The revival of techology investment trusts

At first glance, London’s largest dedicated technology trusts aren't overexposed to the fabled 'Magnificant Seven' stocks that dominated the US market last year.

Open-ended funds can only hold 10 per cent in a single company, meaning they must underweight the megacap companies that sit at the top of global tech indices. Both Allianz Technology Trust (ATT) and Polar Capital Technology (PCT), by contrast, can hold up to 15 per cent in a single stock, yet both are underweight the sector behemoths relative to their benchmark. The runaway success of the Magnificent Seven means neither fund managed to outperform the Dow Jones Global Technology Index in the past 12 months. 

This goes some way towards explaining why the Association of Investment Companies' technology sector trades on a weighted average discount of 12.4 per cent. The other factor is, of course, high interest rates – which famously diminish risk appetites.

As Stifel analyst William Crighton explains: "Investors may think it is not worth paying for active management for US tech exposure when it's been so dominated by those megacaps, which can be bought directly or through a passive fund."

But the tide now appears to be turning, at least in some corners. Last month, Allianz Technology re-entered the 10 most popular investment trusts on the Interactive Investor platform, as Polar Capital did in December. Both trusts also appeared in Fidelity’s top 10 ranking for January, albeit they were also among the most sold investment companies by users of AJ Bell’s platform that month. In light of this, it’s perhaps premature to declare that the trusts are back in fashion – but there are reasons to believe those discounts will start to narrow.

“If all returns are concentrated in seven stocks, a diversified approach with a cap on exposure to any one stock is simply not going to capture the returns that concentrated investment will,” notes Shavar Halberstadt, a research analyst at Winterflood Securities. “However, that was obviously in the context of a higher rate environment, with lots of uncertainty, as well as concentrated returns from the advent of AI revenues.” 

Now, as the possibility of rate cuts comes into view, Halberstadt predicts there will be a dispersion of returns towards smaller players. That is, investors may begin to look more favourably at funds that contain a wide range of tech holdings, rather than chasing incredible returns from a handful of individual companies. This is likely to be beneficial for both ATT, which has a portfolio of 44 holdings, and the 100-strong PCT. 

Of the other two trusts in the sector, Herald (HRI) specifically targets smaller, predominantly UK companies, whereas recent top performer Manchester & London (MNL) has made a gigantic bet on just two stocks – Microsoft (US:MSFT) and Nvidia (US:NVDA) – that as of December made up fully half of its portfolio.

Despite the potential for a wider range of outperformers, analysts think artificial intelligence (AI) will continue to be a strong determinant of tech funds’ fortunes. Polar Capital’s managers have maintained a particularly bullish stance on the matter even if they have declined to overweight the big players, stating at the end of last year that: “AI is a transformational general purpose technology that could ultimately lead to a reimagining of all sectors”. 

Richard Williams, a research analyst at QuotedData, notes that some 80 per cent of the portfolio is currently invested in companies the fund’s managers think are AI enablers or AI beneficiaries. “For instance, PCT is massively overweight on [Nvidia rival] AMD (US:AMD),” he said. “Spending on AI infrastructure isn’t all going to go to Nvidia, and investors might start looking elsewhere for companies that will benefit from chip demand. AMD is definitely one of those companies.”

Not to be outdone, Allianz has some relatively large AI positions of its own. Its top three holdings at the end of last year were Microsoft, Nvidia and Apple (US:AAPL). However, it has historically had a bias towards mid-cap stocks and remains structurally underweight to megacap names. Despite this, it only slightly underperformed its benchmark last year, with a net asset value (NAV) total return of 45 per cent compared with a 48 per cent return from the index. Allianz also looks reasonably well diversified across tech sub sectors, despite the fact that five of its current top 10 holdings are in the semiconductor business.

Other notable positions include cloud-based customer relationship management platform HubSpot (US:HUBS) and the open-source database platform MongoDB (US:MDB). The fund’s managers also have a strong conviction in the growing demand for cybersecurity products and services.

In choosing between Allianz and Polar Capital, investors will ultimately have to assess their own stance on the evolution of AI: is it a world-changing innovation (in the same vein as the internet and the printing press) or a solution in search of a problem? Winterflood’s Halberstadt leans towards the former, albeit he thinks this could favour the incumbents.

Unlike most of the revolutionary moments we've seen in tech over the past couple of decades, this change isn’t bottom-up in the sense that you’ve got start-ups disrupting the established order,” he said. “These are major companies that are developing, introducing and facilitating AI – and reaping the rewards.”

But there remains the risk that the crescendo of hype around AI constitutes a dotcom-like bubble. The chief executive of Amazon’s Web Services cloud business said as much earlier this month – and he’s far from the only one to have drawn this comparison. 

For now, many of the Magnificent Seven will probably continue to look attractive on their own terms, especially because their fates appear to be somewhat (if not entirely) untethered from interest rate expectations. The US Federal Reserve has recently pushed back on the notion that rate cuts are imminent, and yet Nvidia's shares have risen a further 50 per cent year to date.

Back on the London market, shares in both the Allianz and Polar trusts have themselves risen 30 per cent over the past six months, albeit these rises are on the back of improved sentiment relating to the prospect of interest rate cuts. Many economists think the Bank of England’s rate-cutting cycle could begin in May, which would raise the prospect of a potential rerating for both funds.

Given both ATT and PCT are still trading on substantial discounts to their net asset values, both are still highly affordable. While some might be tempted to simply purchase a technology sector tracker to capitalise on the giants' own gains, doing so would mean having less exposure to the small, medium and even large (by UK standards) companies in the sector.