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Scottish Mortgage: The out-of-favour sector investors can’t afford to ignore

21 June 2014

Tech is one of the highest growth sectors in the market, but investors continue to view it with suspicion.

By Daniel Lanyon,

Reporter, FE Trustnet

After a sharp correction hit tech stocks and wider markets in April 2014, harsh memories of the dot com bust likely came back for some investors.

Some tech funds fell up to 15 per cent in April and May, though most have recovered much of these losses since then.

Comparisons between any recent sell-off and the dot com crash are completely meaningless, according to Tom Slater, deputy manager of Scottish Mortgage investment trust.

“The sector has grown considerably from what it was 15 years ago and tech companies have a much larger market to sell to now,” he said.

“There are now at least a billion smartphone users, an increase on the 50 million or so PC users in the late nineties. The audience is now global and the size of the potential market for tech firms has completely changed.”

“Technology can offer a diverse section of risks and rewards.”

Slater says sell-offs such as the one we saw earlier this year are completely predictable given the growth trajectory of certain companies, insisting they should be seen as buying opportunity.

“People who have no interest in examining the long-term potential of individual companies are largely accountable for dramatic movements in the market,” he said.

“When a company’s value is 10 or 15 years in the future, you have to accept share price volatility and hang on while the big trends play out. Turbulence is par for the course.”

Walter Price, who manages the £144m RCM Technology investment trust, says that tech managers have to be more active than most to take profits and recycle holdings.

“The correction in April was cause by interest rate concern and there were no near term earnings to support all the double-downing in the pursuit for growth,” he said.

“However, in 2015 these companies are going to have pretty good earnings growth. What causes the next correction is not certain.”

“I will always trade around the stocks in my portfolio because when you have companies that are growing at 30-40 per cent a year the company gets discovered and the stock goes up 100 per cent.”

“You then have to trim back the stock because it is ahead of itself, but you always seem to have the opportunity to buy it back six months later at a cheaper price.”

“That’s the cycle of discovery and then dissatisfaction that goes with this sector particularly in the high growth areas.”

For investors who can handle the volatility, here we look at the different ways to get exposure to the high growth tech sector.


Funds

In the IMA universe 52 funds have high exposure to the tech, with more than 15 per cent of their portfolios invested in the sector.

Some of the best performing funds include Marlborough UK Micro Cap Growth, Liontrust UK Smaller Companies, Liontrust Special Situations, Threadneedle UK Smaller Companies and L&G UK Alpha.

The £407m Marlborough UK Micro Cap Growth, co-managed by FE Alpha Manager Giles Hargreave and Guy Feld, invests in UK companies with a market cap less than £250m. Its exposure to tech makes up 24.5 per cent of its portfolio although is dispersed across many companies. The fund’s largest holding makes up just 1.4 per cent of the portfolio with 255 stocks held in total.

Those who are particularly positive on tech could also go for a tech fund. There are 13 in the IMA Technology & Telecoms sector, including one tracker – the Close FTSE techMARK fund.

Perhaps worryingly, the Close tracker is the best performing fund in the sector over the last decade, with returns of 192.23 per cent.

Performance of funds and sector over 3yrs

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Source: FE Analytics

However since being launched in 2011, the GAM Star Technology fund has performed much better, achieving sector-topping returns of 64.03 per cent over three years.

Other funds with good track records in recent years include Henderson Global Technology and MFM Techinvest Special Sits. The latter is a top-quartile performer over one, three and five year periods.


Investment trusts

Investment trusts provide exposure to tech with the added benefit of gearing, ramping up the potential for a long-term growth strategy.

Some of the best known trusts to invest heavily in the tech sector include two Bailie Gifford-run trusts: Scottish Mortgage and Edinburgh Worldwide.

Scottish Mortgage, managed by James Anderson and Slater, has grown to be the largest in its IT Global sector with a market cap of £2.5bn.

It currently has gearing of 14 per cent and is trading on a discount of 2.2 per cent.

The trust tends to perform better in upward markets, recording top quartile returns in all of the last 7 calendar years except for the down years of 2008 and 2011.

Over the past 10 years it has returned 331.35 per cent, almost 175 percentage points more than the average return in the IT Global sector.

Performance of trust, sector and benchmark over 10yrs

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Source: FE Analytics

Most of its largest stocks are tech companies including Amazon, Baidu, Facebook and Google.

Anderson recently told FE Trustnet that investing in companies before they are publicly listed on a stock exchange was increasing important in the tech sector as companies need less capital to grow.

This has led the boards of the two trusts to allow their managers to investment up to 5 per cent in unlisted companies.

Price warns there is a bubble in unlisted tech companies however, due to excessive competition among private equity funds.

He thinks investors should be wary as a result.

“You have a phenomenon where venture capitalists have not made that much money in the past 10 years and the few that have did so in just a few companies,” he explained.

“This has led to an auction process where high growth companies are bid off despite not needing a lot of money. That means that when they go public the venture capitalists are looking for an inflated return.”

Other investment trusts with high exposure to technology include Henderson European Growth IT, which has 15.2 per cent of its portfolio in tech, as well as Strategic Equity Capital IT, which has a 21.6 per cent weighting.

Investors could alternatively go for one of the two tech-focused trusts: Polar Capital Technology IT or Price’s RCM IT.

The Polar trust has the better record over the long-term, more than tripling investors’ money over 10 years. This is significantly better than what any tech fund managed over the period.

Performance of trusts over 10yrs

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Source: FE Analytics

Manager Fatima Lu and team have a strong bias towards disruptive technology – game-changers to everyday life such as big data, the cloud and embedded intelligence.


IPOs

Holding individual companies is also another option for tech exposure, with many companies listing on a stock exchange for the first time recently.

However, Price says investors should be wary of buying into tech initial public offerings – IPOs – as flotation prices tend to be inflated due to excessive private equity capital.

“This is why very often you will see IPOs have an initial period of underperformance after listing because the real value is demonstrated only after the second wave of stock is released,” he said.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.