Pick the right fund to capture the next leg up for tech

But although technology shares look more expensive than at the start of the year it doesn't necessarily mean that you should avoid or reduce exposure to this sector.

As we enter a global recession the need for companies to reduce costs should accelerate the move to cheaper and more productive ways of working via technologies such as cloud, software as a service, robotics and cyber security. Technology is also likely to play an integral role in many aspects of life in the future. David Coombs, head of multi asset at asset manager Rathbones says that the acceleration of companies to the cloud over the past two months has been “huge” as firms adapt to remote working, and these technological adoptions are not likely to be reversed. He has a bias to software companies within the funds he runs and thinks there are some great opportunities in the medical technology space. He adds that technology “will be the leading sector over the next three to five years, and that is pretty consensual.”

However, Mr Coombs also points out that technology stocks are likely to be volatile with intermittent price corrections. They have been very much in favour over the past decade and this has helped technology funds outperform broader indices. However, if any global economic recovery is faster than expected, and interest rates and inflation pick up, cyclical companies such as banks and energy firms could outperform technology stocks.

Historically, technology leadership has proved to be quite dynamic. The big tech names of the late 1990s during the dotcom bubble such as IBM (US:IBM), Intel (US:INTC) and Cisco Systems (US:CSCO) are not the dominant players they once were, while Lucent has been taken over. 

However, if you are seeking growth, have a long-term investment horizon and can tolerate volatility, you could include an allocation to technology stocks in your portfolio. Ben Yearsley, director at Shore Financial Planning, says technology funds could account for “at least 10 per cent of a portfolio, if not more [because tech] isn’t going away."

Mr Coombs, meanwhile, says investors could have 20 to 25 per cent of the equity portion of their portfolios in technology stocks.

But be clear on how much exposure to technology you already have before investing in a dedicated sector fund. For example, a global equity fund might have up to 30 per cent of its assets invested in technology companies. Tech funds also tend to be largely invested in the US, so if you already hold a broad US equities fund make sure that adding a tech fund wouldn't mean you end up with more exposure to this sector than you want. Technology funds may also have exposure to Asia, so see how much exposure to technology any broad Asian equity funds you already hold have.

Problems with passive exposure

Also check that the technology fund you are thinking of investing in offers exposure to the areas that you want. For example, the two main technology sub sectors used to be software and hardware, and key companies in these areas included IBM and Hewlett Packard (US:HPE) - 20th century stalwarts. But now technology includes a much broader range of sub sectors and, for example, many technology funds hold companies that service the entertainment, retail and healthcare sectors, if their products or services are driven by technology. 

This is particularly an issue if you decide to invest in technology via a passive fund. Index providers S&P Global and MSCI base their sector classifications on the Global Industry Classification Standard (GICS). So when this changed in September 2018 S&P and MSCI indices' sectors changed accordingly and some of the stocks in them changed sectors.

For example, Facebook (US:FB), Twitter (US:TWTR), Alphabet (US:GOOGL) and  Baidu (US:BIDU) moved out of the Information Technology sector into the newly formed Communications Services sector. Netflix (US:NFLX) was also moved into this new sector, having previously been classified as a Consumer Discretionary stock.

But Amazon (US:AMZN) remains in the Consumer Discretionary sector alongside companies such as Nike (US:NKE), McDonalds (US:MCD) and Tesla (US:TSLA). This is despite Amazon’s cloud computing service, AWS, being one of the largest players in this area.

So a technology sector exchange traded fund (ETF) could fail to provide broad access to the technology theme.

“I am not a big fan of passive sector funds or sector ETFs because they tend to be difficult to diversify and very volatile,” says Peter Sleep, senior portfolio manager at Seven Investment Management.

He points out that active funds which conform to European legislation known as Undertakings for the collective investment in transferable securities (Ucits) would not be allowed to have this level of concentration. 

"It would breach the 5:10:40 Ucits diversification rule – the top 10 stocks of a fund [which account for more than 5 per cent of a fund's assets] cannot add up to more than 40 per cent of the total fund,” explains Mr Sleep.

