A glance at the main US market, the S&P 500, shows that Apple, Facebook and Google occupy three of the top four places by market capitalisation – the remaining position being occupied by Microsoft. That is on the back of several years of rapid share price appreciation. Excluding Apple, each of the FAANG stocks has risen by 100 per cent or more over the past half-decade.
Lately, this enthusiasm has begun to be tempered. Technology indices have passed their dotcom era highs and the risk of greater regulation has grown.
Richard Clode, portfolio manager on the Janus Henderson global technology team, says: “Everything has performed well since the financial crisis, but tech has performed even better. The reason technology companies have managed to grow their earnings by 100 per cent in the last decade is [because] everything else hasn’t grown. All of the outperformance of those technology stocks has been taking share of a lot of other sectors.”
Mr Clode remains optimistic about the future of the sector, saying that Google can still grow its top line at 20 per cent a year, but plenty of fund selectors and generalist equity managers have become more cautious.
Fidelity multi-asset manager Bill McQuaker says: “We [have] added to an American equity fund which has lagged peers in recent months as a result of not owning key technology stocks. Technology stocks are where some of the riskiest behaviour has been seen, with investors displaying ever more faith in future expectations.”
Tom Walker, manager of the Martin Currie Global Portfolio Trust, says: “We acknowledge the attractive business models of most of these stocks, but, in some cases, find the valuations too rich.”
The manager holds Facebook, Apple and Chinese giant Alibaba nonetheless.
Winners keep winning
As Mr Clode outlines, equity markets have enjoyed a rich run of performance in recent years, with tech stocks a key driver.
Table 1 lists the top-performing technology funds and trusts over the past five years and makes for impressive reading. The Investment Association sector, numbering just 17 funds, has achieved average annual growth of 21.9 per cent over the period, bettered only by European and Japanese smaller companies funds.
Success has been maintained over every measured period, with average growth over 10 years falling just shy of 15 per cent. Allianz Technology trust is the best performing closed-ended vehicle, averaging 26.7 per cent over five years, including a 40 per cent increase in the past 12 months.
Fidelity’s Global Technology fund leads the way in the open-ended space, turning out an average five-year growth rate of 24.3 per cent.
Ali Unwin, global technology fund manager at Neptune, says larger firms still present the best opportunity for future growth.
Mr Unwin says: “The size and scale of the tech behemoths is not an aberration, but a natural function of an increasingly digital economy. When the costs of distribution and transaction fall dramatically – as is the case with online businesses – we see an increasing tendency for winners to keep winning.”
Bubble trouble
Those nervous about investing in technology point towards the infamous dotcom bubble, in which surging tech stock growth between 1997 and 2000 was followed by a market implosion. Such was the turnaround in fortunes that the Nasdaq composite index’s climb from 1,000 points to more than 5,000 points in the boom period was completely reversed in less than two years.
HyunHo Sohn, manager of the Fidelity Global Technology fund, says: “Valuation comparisons with the dotcom bubble also must consider how the sector has changed in the interim. It is now far more global in nature, and less US-centric. Software and associated services, which benefit from steady, recurring revenue streams, are taking an ever-greater share of the market relative to more cyclical hardware and equipment companies.”
Optimism or pessimism?
The risk of a pullback is not the only potential problem for the sector. Regulation is an ever-present obstacle for growth sectors, albeit a necessary one. Technology is no different. As more people manage their affairs online, including highly sensitive personal data, peace of mind that this information is protected becomes paramount. Wider global issues have also seen the technology sector come under close scrutiny.
Mr Clode says: “As tech becomes a bigger part of the economy, are we going to be able to protect the individual in terms of privacy?”
Holding up
The traction gained by well-known tech companies such as the FAANG stocks has meant portfolios sway heavily towards US shares. Polar Capital Global Technology provides evidence as nearly two-thirds (65.5 per cent) of the fund is positioned in North American equities.
Given technology stocks’ dominance of US indices, even those investors who do not seek dedicated funds in the space will likely have sizeable exposure to the sector. For those who do buy into technology as a theme, the preference is often for a fund sitting outside the Investment Association (IA) or Association of Investment Companies’ Technology sectors.
In the past 12 months, net inflows into the IA’s Technology and Telecoms sector stand at a paltry £140m. This is not necessarily because investors have grown cautious on the outlook for tech. Rather, they prefer to gain exposure elsewhere.
Witness the success of the Scottish Mortgage investment trust, for example: investors’ continued backing of the trust saw it enter the FTSE 100 for the first time earlier this year. With seven of its top-10 holdings in the technology sector, there is no doubt it is this attribute most shareholders are backing.
Other investors’ concerns for the sector focus on fund management rather than fund performance. A small number of stocks’ increasing dominance of indices has left active managers with little choice but to hold weightings in some, if not all of the big tech players.
Consequently, critics have questioned the role of an active manager, suggesting that passive technology funds hold more or less the same stocks, but at substantially lower cost.
Hargreaves Lansdown removed tech funds from its Wealth 150 for this reason in August.
“Over time, especially in a fast moving world, it still should be easy enough for active managers to beat these indexes and ultimately passives,” Mr Clode claims.
By its nature, the technology sector is well positioned to continue to capitalise on new developments. Come what may with regards to valuations, it will remain at the forefront of economic development.
As Mr Sohn explains, developments in the tech space provide good reason for big companies to keep getting bigger.
“The development of future technologies like smart cars, artificial intelligence, virtual and augmented reality and 3D printing, makes for a very promising long-term investment backdrop,” he predicts.
