SG keeps faith in technology sector

Speaking just before last week’s stockmarket falls, Alan Torry, SG Technology fund manager, was upbeat on the prospects for the sector, saying we are at the start of a new corporate buying cycle.

What a difference 10 days can make. I interviewed SG’s Alan Torry, perhaps Britain’s best-known technology investor, just days before the big market sell-off. The fund – from certain perspectives at least – was in rude health.

But what, I asked, would be the worst-case scenario for his SG Technology fund? Torry said a deceleration in economic growth and a market sell-off. In such conditions, it is technology stocks that get hammered.

Oops. The fund’s biggest holding is Microsoft, at 4% of the portfolio, and the 124bn market cap software giant has had a lousy year. Over 12 months it is down 13.6%, and relative to the S&P it is down 16.9%. The recent market falls, plus a weakening dollar, have hit Microsoft hard – over the past month alone it is down 19.3%, in sterling terms.

Cisco and Oracle, respectively the second and fifth-largest holdings in the fund, have fared little better, although over 12 months they have at least kept their heads above water. Cisco is up 2.7% over the past year but down 9% on the month, while Oracle is up 9% over the year but down 8% on the month.

But Torry can safely say he has been here before, and it was a lot worse last time around. This is a manager who at one time was riding high running a portfolio worth 450m at the peak of the dot.com boom. Today it has 89m under management and those investors (sadly the majority) who came in at the top are still nursing considerable losses.

But it is to Torry’s credit that, despite the recent sell-off, the fund has managed a 14.2% gain over the year, compared with the technology sector average of 11.6%. Over three years it is up 29.3%, but over five years it is down 38.5%.

At least the price/earnings ratios on technology stocks now look surprisingly normal. Microsoft, when I was speaking to Torry, was on 17 times forward earnings; now it is on 16. Oracle is on 15, Dell on 15 and Hewlett Packard on 14. These are not, as Torry says, uncomfortable numbers.

But what gives Torry most comfort is that he believes we are at the start of a renewed corporate technology buying cycle. Around 50% of all corporate capital spending goes on technology. “We think the corporate cycle is about to pick up,” he says. “Software companies will be the leaders, plus semi- conductor companies not aimed at the consumer but working more in areas such as telecoms. Other beneficiaries will be office PC and server makers, plus storage companies and certain software services companies in India.”

In this spending cycle, corporate buyers are as likely to be in emerging markets as they are in the developed world. For example, 40% of Cisco’s sales now come from emerging markets. But it would be wrong to characterise the fund as a very corporate-oriented portfolio. Torry is riding lots of retail themes, such as mobiles, satnav and flat screen televisions. But he has no interest in consumer electrical makers – what interests him is the hi-tech components that go inside the boxes.

If you think mobile telephony is a mature market, then consider this fact. Over the next 12 months, one in every six people on this planet will buy a mobile phone. The number of subscribers in emerging markets now tops 1.2 billion, compared with 0.75 billion in the West. One third of all semiconductors now go into phones rather than PCs or other applications.

The stocks that Torry thinks will benefit include companies such as Qualcomm, one of his top 10 holdings. The San Diego-based wireless technology group is currently developing a new type of handset with partners Vodafone and Samsung that will potentially offer faster, cheaper internet access and video sharing. The company only launched in 1985 but today has a market cap of 41.4bn, higher than Oracle’s. Not that it has been spared from the recent sell-off. Although up 24% over the past year, it is down 16% in the past month, in sterling terms, and is now on a forward P/E of 25.

More recently, Torry has focused on the money to be made from satnav systems. He is a big fan of Sirf Technology. The company is only 10 years old but is behind the chips that go into the vast majority of wireless location devices. It has had a stellar run on the stockmarket, up 107% over the past year, but, even so, it is still only on a forward P/E of 27 and is growing sales by 50% a year. That said, it has fallen by 29% over the past month. This technology investing business is only for the long-term investor.

Torry, though, is not buying Sirf for what it puts in automobile satnavs but because the same technology is going to be introduced into mobile phones. But before you jump for joy at this new “location aware” technology on your mobile, remember it will be used by them trying to find you as much as you trying to find them.

The biggest, slightly later in the cycle, “take-off” technology product is LCD televisions, says Torry. But there is no sign of Sony or Samsung in the portfolio. Instead Torry holds Corning Glass. It is a 150-year old glass maker, not the sort of stock you would normally expect to see in a technology portfolio. But Corning has reinvented itself as a “diversified technology” company whose big new line is flat-panel display screens. It is still showing a 58% price gain over the past year despite recent falls.

You might have noticed by now that every single company mentioned so far is American. The domination of America in the technology sector has, if anything, tightened even further since the dot.com days. America makes up 67% of the fund, with no other country making much of a showing apart from Israel.

Israel has made remarkable strides in turning technology that was designed for its military into commercial applications. For example, the Israeli military developed a device for locating downed pilots. It subsequently spun the technology across to a private firm, which has developed it into a low-cost device for finding stolen cars. It seems it is particularly popular in Brazil.

Torry can entertain and inspire you for hours on this subject. After all, he has been investing in technology since 1982, and is unfazed by the current hiccup. He is confident that today’s investors will still achieve 12-15% annual returns. But you would want that sort of premium to justify the scary volatility this sector always gives you.