Ride the new wave

The tech-heavy Nasdaq has surged this year, hitting new records in April, June and July, but earnings season has not been a good one for today's tech giants. Analysts were rubbing their hands in the run-up to Trillion Dollar Tuesday last week - when the biggest tech companies open their books - in anticipation of yet more blockbuster earnings for the tech sector. But disappointing results across the board shattered that optimism, sending US markets on a week-long downturn as a result.

Apple (US: AAPL) was one of the biggest let-downs for markets. Despite solid revenue figures, its shares fell by more than 4 per cent on Wednesday after sales of the iPhone 6 fell below expectations and the company failed to reveal sales figures on the Apple Watch. Revenues and earnings came in ahead of analysts' consensus estimates - net income was up 39 per cent to $10.7bn - but that was not enough to please Wall Street and by Wednesday morning investors had wiped about $66bn off the value of the company.

Microsoft also suffered after reporting its worst ever quarter. Shares fell 3.7 per cent during trading on 22 July after the company reported losses due to the failed acquisition of Nokia's handset business and waning profits in the PC market. Its hopes rest on the imminent launch of its new Windows 10 operating system, but the market isn't yet convinced. Meanwhile, results from IBM and Yahoo also took their toll on the Dow Jones, which lost 1 per cent during trading on Tuesday.

Tech grows up

Technology remains an exciting, if volatile, place to invest, with the Nasdaq returning 192 per cent over the past 10 years.

The US has already witnessed a record year for buybacks and dividends, and observers point to the volume of mature tech companies returning money to shareholders rather than reinvesting as evidence of a decision to age gracefully. Those lining up to line shareholder pockets included Apple - which ramped up its capital return programme by 50 per cent to $200bn this year - IBM (IBM) and Oracle (ORCL).

Walter Price, manager of Allianz Technology Trust (ATT), says: "Apple and Microsoft are modest growth companies now" and David Coombs, head of multi-asset at Rathbones, says: "I think Microsoft is ex-growth. Companies like HP and Microsoft are not where you get exposure to the exciting new themes."

Next generation tech

According to Ben Rogoff, manager of Polar Capital Technology Trust (PCT), technology has broken out of its sector confines and infiltrated consumer, retail and security. Themes such as cloud computing, big data and cyber security are the stories to track today and he says "these new opportunities have very little to do with legacy incumbents".

Mr Rogoff says: "The new technology cycle continues to be underpinned by three core themes: internet infrastructure, broadband and internet applications and mobility, with 'big data' playing a galvanising role."

"People tend to think of technology in terms of one easy-to-consume sector and we think that's missing the point," says Catharine Flood, spokesperson at investment manager Baillie Gifford. From electric cars to heating systems operated from your mobile phone, tomorrow's tech giants are tapping into the flood of data we feed into the ether in order to send technology's tentacles reaching into new aspects of our lives.

Valuations mean now is a good time to back younger entrants in these fields too, according to Mr Rogoff. Polar Capital Technology Trust's annual report claims: "Despite more challenging fundamentals, many of the legacy companies in our sector are today trading at their highest relative price-earnings ratios for years.

"In contrast, most of our favoured next-generation companies with modest (if any) exposure to challenged areas are materially cheaper today than 18 months ago despite most having continued to deliver strong performance."

Walter Price at Allianz agrees that a convergence between valuations in the high- and low-growth sectors of the market are making higher-growth, smaller companies more appealing on a relative basis.

THE TRENDS TO WATCH

The Internet of Things and big data

The Internet of Things (IoT) is a key playground for some of those high-growth companies. IoT is shorthand for everyday objects that are able to connect online and use data to perform tasks without human input. It is an increasingly powerful trend backed by the likes of Google, which paid $3.2bn last year for Nest, a company that created WiFi-connected thermostats.

One share backed by many tech fund managers is semiconductor and software design company Arm Holdings (ARM). In 10 years its shares have risen sevenfold and its chips are now used in 95 per cent of the world's smartphones. But its fortunes have so far been shackled to the smartphone and, in a bid to diversify away from its reliance on companies such as Apple, the microchip maker has branched out into the IoT.

It has set its sights on the batteries and sensors required to power up connected everyday objects, working on technologies to enable machines such as fridges and watches to interact with each other over the web. In July it revealed that 20 out of the record 54 processor licences it signed in the last quarter were "for use in technologies required for the Internet of Things".

Another IoT innovator is Splunk (US: SPLK), which entered the US public market in 2012 via a mammoth IPO. The company creates software aimed at analysing and digesting big data and has garnered a lot of attention in recent years. However, many argue that the company is looking overvalued. Then there are the companies taking big data to DNA. Genomic testing machine maker Illumina (US: ILMN) has featured heavily in healthcare and tech fund portfolios in recent years.

