Could tech be a defensive stronghold against recession?

The latter is one of the greatest players in the game and is a former four-time world champion. But he has his detractors due to what some would say is a risk averse, pragmatic playing style – not the best thing for a game that can take a number of hours to finish.

While his style does not give an inch to his opponent, the reality is that Selby is much more than a defensive player. He actually has all the tools needed for a great player, as evidenced by the 147 maximum break he hit in the final – the first person ever to achieve such a feat. In short, he is much more than a one trick pony.

One investment sector that has proven to be more than a one trick pony in recent times is technology.

Seen as the poster child for growth, the impression of the sector has started to change since the Covid-19 lockdowns of 2020. In fact, many experts would say tech has replaced the likes of healthcare and energy as a safe haven asset.

There is a host of high-quality, profitable companies that operate behind the scenes and support the growing defensive nature of the sector.

It has been a key topic in our discussions recently, as we look for ways to navigate the likelihood of recession – in short, could its defensive traits shine through once again?

Returns for 2022 would point to the contrary, as rising rates, moderating growth and the global reopening created a perfect storm for the sector. 

The technology-heavy Nasdaq 100 index shed around a third of its value in 2022, while some individual stocks are down even more with many names trading at a significant discount.

But this is no repeat of the dotcom bubble, in those days the internet was in its infancy, many companies had no cash flows in their business models and had no customers.

Cloud-based architecture and digital payment technology are now the bedrock of people's lives, while AI, the metaverse and cybersecurity are also likely to become increasingly relevant in the future.

Defensive capabilities are on show

We have already seen their resilience in the first quarter of this year, with both Microsoft and Alphabet kickstarting the tech season by beating consensus expectations with their quarterly results, both of which saw their respective share prices rise as a result.

It feeds the argument that mega-cap tech is very profitable, high margin, generally trades on reasonable multiples, and has boat loads of cash on its balance sheets.

Research from Alliance Bernstein shows that while the Faangs may be the divas – glamourous but temperamental – and the smaller, unprofitable tech firms have not helped the perception of the sector, there is also a host of high-quality, profitable companies that operate behind the scenes and support the growing defensive nature of the sector.

Kent Hargis, co-chief investment officer of strategic core equities at Alliance Bernstein, says: “These are the computer hardware manufacturers, payment services firms, cloud computing providers and chip makers that serve as the backbone of the information-based economy and permeate our daily lives.

While tech held up well during the past recession, we should also remember it does suffer from a slowdown in the wider economy.

"While not showy, these reliable stalwarts have sustainable business models and large, recurring revenue streams. Owing to their ability to cushion against big price swings, these higher quality technology enablers outperformed the information technology sector as a whole in 2022.”

Interestingly, figures from Alliance Bernstein show these stocks have a lower sensitivity to the broader market – they are lower beta – than the big tech names.

In fact, roughly one-quarter of the MSCI World index technology stocks have a beta of less than 1.0, putting them in the same universe as traditionally defensive stocks.

Guinness Global Innovators co-manager Matthew Page says while we perceive that certain areas of the tech industry are more defensive than they once were, it is important to distinguish between the three key industries.

He says: “Both the technology hardware and semiconductor industries have historically had greater exposure to business spending cycles.

"However, in areas of the semiconductor industry, these spending cycles are being dampened as businesses make long-term investments into capacity and technological advancement, particularly in the context of secular growth themes such as the cloud transition and development of AI."

Tech is unlikely to ever be as defensive as healthcare or utilities, but it is also no longer as cyclical as the likes of energy, industrials or financials.

Page adds: “Perhaps a more important factor than these long-term secular growth themes is the shift towards ‘as-a-service’ businesses, particularly within the software industry.

"Businesses offering these services are now more exposed to stickier recurring revenues than one-time capex, reducing the cyclicality of their revenues.

"Adobe is a good example, where recurring revenues now account for over 70 per cent of sales, up from 19 per cent in 2011. These revenues are less likely to be cut since they (a) are under longer-term contracts and (b) have a much lower upfront cost than a one-time fee.”

While tech held up well during the past recession, we should also remember it does suffer from a slowdown in the wider economy.

Google and Meta are heavily exposed to advertising spending. Amazon is obviously dependent on how much the consumer has to spend, and Microsoft will suffer if corporates pull back on their IT spending. 

It is also a very different story for smaller, unprofitable tech, where many may run out of cash and struggle to fund themselves in recession.

For these reasons tech is unlikely to ever be as defensive as healthcare or utilities, but it is also no longer as cyclical as the likes of energy, industrials or financials. Even in a severe recession most mega-cap tech will continue to generate lots of cash.

I will finish with the best example someone brought to me about the defensive nature of tech: there are currently 1.5bn Apple iPhone users across the globe, if Apple decided to double the price of your device, would you get rid of it? I think the answer for the majority of us is no, which tells you the power big tech now has in any economic scenario.

Funds to consider

Sanlam Global Artificial Intelligence

This fund 'eats its own cooking' using an AI system to help find companies whose business models are aligned to benefit from this growing theme.

The fund is unconstrained in that it can invest in businesses of almost any size and in more than just technology stalwarts; around half of the portfolio can be found in the healthcare and consumer-related sectors.

Initial screens will then remove stocks under £250mn market capitalisation, which leaves an investable universe of around 500 stocks. These companies will not just be technology companies, they can be from any sector but must have a core element of their future growth based around the benefits of implementing AI.

AXA Framlington American Growth

This fund has a strong growth bias and aims to invest in companies exhibiting genuine organic growth. It is mainly invested in large-caps but does have some mid-caps as well.

About a third of the fund is currently invested in technology, with Apple, Microsoft, Alphabet and Amazon among its top five holdings.

Manager Stephen Kelly benefits from AXA’s strong resources in specialist areas such as technology, biotechnology and healthcare. This fund has done very well and has been helped by the extremely strong performance of US tech companies over the past few years.

The fund does have a heavy style bias to growth and investors should be aware that the fund may underperform when this is not in favour.

Guinness Global Innovators

As the name suggests this fund is all about finding and investing in innovative and disruptive businesses that are changing the world in which we live.

The team creates its investment universe by identifying nine innovation themes, these are: advanced healthcare; AI and big data; clean energy and sustainability; cloud computing; internet, media and entertainment; mobile technology and the internet of things; next generation consumer; payments and fintech; and robotics and automation.

The managers then pick the highest quality, fastest growing and best value stocks from within these themes. Over half the fund is currently held in technology.

Darius McDermott is managing director of Chelsea Financial Services & FundCalibre