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Tech wobbles, but funds could still grow strongly

Technology funds offer the prospect for high growth but come with a hefty dose of risk
Tech wobbles, but funds could still grow strongly

The top contributors to the S&P 500's gains this year have been the so-called FAANGs - Facebook (US:FB), Amazon (US:AMZN), Apple (US:AAPL), Netflix (US:NFLX) and Google, known as Alphabet (US:GOOGL), along with Microsoft (US:MSFT). And Technology and Telecommunications was the best performing Investment Association (IA) fund sector over the month to 30 May 2017, with an average return of almost 6 per cent. However, there was a sharp sell-off in US tech stocks at the end off last week, wiping $140bn (£110.05bn) from the value of US tech stocks on 9 June.

The valuations of technology companies, particularly in the US, had been looking expensive for a while. "Technology stocks have been rallying aggressively in recent times as momentum-chasing speculators bought [the FAANGs]," explains Fawad Razaqzada, a market analyst at Forex.com. "These and a few other stocks have been holding up the entire US stock markets. But such bullish runs often end abruptly and that is what may have happened. The writing was on the wall. Insider selling from the likes of Jeff Bezos, chief executive officer of Amazon, is never a good sign. The eye-catching gains prompted analysts to label the whole sector as the most overweight it has ever been, surpassing even the dotcom bubble."

It is unclear whether the sell-off will continue, or whether it is just profit-taking after a particularly strong run by the sector. But Jeremy Gleeson, manager of AXA Framlington Global Technology Fund (GB00B4W52V57), points out that in the first quarter of the year, 68 per cent of tech companies in the MSCI World Index reported better than forecast revenue, and 72 per cent reported a positive upside to predicted earnings.

"We are very comfortable with the fundamentals and valuations within the sector for the remainder of 2017, so will be using any extended weakness as an opportunity to buy," he says.

Kathleen Brooks, research director at City Index, adds: "Essentially, nothing fundamental has changed for the big US tech giants. There was a sign of money being pulled out of the tech sector and put into energy and financials, which does not suggest that investors are getting defensive and looking for a broad risk sell-off quite yet."

But the sell-off highlights the high levels of volatility that technology companies and the funds that invest in them can experience. This is especially true for smaller tech companies.

"Nine out of 10 start-ups fail, so it can be a very volatile sector," explains Darius McDermott, managing director at FundCalibre. "You can get into real trouble and lose a lot of money if you invest in the wrong stock. It's easy to get caught up in the excitement and invest in a company that has a good story, but doesn't then follow through on it. You have to be very careful with blue-sky companies."

This risk remains even if you choose to outsource investment decisions to a specialist technology fund manager, as trying to determine which tech companies will grow strongly in the future is difficult.

"Investors may be right about the potential of a particular technology, although many do not work out as predicted and are quickly superseded by even better - or cheaper - technology," say analysts at Rathbones. "But you also need to identify how it will be adopted and which companies will profit. The dotcom crash of 2000 serves as an enduring reminder of the risks of believing the hype without appreciating how to extract value from the business model."

  

Disruptive tech potential

Despite the risks, the rewards of technology companies can be high. For example, Apple's share price rose 755 per cent between June 2007 and June 2017.

There is lots of excitement around companies with disruptive technology as these may be able to grow market share quickly. Disruptive technology can be defined as innovation that creates a new market and disrupts an existing market, displacing established market-leading companies, products and alliances.

The opportunity for disruptive technologies to make an impact on various sectors is potentially vast, but a report by Rathbones on the investment impact of disruptive technologies highlights a few key likely areas. These include alternative energy generation and storage, which is likely to disrupt utilities and automotive industries.

"Battery technology has advanced significantly over the past decade, making solar and wind power, and electric vehicles, far more attractive than ever before," says Sanjiv Tumkur, head of equity research at Rathbones. "The role of centralised utility companies could be undermined by the growth of self-sufficient homes and businesses with solar power fulfilling most or all of their power needs."

Finding a fund that gives you exposure to up-and-coming companies in disruptive technologies, and holding it for the long term, could prove beneficial if the businesses grow strongly.

But there are also benefits to holding well-established tech companies such as the FAANGs, adds Adrian Lowcock, investment director at Architas, as many of these companies have high levels of cash, which they often use to acquire smaller tech businesses. For example, Facebook bought photo-sharing platform Instagram and instant messaging service WhatsApp in 2012 and 2014, respectively. This both increased its offering and saw off the threat from rival technologies.

  

Funds and trusts for tech exposure

As technology is a high-risk area, you should only put 2 to 3 per cent of your portfolio in a technology fund, advises Jason Hollands, managing director at Tilney Group. And if you hold a US tracker fund you are likely to already have some exposure to the large technology companies.

For this reason, Mr Hollands likes Herald Investment Trust (HRI) because, unlike many technology funds which are US focused, it has nearly 60 per cent of its portfolio in UK-listed companies. The trust invests in smaller quoted companies in areas such as communications and multimedia, and has more than 250 holdings.

Mr McDermott suggests Polar Capital Technology (PCT). "The managers look for companies they believe have the highest growth potential in the global technology universe, and which offer the potential for shareholder returns. They are not simply investing in technology for its own sake. They have a very good track record through the whole market cycle."

