ISA | ISA Investment Ideas | Transfer a Stocks & Shares ISA

There haven’t been many occasions over the past 10 years when UK investors could justifiably feel like their home market was the best place to be. But on many measures, last year it was.

To understand why, just take a look at recent history. America’s S&P 500 index of leading shares has soared by 172% since 2013. Even the worst of the dips in that time - the Covid crash in early 2020 - turned out to be a short-lived setback.

By contrast, the UK’s top 350 shares (a combination of the FTSE 100 and the FTSE 250) has only managed a pedestrian 10-year return of 29%.

Index performance

What the UK and the US shared in common over the past decade was an environment of low inflation and low interest rates that did businesses and investors a huge favour.

When inflation became a pressing issue in 2021, some thought it would quickly pass. But in reality, the era of cheap money was over. With the outlook for profit growth far less certain, businesses had to adjust quickly.

That uncertainty triggered a fall of -19.4% in the S&P last year. But here in the UK, large-cap indices held up better. The FTSE 350 fell by just -4.3% over 12 months, while the blue-chip FTSE 100 finished the year slightly higher than where it started.

One of the reasons for the difference in performance was exchange rates. An unusually strong US dollar proved to be a very profitable tailwind for UK-based companies generating sales in dollars last year. Conversely, it dragged on the earnings of US firms operating abroad.

• Eight easy ways to boost your ISA returns
• A trio of dividend stocks for income seekers
• 2023 Investment Outlook: stock tips, forecasts, predictions and tax changes

Another reason was to do with the influence of different sectors across the two markets. 

Technology shares have dominated the direction of US markets for more than a decade. Strong momentum across the sector accelerated in the Covid years. But tougher economics and fears of recession pummelled tech shares in 2022.

Here in the UK there’s a dearth of large-cap technology stocks. But the strong weighting to energy, mining and defensive sectors such as healthcare, finance and consumer staples helped to support the market last year. The FTSE’s reputation for solid but unexciting stocks worked out well.

New year, new opportunities for diversification

As you can see from the table below, despite last year’s sell-off in US tech, the sector still represents more than 26% of the S&P 500 by value.

Add in the communications sector (which is naturally technology-related) and you have two sectors that account for more than a third (34.3%) of the market. That compares to just 2.7% of the FTSE 350 in the UK - a staggering difference.

Industry breakdown and index weightings

Source: FTSE Russell and S&P Dow Jones Indices.

What’s clear is that British investors just don’t have many options when it comes to tech in their home market. So with many US tech shares selling off last year, this could be an opportunity to grab some technology exposure in the biggest, deepest market in the world.

If you’re tempted, here’s a quick look at how some of the biggest names in US tech currently shape up:

US Technology and Communications shares (by size)

Source: SharePad. *Alphabet has two classes of share (GOOGL and GOOG)

This table gives a hint of the wide operating margins and strong profitability indicators in measures such as Return on Capital Employed that you can find in the tech sector. Microsoft (NASDAQ:MSFT), the largest stock here, had a blistering operating margin of 42% last year.

Like many others, Microsoft’s price came under huge pressure in 2022, falling nearly 30%. That in part has compressed its price-to-earnings ratio since the start of 2022 (just over 13 months) by 25%. A forecast PE of 29.1x might feel racy to value-sensitive investors, but it’s less than it was and the price is now in an uptrend.

Meta Platforms (NASDAQ:META), which operates social media platforms Facebook and Instagram, saw its price collapse by 64% in 2022. It has a long way to recover, but the 49% rise in 2023 suggests that that market is warming to it again.

• The seven deadly sins of ISA investing
• My first four years as an ISA investor
• 11 ways to invest your ISA like Warren Buffett

Another casualty last year was Alphabet (NASDAQ:GOOG), which runs Google, where the price fell by 39%. That has left it on an unusually low forecast PE ratio of 18x - making it another tech giant trading close to a historically low valuation.

Two Communications shares making it into this list of 10 are Cisco (NASDAQ:CSCO) and T-Mobile (NASDAQ:TMUS). The latter had a very solid year price-wise in 2022 but is notably less efficient in its profitability (so watch for those kinds of differences between the sectors).

If you are wondering where the likes of Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Tesla (NASDAQ:TSLA) and Netflix (NASDAQ:NFLX) are, those global giants with strong technology biases are actually all Consumer Discretionary stocks.

Here you can see that Amazon continues to reinvest cash at high rates, which crimps its profitability figures and pushes up its PE ratio (despite the stock halving in price last year). Again, all the shares here have seen a solid start to 2023 after a difficult 12 months. Tesla stock in particular, is up by nearly 70% since the start of this year. 

US Consumer Discretionary shares (with a strong tech bias)

Source: SharePad

Looking further afield for tech ideas

It’s undeniable that the UK market struggles to provide anywhere near the range of technology companies that can be found in the US. It is also true that the tech sector has played an important role in the breathtaking returns seen in American markets in recent years.

While major changes in the economic climate poured cold water on the sector last year, forcing strategy shifts and cutbacks and driving down share prices, few would bet against this sector continuing to flourish in the future.

For UK investors, this ISA season coincides with an unusual moment for US tech, with valuations at multi-year lows but sentiment improving. It could be that US markets are the best way to find that much-needed diversification.

Ben Hobson is a freelance contributor and not a direct employee of interactive investor.