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Retaining faith in technology

John Baron suggests the latest technology revolution is still in its early stages
August 8, 2019

In general, the past decade has seen growth indices trump their value counterparts. Value managers and investors point to value making a comeback and highlight its longer-term track record. However, the very nature of the latest technology revolution – the internet and, with it, the digital transformation and extensive adoption of more technology-enhanced business models – is ensuring the sector will continue to benefit from its own multi-year cycle which is still in its early stages.

Changing corporate landscapes

Many companies and sectors across the economy are embracing the latest technology solutions to enhance efficiency, improve productivity and increase revenues. This digital transformation will not only continue to be supportive of technology growth in itself, but will also help to create new products and markets across swathes of the economy. Sectors as diverse as biotechnology, advertising, manufacturing, distribution and retail are all being strongly transformed by technological advances – and at speed. 

And yet there remain many sizeable markets that have yet to fully embrace and therefore benefit from this technology’s potential. This has implications for the corporate landscape. Corporations have always had to evolve in order to survive and thrive. Only a few of the top 100 UK-listed companies at the beginning of the last century remain independent today. However, the pace of demise has increased for those too slow or unable to respond to the latest technology revolution.

Many large and average companies – which normally would have endured through previous cycles – have found their very existence being brought into question. Not only is the penetration rate of this digital transformation faster than previous technology revolutions (think electricity, telephones, cars, etc), but its disruptive effect is being felt far more extensively across the economy because it is far less respectful of sector boundaries. 

And market valuations will reflect the impact of increasing returns. In contrast to the norm previously, when companies would typically have had to sacrifice profitability in order to gain market share, those companies today correctly embracing the new technology can look forward to increasing returns. This is because, once the initial investment has been funded, returns rise as the growing customer base costs relatively little to attract and service. Investment managers who recognise this will continue to do well. 

This development will particularly have implications for smaller companies in that, almost regardless of size, this technology better enables them to compete on a more level playing field with their larger brethren. Larger companies will wither on the vine or die at a rate hitherto thought unlikely. Armed with the latest technology, the barbarians are at the gates and few citadels will be safe from their wrath. Picking companies with wide moats or high walls will become increasingly difficult – and more prized.

There is a further consideration. The corporate sector has benefited more than most from the present economic environment, but one has to question whether the current high level of profitability can last much longer – particularly for the larger and less-nimble companies. Over the past decade or so, various factors have made for record profitability including low interest rates, below-inflation wage increases, a benign tax and regulatory environment, and globalisation allowing easier access to markets.

At least some of these tailwinds may be about to change – and this at a time when the authorities continue to struggle to generate better economic growth. For those investors approaching a cusp in their investment journey by introducing greater diversification, this may not be a bad time. For those who are not, it will be important to ensure that, while maintaining an element of balance, a portfolio’s equity exposure focuses on growth investments which will benefit from these structural technology trends.

Great prizes await those who get their stock selection right, and elephant traps await those who do not – there will be less middle ground in which to seek safety.

Strategic assets

But there is another reason why technology as a sector and growth as an investment approach will, for the foreseeable future, continue to do well – one that is more strategic. The US is at a pivotal moment in deciding the nature of its relationship with China. This involves and goes beyond the trade talks. It relates to how best to respond to China’s rise given that its economy, wealth and military are set to surpass that of the US – it’s a question of time.

Although China has never invaded a country, Washington is clear about its purpose – the Communist Party’s objective is for the country to become the world’s leading superpower, and this presents various challenges. But how should the US react? History suggests the best policy continues to be one of containment – of buying time in the hope that democracy will prevail and a more moderate leadership will emerge. 

It is a policy that served the west well during the Cold War. But it requires a change in approach which President Trump is now implementing – the logic relating to Einstein’s definition of insanity. Containment requires a different approach to hard and soft power coordination, together with different economic policies – trade agreements and technology prowess now being some of the major pieces on the chessboard. If China’s export model and technology giants can be tamed, then its rate of ascendency can be slowed.

Those countries subjected to China’s redirected exports (trade deal or not), lacking in technological and IP clout, and labour-intensive (given the progress of technology including automation and artificial intelligence) are going to find the going particularly hard. In this scenario, various assets will assume greater strategic importance but it is their technology assets that both countries will continue to nurture and protect – strong US opposition to Europe’s mooted digital taxes being but straws in the wind. Investors need to be positioned accordingly.

For all these reasons, when investing across the nine real investment trust portfolios run in real time on the website www.johnbaronportfolios.co.uk, including the five representing a risk-adjusted investment journey, we continue to focus where appropriate on companies successfully embracing this new technology revolution. The focus includes the oft-neglected smaller companies even when seeking yield. 

This path will continue to be the more volatile but also the more rewarding over time. Volatility should therefore be seen as an opportunity. As such, it is incumbent on investors to ensure their time horizons and risk tolerances are in sync.

Portfolio changes

During July, the Growth portfolio added to its holdings in Allianz Technology Trust (ATT) and Henderson Smaller Companies (HSL) at prices of £17.14 and £8.53, respectively. 

Meanwhile, the Income portfolio added to its holding in Herald (HRI) at a price of £12.97.