While lingering caution is understandable, the dynamics of technology are undeniable as it pervades every aspect of our daily lives.
In the late ’90s, it was runaway valuations that caused the problems. With tech stocks now more attractively valued, a general bullishness has spread, buoyed by the commercial success of companies such as Apple and Amazon.
Several funds sprang up in the wake of the tech boom – with such fad-signalling names as Wired, NetNet and Techtornado – and many closed in the fallout. But the few tech vehicles that have stayed the course, often backed by long-term bullishness on the sector, now boast strong numbers and might be worth another look.
Before focusing on technology’s underlying merits, it is worth pointing out that several market watchers believe the sector is vulnerable in the short term and it has underperformed the S&P in recent months. Apple has seen a 20% share-price dip in past months and names such as Google and Microsoft released weaker than expected earnings recently.
Bill O’Neill, chief investment officer for EMEA at Merrill Lynch Wealth Management, says its research shows technology is the most overweight position held by fund managers globally.
He adds: “With such a high degree of ownership, it has been vulnerable to heavy falls on earnings disappointment. We are still supporters of the tech sector based on sustainable margins, high global sales exposure and an improving multi-year capital spending cycle. Valuations are in no sense into bubble territory and the sector is a clear beneficiary of developing economies’ consumer appetite.”
As might be expected, veteran technology managers paint a compelling picture of its prospects.
Ben Rogoff, who runs Polar Capital’s tech investment trust, believes the sector is in the early stages of a new business cycle based on three inter-related factors: cloud computing, internet applications and mobile computing.
He says: “Market earnings growth is slowing, yet the technology sector is expected to continue to deliver growth. Given corporate profitability remains high and balance sheets strong, there is scope for increased investment once political and budget uncertainties are behind us in 2013.
“However, we expect IT budgets to grow 2% to 3% over the coming years, which is likely to constrain the ability of a number of technology incumbents to deliver growth and should favour a less index-oriented investment approach.”
All-time P/E lows
Perhaps most importantly for investors burned by paying over the odds during the TMT bubble, valuations are attractive and the relative forward P/E ratio is near all-time lows – around 12/13 times compared with 40-plus in late 1999.
Another benefit is the belief the technology sector also has some attractive defensive qualities. Technology businesses are cash-generative and companies have been focused on profit growth and expansion. The the nature of the replacement cycle should mean demand is less vulnerable in a downturn too.
This defensive element has also given companies a potential role in income funds for the first time, with businesses like Apple recognising the benefits of paying dividends. Peter Vanderlee, manager of the Legg Mason US Equity Income Fund, points out that while in July 2002 only 17.9% of S&P 500 technology companies paid a dividend, by the end of last year the figure was 53.5%.
All this is well and good, but is it enough to tempt investors back into technology funds? The answer, for the most part, is a resounding no, particularly with so much volatility remaining in markets.
James Calder, head of research at City Asset Management, believes clients are currently more concerned about capital preservation than piling into higher-risk equities.
Calder says: “As a sector, technology has much going for it and the risk profile has changed from the bubble years. Investors need to be clear about exactly what they mean by technology. Stocks like Amazon, Apple and Microsoft can be found among the top holdings of most US managers, but smaller names operating in niche markets are a very different proposition.”
Darius McDermott, managing director at Chelsea Financial Services, says demand for technology funds remains marginal, although he has buy ratings on GLG, Henderson and Axa Framlington funds.
“We like the sector and feel funds are a completely different beast to during the boom, when portfolios were full of speculative businesses with no profits or earnings,” he says.
“Now, companies like Apple are among the biggest in the world and tech funds have outperformed most major markets over the past five years. That said, the Facebook situation shows care is still needed around valuations, with the stock falling substantially after it was priced aggressively by investment banks.”
Demand remains marginal for the specialist funds then, especially since the biggest most successful firms are held by mainstream funds.
This could mean investors miss out on the next Amazon or Apple, but since those firms returns haven’t treated shareholders too shabbily, something tells me they won’t be complaining.