Is it time to invest in technology funds?

The technology heavy Nasdaq fell 3.1 per cent on 11 April, the worst one-day percentage loss since 2011. Even after the recent fall, the Nasdaq still thumped the S&P 500 over three years, with a 78.2 per cent return compared with a 46.0 per cent return over the period. The S&P 500 index comprises the US's 500 largest companies having common stock listed on the NYSE or Nasdaq.

However, over the long term the technology sector is a picture of success. For the last 15 years the sector has boomed as tech companies' market has spread across the world. In the 1990s there were around 50m PC users, but now there are at least a billion smartphone users - showing how far the potential market for tech firms has come.

This growth is directly reflected in the performance of technology funds and investment trusts. Morningstar data shows that every single technology-focused open-ended investment company, unit trust and investment trust listed on the London Stock Exchange made a profit over the one, three, five and 10 years to 16 April 14. The average 10 year return is 89 per cent.

Tom Slater, manager of Ballie Gifford's Scottish Mortgage Investment Trust (SMT), says he is sceptical about the extent to which recent share price movements tell us about the technology sector.

He said: "Technology can offer a diverse section of risks and rewards. People who have no interest in examining the long-term potential of individual companies are accountable for movements in the market. Where a company's value is 10 or 15 years in the future, you have to accept share price volatility and hang on while the big trends play out. Turbulence is par for the course."

And he also questions what the 'technology sector' actually encompasses. "There are now so many parts of the market, each with their own different dynamics.

"For example, many people would typically include Facebook and Twitter under the technology banner when arguably they are better described as advertising companies, concerned with the movement of advertising dollars online. This side of the sector differs completely from the retail market where companies such as Amazon are exploiting the fact that shoppers are moving online," he says.

So-called 'high-multiple stocks' such as Facebook and Amazon, which have high price to earnings ratios, have experienced a 20-40 per cent correction in recent months, which Walter Price, manager of the RCM Technology Trust (RTT), says is mainly because of concern about rising interest rates in the US.

He says there are around 20 well known tech companies which are trading on "dangerously high" price to earnings multiples of more than 10 times earnings (see table). "This isn't a definitive sell list, but the growth of these companies must be extraordinary, or the margins very high, to allow the stock price to increase from these levels. In other words, it's going to be difficult to make money from these stocks.

"The good news is that with the correction, nine companies have already dropped off this list for 2014, and by next year, I believe most of the companies will have outgrown this danger zone," he says.

Adrian Lowcock, senior investment manager at Hargreaves Lansdown, believes there is still the potential for individual companies to produce "exceptional growth". However, he warns that valuations remain high and at these levels he remain cautious and suggest investors look to access the sector via more diversified US funds.

One of the biggest risks with investing in technology businesses is that they are valued on their potential, rather than their actual profits. Fund mangers and investors alike have to weigh up the "breakthrough" innovations and products – as well as the way the businesses spearheading them are run.

Most fund managers say they're looking for "disruptive" technology which changes the way businesses operate. One of the disruptive technologies of the moment is 3D printing. Last week, 3ders, a 3D printing industry website, reported that a Shanghai company, Shanghai WinSun Decoration Design Engineering Co, made 10 3D printed houses in less than 24 hours – the first time the process has been used for construction.

But Mr Price says he's not entirely convinced by it. He says plastic 3D printing is mainly a market for prototypes and hobbyists, and he doesn't see a sustainable future in it. He's far more convinced by metal printing, which he says is much harder to do well, because the products have to be durable and useable. But because there’s such a high demand for metal parts, he sees a profitable future for companies that can deliver this.

Source: Walter Price, RCM Technology Trust

Find a technology fund

Many of the technology specialist trusts have seen sharp drops in their NAVs in recent weeks which have lead to wide discounts, meaning now could be a good time to buy them while they're cheap.

Polar Capital Technology Trust (PCT) has widened to a 7 per cent discount, its widest level over the past six months. RCM Technology Trust is also on a wide a 10 per cent discount, and Herald, which has more of a European focus, is on an even wider discount of 18 per cent.

Over one year Polar Capital has returned 4.1 per cent, while over three years it has managed to return 20 per cent, slumping below the RCM Technology Trust, which has performed better over the much longer term. It has an ongoing charge of 1.22 per cent.

RCM Technology has returned 23.9 per cent over one year and 29 per cent over three years. Its manager, Walter Price, is a seasoned stock picker with 40 years' experience and has a good eye for finding value. If there's one thing he doesn't do, it's sticking to the index (Dow Jones World Technology index). His principal focus is on growth technology companies that do not pay a dividend, and as a result neither does the trust - and nor does it have any intention of doing so in the future. The fund has flagged over the past six months but Mr Price attributes this to his 30 per cent exposure to what he calls "high growth stocks".

Iain Scouller, analyst at Oriel Securities, says: "Whilst these discounts have widened, we would still be somewhat wary as sectors that see a sharp de-rating after a period of strong performance tend to stay out of favour for some time."

There are also some open-ended funds that have performed consistently well – the average Morningstar sector return over a one year (to 16/04/14) is 10.5 per cent, and a respectable 20.4 per cent over three years.

AXA Framlington Global Technology (GB0006598998) is a strong performing active fund but two of its three top holdings (Google and Facebook) are trading on very high valuations.

JPMorgan's Europe Technology Fund (LU0104030142) is worth checking out. Its top holdings are Nokia, Capgemini and ASML Holdings, and it produed a 23.4 per cent return over one year (to 16/04/14) .

A cheaper way to get technology exposure in your portfolio is through exchange traded funds (ETFs) – and there are a number that focus on the sector. Investors looking for passive technology investments, usually look at ETFs tracking the Nasdaq 100- the index of high tech US firms listed on the Nasdaq stock exchange.

About 60 per cent of the companies in this index are technology firms, with some healthcare and consumer stocks thrown into the mix too. One of the best known Nasdaq ETFs is the PowerShares EQQQ Nasdaq-100 UCITS ETF (EQQQ). It's the sister fund to the well known US ETF Powershares QQQ Trust (QQQ) – and is a fully physically replicated ETF with a TER of 0.3 per cent.

If you want something that's strictly technology, Lyxor has an ETF tracking global technology firms called Lyxor ETF MSCI World Information Technology ETF (TNOG) with a TER of 0.4 per cent.

Performance of recommended technology funds

Source: Morningstar as at 15 April 2014