Electric cars

In the formerly unsexy world of electric cars, electric carmaker Tesla Motors is making strides (US: TLSA). Dubbed the Apple of autos for its ability to create luxury cars in the electric market, it has recently also waded into the home energy storage market with the launch of the Powerwall battery in April this year. The product puts it ahead of peers in the race to solve the issue of expensive grid electricity and reach the holy grail: home battery storage. The Powerwall charges using electricity generated from solar panels during the day, or when utility rates are low, and then powers your home in the evening. Tesla's shares have been volatile since its IPO but have levelled out in recent months.

Cyber security

Cyber crime is arguably one of the biggest security threats facing corporations today and a major area of spending. The number of detected cyber attacks increased by 48 per cent between 2013 and 2014 and high-profile hacks at Sony Pictures last year sent shivers down the spines of chief executives.

According to Allianz, total spending on cyber security is expected to grow at a rate of nearly two times that of overall technology spending in the coming years and companies such as Palo Alto Networks (US: PANW) look set to gain. The company creates advanced firewalls and has grown rapidly, with its shares last week trading at a 52-week high on a forward PE ratio of 118. But managers say those figures are not overheated and are backing it as a solid contender for future growth.

Allianz Technology Trust manager Mr Price says: "Security providers that create more sophisticated solutions and adapt these solutions as threats evolve should be the largest long-term beneficiaries in the security industry. Within the portfolio, Palo Alto Networks and FireEye (US: FEYE) have been among the top performers as both companies are benefiting from increased spending on security solutions. We believe this growth in spending will continue at a rapid pace as hackers are showing no signs of slowing down."

HOW TO INVEST

Why funds could offer you the keys to the tech jackpot

Using a fund to invest in technology will give you access to stocks on the major US exchanges as well as allowing you to spread your risk. You could also gain access to some blockbuster companies racking up valuations in the private market normally off limits to retail investors.

The whole picture

Allianz Technology Trust (ATT), run by Walter Price and Huachen Chen in San Francisco, is a solid way to back the disruptive technology theme, according to Jason Hollands, managing director of Tilney Bestinvest.

Mr Price backs cyber security stocks such as Palo Alto Networks, as well as themes such as IoT via Splunk and cloud computing via ServiceNow (US: NQE), Amazon (US: AMZN) and Microsoft (US: MSFT). The fund holds a mixture of high-growth, high-multiple companies and larger, lower-growth companies that the managers think are showing signs of innovation. That includes Microsoft, which the group believes is adapting to the cloud and Apple.

The trust suffered in the 2014 sell-off, underperforming its benchmark, but still returned 7 per cent in the year. It is a concentrated bet, with just 57 holdings, but in recent years that conviction has paid off and the trust grew its net asset value (NAV) by 191 per cent between 2007 and April this year.

Allianz Technology Trust top 10 holdings and valuations

Source: Bloomberg, as at 24 July 2015

Polar Capital Technology Trust (PCT) is another solid choice. The fund is run by Ben Rogoff, who also manages open-ended fund Polar Capital Global Technology (IE00B42W4J83) with a similar remit. Over 10 years it has returned 282.8 per cent and has returned double-digit total returns each year since 2011.

Mr Rogoff believes we are entering a new phase in the technology cycle and is reducing exposure to companies such as Microsoft, one of the fund's largest underweight positions at 3.2 per cent. He favours shares such as Tesla, Illumina and Splunk, as well as software company Mobileye (US: MBLY) and Medidata Solutions (MDSO), a US company specialising in cloud computing and big data in healthcare.

Kieran Drake, an analyst at Winterflood, says: "Mr Rogoff makes a compelling case for the emergence of the next technology cycle and the disruptive effect that it is having on many of the sector's large-cap incumbents. This strategy served the fund well during the tech/growth downturn in 2014 and reduces volatility relative to the benchmark."

Polar Capital Technology Trust top 15 holdings and valuations 

Source: Bloomberg, as at 24 July 2015

Darius McDermott, managing director at Chelsea Financial Services, says: "AXA Framlington Global Technology (GB00B5MQXC30) is a solid, consistent performer, offering growth at a reasonable price." Over five years the fund has returned 96.6 per cent, beating the average 87.3 per cent for the technology and telecoms open-ended fund sector.

However the majority of broad tech funds will have a high exposure to the biggest names such as Apple and Microsoft and have suffered due to Apple's recent share price losses. Henderson Global Technology (GB00B288CP83), Invesco Global Technology (IE0003707928) and AXA Framlington Global Technology all hold more than 9 per cent of their portfolio in Apple.

Targeting smaller stocks

Jason Hollands, managing director at Tilney Bestinvest, says: "If you want to be in earlier-phase businesses, look at Herald Investment Trust (HRI), which invests in around 200 companies and, unusually, is mostly exposed to the UK - the core tech funds tend to be 70 per cent in US stocks."

The trust invests in early-stage technology, media and telecoms companies with a heavy emphasis on innovative, high-growth companies set to be the targets of takeovers and looks at unquoted companies, as well as those on the public markets including London's Alternative Investment Market (Aim).

In its half-year to 30 June 2015 the trust earned £44m from a steady stream of takeovers including those of software provider Kofax, IT company Phoenix IT and Advent Software, contributing 25 per cent towards a NAV increase of 7.9 per cent.

