The technology sector is developing rapidly, but some investors may be opting to overlook it because of high valuations and scepticism about its growth potential.
For the year to January 17 2017 the FTSE All-Share index gained a sizeable 27 per cent in sterling terms, according to data from FE Analytics, yet the FTSE All-Share Technology index produced a more impressive gain of 44.5 per cent, suggesting investors who ignore the sector do so at their own peril.
Walter Price, manager of the Allianz Technology Trust, points out the technology sector has often been seen as a growth investment, but has broadened to include more “annuity-style” businesses like Apple, alongside high-growth companies such as Facebook.
“Recently, some of the higher growth stocks became very expensive. In a low-growth world, the ability to achieve high earnings growth was considered valuable and shares were bid higher. Most have achieved the expectations set for them. Facebook and Amazon, for example, continue to meet, and even surpass, earnings expectations,” he says.
“However, the mood has changed. Investors have become more sensitive to valuation and there has been a steady decline in the ratings for these higher growth companies, which need sustained high growth rates to justify their ratings and for the stock to work as an investment. They tend to be punished at any sign that growth is slowing. Despite high valuations for some cloud and internet companies, we continue to see massive addressable markets much larger than the revenue today.”
In terms of development, Brad Slingerlend, portfolio manager of the Janus Global Technology strategy, says there is a new wave of growth. He explains: “The combination of low-cost, always-available, cloud-based storage and software, and new connected sensors and devices throughout the economy is spurring entrepreneurs to create a whole class of new companies built on existing platforms. Cloud giants such as Microsoft, Amazon, Google and Alibaba are creating platforms and advancing artificial intelligence and machine learning to enable a host of new business models.”
There are obstacles among all this innovation, with Mr Slingerlend highlighting potential regulatory headwinds related to the risk of increased scrutiny.
Thomas Fitzgerald, associate fund manager at EdenTree Investment, agrees “the increasing power and influence held by the world’s leading technology conglomerates has led to heightened levels of regulatory scrutiny”.
He adds: “Google has been under investigation for alleged antitrust violations by the EC since 2010 and Facebook faces a similar legal battle. If found guilty of any wrongdoing, these companies could face substantial financial charges as well as potential disruption to operations of competitiveness in order to adhere to requirements. Expect heavy regulation of safety-critical technology such as autonomous driving systems, which may hinder the adoption timeframe.”
The election of Donald Trump as US president could also be a headwind to technology if protectionist trade policies are implemented. Mr Fitzgerald explains this could restrict US companies’ ability to access overseas centres of technological innovation.