Investing in US technology companies doesn’t have to be risky if you know what to look out for, according to Comgest Growth America manager Justin Streeter.
Funds in the IA Technology & Technology Innovation sector were the seventh most volatile among the 57 peer groups in the Investment Association universe over the past decade, proving themselves a risky asset to hold.
However, Trustnet found that Comgest Growth America made top quartile returns whilst being one of the least volatile funds in the IA North America sector of the past decade.
Although it was low on volatility, Streeter didn’t sacrifice any technology exposure. In fact, his 37.7% allocation the sector was 7.8 percentage points higher than the peer group average.
Total return of fund vs benchmark and sector over the past decade
Source: FE Analytics
“It's quite rare to have low volatility and still try to get those returns,” he said. “One of the ways we do that is by not being afraid to be a little bit boring - we don’t catch every shooting star.
“A lot of our peers would have said we’re not exciting, growthy or punchy enough because they want to go after the newest, fastest growing thing, whereas we want something that is going to have a strong profile.”
Streeter credited Comgest Growth America’s high return and low volatility to stock selection. Many investors buying into US tech were captured by the allure of stocks offering high growth, but he said it paid off to be sceptical.
This was echoed by Legal & General head of solutions research John Southall, who said investors rush into highly volatile investments “without fully appreciating the gut-wrenching gyrations or potentially protracted periods of disappointment involved”.
Streeter explained: “People don't want to get rich slow, they want to get rich quick. If they want to try doubling their money every year, they're going to go for a shooting star with a lot more risk.
“For us, if we double it every six years, that's fine. Some people say that's too boring and they may be able to get more somewhere else, but that depends on their level of greed versus conservatism.”
Tesla, Netflix, Zoom and Shopify were among the names Streeter cited as being too volatile to warrant the risk. While each has garnered high returns over the past decade, they rely on a lot of speculation that is not solid enough grounds to make an investment decision.
Share price of stocks over the past five years
Source: Google Finance
It is for this reason that Streeter avoids customer-facing companies such as these – they are well known to retail investors, which can inflate stock prices and create a higher level of volatility.
Instead, Streeter prefers specialist companies outside of the mainstream that require a greater knowledge to understand.
“Everybody knows someone who uses something like Peloton, so you can have this retail frenzy whereas people get bored reading about some arcane, back-office tech stock,” Streeter explained.
“It's easy to understand so it's easy for people to get ahead of themselves. These companies where you need to do more work you understanding the risks and returns are not going to have a million people putting that much time into it.”
One such company is Comgest Growth America’s top holding Oracle, which accounts for 9.8% of the 27-stock portfolio. Despite being worth an estimated $322bn, the computer software company is unknown to many retail investors, shielding it from fluctuating sentiment, according to Streeter.
He said: “For some people it’s too boring, but there’s a high recurring nature to the business which is serving a critical need, making work for its customers better, cheaper and faster. It's really a win-win.”
However, some more conventional names in the US tech space demonstrate the reoccurring and reliable revenues Streeter seeks. Microsoft and Apple are also top holdings in Comgest Growth America (accounting 17.3% of the fund) as they are well-established businesses.
“If you're assuming this one company is going to conquer the market in so many years, the cone of uncertainty is much wider and that's why we naturally steer towards businesses that are mature to already be a leader but also have growth,” said Streeter.
“You’ll have a higher amount of visibility because they're already number one but they still have room to grow double digits - that's very different to somebody just starting out and we'd rather have the fewest assumptions possible.”
The sheer volume of tech companies in the US also gives investors a much wider set of opportunities to choose from compared to smaller markets.
For example, 25% of the FT Wilshire 5000 Index are tech companies – that’s 870 names. In the UK, however, there are only 18 technology companies in the FTSE All Share, accounting for just 1.1% of the index.
“If there's only one name, everybody will want to buy it and there's no reasonable valuation. You're bound to get caught up in trade winds,” Streeter said.
“If there's a deep pool for you to choose from, you have time to do your work and it becomes a valuation exercise and not just a popularity exercise.”
Of the hundreds of tech companies in the US, many investors focus on a few ‘shooting star’ stocks with allusive plans for extraordinary growth, but there are an abundance of steadier business that appeal to cautious investors.
Many high-growth companies have made some of the highest gains over the past decade, but there are still options for investors with a lower risk appetite.
“Sometimes we're wrong in terms of being too conservative and there'll be one that gets away, but we typically steer clear of IPO stocks,” Streeter said.
“When we see those shooting stars, we would have to take cash away from a name we already really like and have held for five to 10 years to put into this more risky one. It’s got to demonstrate that it's better than what we already have.”
Nevertheless, Richard de Lisle, who manages the VT De Lisle America fund, has the lowest allocation to tech in the IA North America peer group at 4% was still unconvinced by the sector.
He said even if investors find a reliable tech company, they will likely be paying too much for it, notwithstanding the market drawdown of 2022 bringing valuations down and adding a higher level of risk.
“Today, in a normalising interest rate environment, big tech stocks are still being touted as the best companies we’ve ever seen,” he said. “They can’t help looking the best but beware the horrendous price to sales ratios.
“Their prices are high compared with history so while they’ve recovered some of last year’s losses, the long-term statistics do not suggest good returns going forward.”