Are pricey tech stocks still a good investment?
Managers warn of hype in otherwise profitable sector
Technology may have disrupted the way we work, shop, engage and entertain ourselves, but there is room for much more disruption, which means higher returns for investors from this sector of international share markets, according to Richard Clode of Janus Henderson Investors.
South African investors had witnessed first hand the outperformance of a tech stock and how it had disrupted their own share market, Clode, who manages the Janus Henderson Horizon Global Technology Fund from London, told the recent Sanlam Investments and Glacier i3 Investment Summit.
"Here you have a share that has had a 1,650% return in just 10 years, has outperformed the stock market by 124% and ended up being a quarter of the stock market all because they invested $32m in a Chinese internet company 18 years ago," Clode said of Naspers and its investment in Tencent.
Globally, technology companies had outperformed other shares for the past decade and now had a market capitalisation (the value of all the shares at current prices of over one trillion dollars), Clode said.
Tech companies that have become household names — Facebook, Apple, Amazon, Netflix and Google (or Alphabet) — have driven this outperformance. Fund managers are increasingly divided on whether these shares are now overpriced.
They are known by the acronym FAANG. Some managers, like Ed Blain, portfolio manager at value manager Orbis, the offshore partner of Allan Gray, say that when shares become an acronym you shouldn't invest. These shares had been market darlings for 10 years and you would not find a bargain anywhere, he told advisers at the recent Collaborative Exchange Investment Forums.
But though Clode agrees market hype can cause some tech stocks to be overvalued, he believes the tech theme will persist well into the future and the recent outperformance isn't a repeat of the TMT (technology, media and telecom) boom and bust of almost two decades ago.
Profits are the difference, Clode said. "Technology companies today make profits — not just little profits, massive profits.
"Apple makes $50bn profit a year, Google $40bn, Microsoft $35bn — the list goes on."
Those massive profits supported a huge research and development budget that drove innovation and new, fantastic services and products all the time, creating more profits.
Clode said anyone who had bought a smartphone, shopped online, started using Uber and stopped reading newspapers was part of the trend of moving money from a non-tech company to a tech company.
Tech companies were likely to continue to grow their earnings, making their outperformance that much more sustainable. It was not just a one-off re-rating of the price of these shares, the tech sector was outperforming because the earnings were outperforming, and that would continue, he said.
Demographics would help this trend. Millennials, the first generation of digital natives, were now in their 30s and by next year 59% of the global workforce would be millennials, Clode said.
This generation used technology because it reduced friction in their lives. They don't need to learn to drive or stand in taxi queues because they can hail an Uber; they don't go to a shop and buy CDs or rent DVDs because they can stream Netflix and Spotify or click once on Amazon.
So far technology had only seriously disrupted two industries — retailing and traditional media — but now it was open season on the rest. Clode believes that in three, five or even 10 years, tech company earnings will still be growing faster than the market.
Recognising that technology stocks are driving returns in an otherwise low return environment, at least two local investment houses have launched index-tracking technology funds. One of them is Stanlib, which closed its actively managed Global Technology Fund after the TMT bubble burst.
Wehmeyer Ferreira, chief operating officer at Stanlib Index Investments, said technology as a sector had come a long way since the late 1990s. The dotcom bubble was created in an isolated subset of tech and was fuelled by investments in internet-based companies, he said.
The premium you pay on average for tech stocks
Stanlib's technology-focused exchange-traded fund, the Stanlib S&P500 Info Tech Index Feeder Fund, tracks the S&P500 info tech index. Ferreira said the constituents of index trackers today included 13 subsectors (including systems software, hardware and storage, internet software and services) in which established companies like Microsoft, Apple, Via, Intel and Adobe are listed.
Sygnia has also launched three funds with a tech theme since 2016. One is passively managed, one actively and one blends active and passive.
Kyle Hulett, the head of asset allocation at Sygnia, said it had been 20 years since the dotcom bubble and now most tech companies were generating cash and paying dividends. They were far bigger, more diversified and robust businesses than those that were around in early 2000, he said.
Clode said when investing in tech you had to avoid the hype — technology trends like the internet, cloud computing and artificial intelligence were long-term and consistent.
Individual stocks are more volatile because investors fall in love with new technology and drove such stocks to huge valuations (prices relative to earnings or profits).
"When these companies inevitably disappoint, they do not go down 10%, they go down 50% or 90%, becoming zombie stocks," he said.
To avoid this you have to look for shares that will deliver strong risk-adjusted returns that correlated with the long-term technology trend. You have to make sure your expectations are realistic and the valuations are reasonable, he said.
Passive investing in an index that tracks the market by market capitalisation will lead you to investing in market darlings regardless of whether their valuations were reasonable.
Hulett admitted there would be so-called unicorns that would pop up and disappear a year or so later.
But, he said, in an index that tracks about 400 shares, if a small company goes bust you would still benefit from the one that goes up 10 times.
Clode said that currently tech stocks were trading at a 24% premium to the rest of the market, but the premium pays for shares of companies on the right side of disruption with faster earnings growth and stronger balance sheets.
Tech fund options for South African investors
Most rand-denominated funds do not have meaningful performance track records as they were launched in the past three years.
• Sygnia Itrix 4th Industrial Revolution Global Equity Exchange Traded Fund: this tracks the Kensho new economies composite index, compiled and owned by Kensho Technologies, a US "big data" analytics company.
The index blends exposure to 22 Kensho indices, each representing a different "new economy" sector of the market. The exchange-traded fund (ETF) has delivered a return of 13.6% a year since its launch in December 2017, of which 12.1% is a result of rand-to-dollar depreciation.
• Sygnia Itrix 4th Industrial Revolution Global Equity Fund: a unit trust that tracks the 22 indices in the Kensho new economies composite index, but the allocation to each sector is actively managed. This fund has delivered 16% a year since inception in September 2016.
• Sygnia FAANG Plus Equity Fund: the benchmark of this fund is the NYSE FANG+ index, which equally weights the 10 largest tech stocks on the New York Stock Exchange. The fund actively manages the weights of these stocks in an attempt to beat the benchmark. The fund is not yet a year old and is showing a year-to-date loss of 15.6%.
• Stanlib S&P500 Info Tech Index Feeder Fund: this invests in the iShares S&P500 IT Sector UCITS ETF.
It has delivered 35.15% since its launch in March last year.
Offshore foreign currency denominated funds
• Janus Henderson Horizon Global Technology Fund.
• Franklin Templeton's Technology Fund.
• iShares S&P500 Information. Technology Sector UCITS ETF.
Be prepared for some volatility
What kind of investor should consider investing in a technology fund?
Remember that these shares are suited for long-term investors with at least a five-year investment horizon and the returns can be volatile. You must be prepared for short-term losses.
The core of your investment portfolio should be diversified across asset classes and market sectors, while a fund focused more narrowly on technology shares should be something you add for additional returns, Sygnia's Kyle Hulett and Glacier's Leigh Kohler say.
If you are invested in a global equity fund or your local fund has taken advantage of its offshore allocation, you will most likely have good exposure to the technology sector.