Sector Focus: Extravagant valuations could make tech stocks vulnerable

There hasn’t been a discreet sector in the Investment Association’s portfolio of fund groupings devoted exclusively to Technology, just one that embraces Technology and Telecoms. Back in 2015 I used a Lipper categorisation of funds that included closed-ended as well as open-ended funds and several different jurisdictions and currencies in order to concentrate solely on technology.

This time I have concentrated on more conventional, open-ended funds, many of which featured in the tables of two years ago, using the Investment Association’s categorisation. While this has reduced the universe, it is likely to be more relevant to the likely shopping basket an adviser will be looking through if a technology fund looks to be suitable for a client. Although for many, this sector will look too risky and too expensive.

That this sector might be considered as high risk doesn’t seem to have harmed performance in any way, though. Last time I remarked that there were no funds delivering negative returns.

The same is true today. Indeed, while the six months table may look a little less exciting than in 2015, all the other time frames have produced significantly better returns than two years ago. The average fund over one year delivered 24 per cent in 2015 and 41 per cent today. Over three years 2017 comes in at 72.6 per cent, compared with 50 per cent in 2015, and 113.5 per cent over five years versus 73.5 per cent in 2015.

If anything technology is even more in the news today than it was then. In our industry algorithms and artificial intelligence are making so-called robo advice possible and changing the way in which managers’ research investments for their funds and even how the funds themselves are managed. In other industries technology is changing the way business is transacted and the growing importance of the smartphone in everyday life is making a fundamental shift to the way we conduct our lives.

Not everything is a positive, though. Aside from the changes to society that the increasing intrusion of technology is engendering, the sheer speed at which change now takes place can be upsetting. The shares of Imagination Technologies Group, a British semi conductor manufacturer, crashed on the news that Apple would be ceasing to use their products in two years’ time. And there are plenty of examples of companies caught out by the swift nature of changes within this sector.

Yet overall individual funds have performed well in this fast-moving environment. Several of the managers that featured two years ago are in the top tables today, including Axa Framlington, Invesco, Fidelity, Pictet and Polar Capital. Interestingly, though, one of the more consistent funds is an index tracking vehicle – the Legal & General Global Technology Index fund – which, while slipping to third quartile over a year, is up among the leaders the rest of the time.

The appetite for technology stocks remains considerable, with newcomers to the market often commanding high initial valuation levels and still managing to deliver early profits to those fortunate enough to secure shares at launch. There may be some similarities, though, between the present and the tail end of the TMT (technology, media & telecoms) boom as the 21st century was ushered in.

The final upward rush in the value of these companies took place against a background of easy money, as central banks made cash resources available to head off a credit crunch as 1999 became 2000. In the end, fears that the disruption the so-called millennium bug might deliver were unfounded, but it is interesting that the bubble burst as the Fed withdrew the cash pumped into the system.

Today we have had a lengthy period of monetary easing as a consequence of the financial crisis of 2008. It can be argued that much of this money found its way into financial assets, allowing the long bull market to take place. Central banks are starting to wind down their money printing activities as confidence in the robustness of the global economy builds. While there is no evidence technology companies have benefited especially from easy money, their extravagant valuations could make them vulnerable to any market correction.

But technology is now a core and crucially important industry in the world. The biggest and most successful now lead the field in terms of market capitalisation. It is hard to imagine a world without Apple or Google today, but these are relatively new businesses. And Facebook is only just a teenager in terms of corporate life. Technology may be expensive and potentially risky, but it can’t be ignored.

Key Takeaway

Technology continues to occupy a principal place in the investment community, but valuations are demanding. While this industry has moved on significantly from the days of the TMT bubble at the turn of the new millennium, a well researched, well diversified fund giving a wide spread of investments looks no more than prudent. It should be considered more appropriate for the more aggressive, growth focused investor, prepared to take a greater degree of risk.

Numbers

56.8% Return of the Polar Capital Technology trust over one year

41% One-year return of the average fund compared to 24% in 2015

14 Number of funds in the sector over one year

114.9% Three-year return of the Fidelity Funds Global Technology fund