Manager Katie Potts, a former technology analyst, is wary of the valuations in the private market in the US and thinks a bubble is emerging in Northern California. The fund is currently invested 63.8 per cent in the UK and has 286 holdings, including companies such as Diploma, an £877.6m company invested in technical products sold to sectors including life sciences and industrials.

Another fund targeting small companies is Marlborough UK Micro Cap Growth fund (GB00B8F8YX59). Although not strictly a technology fund, 23 per cent of its assets are invested in the sector. Adrian Lowcock, head of investing at AXA Wealth, says: "It is a niche player, buying very small companies. The managers are interested in the big data theme, which is very cutting edge, but they're diversifying across a range of asset classes." Holdings include wireless machine-to-machine technology company Telit Communications (TCM) and cloud services company Redcentric (RCN).

Access to unlisted stocks

A benefit of investing in trusts for those keen to get in to companies at the earliest possible stage is their ability to invest in unquoted stocks. The cluster of so-called technology 'unicorns' - private companies with billion-dollar valuations - is expanding rapidly. Global venture capital tracking company CB Insights lists 24 new unicorns in the second quarter of 2015, compared with just nine in the same period in 2014. Those include sharing sites such as Uber and Airbnb, which are set to headline IPO season this year, as well as companies such as Spotify, which raised $526m last month, taking its total fundraising to over £1bn.

Ms Flood says: "Technology companies are listing much later because they are not as capital-intensive in their requirements for growth. Traditionally, you would have needed a large capital injection to buy machines, expand a workforce and buy materials, but that's not true for these internet companies. They don't need the markets in the same way and it means the unlisted businesses we're looking at are more mature and their risk structures are more akin to traditional growth companies."

Scottish Mortgage Investment Trust (SMT), 33 per cent invested in technology according to Morningstar, has targeted Indian ecommerce company Flipkart, Spotify and cyber security company Palantir. Ms Flood at Baillie Gifford says: "The private company holdings account for roughly 6 per cent of the fund. It is a relatively small percentage, but important given the extent of the value creation we would otherwise miss in such a private company."

However, with unlisted market potential comes risk. Adam Laird, passive investment manager at Hargreaves Lansdown, says: "There are a lot of great success stories among unlisted firms, but the word bubble is used a lot and certainly there are some stocks out there that do look as though they're at the top end of valuations."

So make sure you are putting your faith in the right manager. One such manager may be Neil Woodford. He launched the much-feted Woodford Patient Capital Trust (WPCT) earlier this year and has set out to target nascent companies, both listed and unlisted, which are often at the first stages of development and not yet generating revenues or profits. The risks are high, but so are the potential rewards if his convictions come good.

Sky-high demand for the trust made it the largest ever UK-domiciled investment company raising and the premium has been on the up ever since, making it a costly entry point. It is currently trading at a premium of 11.81 per cent. Mr Woodford has said he has 30 investment ideas ready to go and aims to eventually have between 50 and 100 holdings, predominantly from the UK. He has already been invested in a range of unquoted tech companies via his CF Woodford Equity Income fund and will be using the same approach in Patient Capital. Examples of those include Oxford Nanopore, an unquoted stock developing the next generation of DNA sequencing technology and Gigaclear, an unlisted company building and operating broadband networks in rural communities.

The cheapest way in

Passive investing through trackers and exchange-traded funds (ETFs) is the lowest-cost way to gain access to technology funds, but you are likely to end up with high exposure to the larger names in the market. That is because ETFs, unlike open-ended funds, are able to hold the maximum benchmark amount of stocks such as Apple and Microsoft, which could be almost 18 per cent.

It is both an argument for and against this route. Shaun Port, chief information officer at online investment manager Nutmeg, says: "Over the past year Apple has produced about half the gains in the overall tech sector and it is tricky for mangers to replicate that performance, so that's one reason to go passive."

If you want to take less risk, one option is to track the Nasdaq 100 instead of a technology-specific index. Mr Laird says: "The Nasdaq 100 is one of the most popular ways of accessing US shares, after the S&P 500. It is not strictly an IT index, but contains a lot of biotech companies and tends to hold more innovative and technologically minded companies."

A popular ETF in this area is the PowerShares EQQQ Nasdaq 100 UCITS ETF (EQQQ), which has an ongoing charge of 0.3 per cent. The iShares Nasdaq 100 UCITS ETF (CNX1) tracks the index with an ongoing charge of just 0.33 per cent and has returned 2.1 per cent in the year to date.

Mr Port's choice is the Source Technology S&P US Select Sector UCITS ETF (XLKQ). "It's pretty well traded and has a relatively tight spread," he says.

Trusts' exposure to new generation tech shares

*As at 30 May except Splunk, FireEye and Palo Alto Networks (as at 30 June)

**As at 30 April 2015 except Splunk (as at 30 June)

***As at 31 March 2015, except Illumina, Tesla (as at 30 June)

Source: Trust websites

Fund, trust and ETF performance