Mr McDermott also likes AXA Framlington Global Technology, which has a bias to small- and medium-sized companies. Its three largest sector exposures are internet software and services, software, and semiconductors, which together account for around two-thirds of its assets. "Its manager (Jeremy Gleeson) prefers to find 'new technology' stock ideas and avoid the slow growth 'old guard' companies altogether," says Mr McDermott. "Technology is inherently risky, but by avoiding the blue-sky companies - grand ideas but no income and growing development costs - and waiting for companies to fully develop their products, the fund is more likely to avoid pitfalls."

There are also funds that invest in a particular trend, such as Pictet Robotics (LU1316549283). This launched in 2015 and invests in companies operating in areas such as robotics applications and components, automation, autonomous systems, sensors, microcontrollers, 3D printing, data processing, and image, motion and voice recognition technologies.

David Liddell, chief executive of IpsoFacto Investor, prefers to gain exposure to technology companies via funds that have a broader focus and give access to the private market normally off limits to retail investors. He suggests Scottish Mortgage Investment Trust (SMT), which also counts Amazon, Tesla (US:TSLA), Tencent (HKG:700), Facebook and Alphabet among its top 10 holdings. The trust aims to achieve a greater return than the FTSE All World Index over a five-year rolling period, and is able to invest up to 25 per cent of its assets in unquoted companies.

Other global funds with a bias to technology shares include Baillie Gifford Global Discovery (GB0006059330), which has 30 per cent of its portfolio in this area, and Rathbone Global Opportunities (GB00B7FQLN12), which looks for under-the-radar and out-of-favour growth companies, and has 23 per cent of its assets in technology stocks.

Mr Liddell also highlights Woodford Patient Capital Trust (WPCT), run by highly regarded manager Neil Woodford. This investment trust invests in young, mostly UK, businesses, a large proportion of which are unquoted.

"The dividing line between healthcare and tech is getting a bit blurred," he says. "Woodford Patient Capital has a lot in healthcare tech and in small start-up companies, whereas the straight tech trusts now tend to have quite large stocks in them."

Another UK fund with a substantial weighting to tech stocks is Marlborough UK Micro-Cap Growth (GB00B8F8YX59), which primarily invests in companies with a market cap of £250m or less. It has 21 per cent of its assets in technology stocks.

Another way to gain exposure to tech stocks is a North America fund as many of the world's tech companies are based in the US.

Mr Lowcock suggests Baillie Gifford American (GB0006061963). "This fund invests in large-cap American tech companies such as Amazon, Tesla, Facebook and Netflix," he says. "However, the fund's objective isn't specifically to invest in technology and the managers can invest anywhere in the US market that they see exceptional growth. They are looking for companies that can grow their earnings at least 2.5 times over five years, and most of the companies they own are not tech companies but businesses that utilise technology effectively. The fund invests in three types of businesses: those with transformational growth that are disrupting the status quo, those with enduring growth that have deep franchises, and those with dynamic growth that require more capital investment, but are growing market share."

There are also significant technology companies in Asia, such as Samsung Electronics (SMSD), Tencent, Alibaba (US:BABA) and Taiwan Semiconductor (Tai:2330). Mr McDermott says a way to get exposure to these is Schroder Asian Alpha Plus Fund (GB00BDD27J12) of which the four largest holdings are technology stocks. It has 35 per cent of its assets in tech stocks.

Stewart Investors Asia Pacific Leaders Fund (GB0033874768) invests in large- and mid-cap companies in the region and has 23 per cent of its assets in technology stocks. It is among the top-performing funds in the IA Asia Pacific Excluding Japan sector over five years.

First State Greater China Growth Fund (GB0033874321) invests in companies that are based in, or have significant operations in, China, Hong Kong and Taiwan. The fund has 32 per cent of its portfolio in information technology shares, but a single-country emerging markets fund is arguably even higher risk than a single-sector technology fund with the majority of its assets in the US.

 

Fund performance

 

Fund/benchmark1-year total/share price return (%)3-year cumulative total/share price return (%)5-year cumulative total/share price return (%)Ongoing charge (%)
AXA Framlington Global Technology 54.4115.1163.10.83
Schroder Asian Alpha Plus*52.863.790.81.71
Stewart Investors Asia Pacific Leaders 26.051.192.40.89
First State Greater China Growth 41.960.7105.21.08
Baillie Gifford Global Discovery 32.866.0177.60.78
Rathbone Global Opportunities 31.472.2130.50.79
Pictet - Robotics* 53.2nana1.21
Marlborough UK Micro Cap Growth 29.947.0153.90.80
Baillie Gifford American 43.191.6151.70.52
Woodford Patient Capital Trust-2.1nana0.18**
Scottish Mortgage Investment Trust 61.8108.6237.90.45**
Herald 40.643.9109.71.09**
Polar Capital Technology 75.3117.4186.91.10**
IA Technology & Telecommunications sector average47.379.4137.0 
AIC Sector Specialist: Tech Media & Telecomm sector average73.8112.582.8 
DJ Global Technology index53.799.3162.7 
MSCI World/Information Tech index49.6101.2164.5 
S&P 500 index33.375.0147.0 
MSCI World index30.834.0102.8 
MSCI AC Asia Pac Ex JPN index40.647.480.0 

 

Source: Morningstar as at 09/06/17. *Share class shown is different to that mentioned in the text **Association of Investment Companies