This diversification rule was instigated by regulators to protect investors, but passive funds such as ETFs can have higher concentration levels because the Ucits rules make an exception for index trackers.

He highlights iShares S&P 500 Information Technology Sector UCITS ETF (IITU) which had about 22 per cent of its assets in Microsoft (US:MSFT) and 19.5 per cent Apple (US:AAPL), as of 25 June. Its third largest holding is Visa (US:V) in which it has 5 per cent of its assets. iShares S&P 500 Communication Sector UCITS ETF (IUCM) had about 19 per cent of its assets in Facebook and 30 per cent in Alphabet, and iShares S&P 500 Consumer Discretionary Sector UCITS ETF (ICDU) had about 35 per cent of its assets in Amazon, as of 25 June.

However, if you are comfortable with taking the risk of being very concentrated in certain companies, an ETF which tracks a technology index is a low cost and easy way to get exposure to this sector. And if you want exposure to a specific sub sector of technology you can do this via ETFs.

For example, iShares Automation & Robotics UCITS ETF (RBTX) tracks iStoxx FactSet Automation & Robotics index which includes companies based on how much revenue they derive from these industries. It has an ongoing charge of 0.4 per cent.

WisdomTree Cloud Computing UCITS ETF (KLWD) tracks BVP Nasdaq Emerging Cloud Index which is composed of companies that derive the majority of their revenues from software products via a cloud delivery or cloud economic model. It also has an ongoing charge of 0.40 per cent. 

But before investing in any technology ETF make sure you know which index it tracks and what weightings this has to the companies in it.

Active funds for tech exposure

If you want broad and diversified exposure to technology companies you might be better off investing in an active fund. The open-ended ones have to comply with UCITS diversification rules, and active funds do not aim to replicate indices. Also, as their managers can decide which companies count as technology ones, active funds have a wider universe to invest in than many ETFs. But when choosing an active technology fund, make sure it is well diversified, as this is a high risk and volatile sector and being well spread can dilute some of this risk.

Darius McDermott, managing director at research company FundCalibre, suggests AXA Framlington Global Technology (GB00B4W52V57) which he says has “consistently been an excellent performer.” The fund held 66 stocks at the end of May, and had about 30 per cent of its assets in software companies and 16 per cent in semiconductor companies.  

Polar Capital Technology Trust (PCT) run by  Ben Rogoff , and Polar Capital Global Technology Fund (IE00B42W4J83) run by Mr Rogoff and Nick Evans, have both performed well.  They have made similar returns to each other over three and five years but the trust has made a better share price total return over 10 years.

They have seven top 10 holdings in common, though the open-ended fund has 78 holdings and the investment trust has 108.

Polar Capital Technology Trust has an ongoing charge plus performance fee of 1.33 per cent. Polar Capital Global Technology Fund has an ongoing charge of 1.14 per cent and can levy a performance fee of 10 per cent of the out performance of Dow Jones Global Technology index. However, no performance fee was charged during 2019.

Allianz Technology Trust (ATT) has also made strong long-term returns. About 90 per cent of its assets are invested in North America and it had 71 holdings at the end of May. Its three largest holdings are Apple, Microsoft and CrowdStrike (US:CRWD). It's ongoing charge is 0.92 per cent and although it can levy a performance fee did not do this in 2019. However, in 2018 the performance fee took its ongoing charge up from 0.91 per cent to 2.05 per cent.

If you feel that a dedicated technology fund is too high risk an option for you, or you have a small portfolio and do not want a large concentration of it in a single sector fund, you could also get exposure to technology stocks via a global fund with a heavy weighting to this sector. 

Mr McDermott suggests Baillie Gifford Global Discovery (GB0006059330) which aims to outperform S&P Global Small Cap index, as stated in sterling, by at least 2 per cent a year over rolling five-year periods. The fund had 20 per cent of its assets in the information technology sector at the end of May and its largest holding was UK-listed online grocery retailer Ocado (OCDO).