Technology valuations are nowhere near the levels seen during the early 2000s bubble and still have more room for growth, according to Allianz Global Investors’ Michael Seidenberg.
The strong performance of the sector has been one of the driving forces of global stock market performance in recent years, given the importance and disrupting effect of new technologies.
According to the latest Bank of America Merrill Lynch Global Fund Manager Survey, the sector remains the second most popular among global asset allocators.
Source: BofA Merrill Lynch Global Fund Manager Survey
Seidenberg, analyst and portfolio manager on the Allianz Technology Trust, said technology provides opportunities in all market environments.
He added that companies are allocating increasing amounts of money to new technologies that provide more efficient and productive methods of doing things.
“In a low-growth world, investors need to find companies that are generating organic growth by creating new markets or effecting significant change on old markets,” explained Seidenberg.
Indeed, its increasing importance to a wide range of industries has seen the technology sector’s share of the market quadruple since 1990, said the Allianz specialist.
It’s not surprising that technology is becoming an increasing part of the S&P 500, he said: “Just think about your daily life, and how often you interact with technology.”
At the same time, he said, corporations and governments are moving to the next generation solutions, such as cloud, storage, and networking.
Yet, with the strong run of performance for the sector during the past 10 years – with the FTSE World – Technology index up by 473.58 per cent in sterling terms, compared with a 260.96 per cent rise for the broad FTSE World index – some investors may be left wondering whether valuations are still compelling.
However, the analyst said that tech valuations remain “quite attractive”.
“Tech companies have loads of cash and are generating free cash flow,” Seidenberg explained. “And tech managers are returning more of this cash to investors.”
Indeed, the strong cash flows witnessed by technology companies in recent years suggest that investors should not be too concerned about an early 2000s-style technology bubble.
The analyst noted that current valuations are a far cry from what was seen during the tech bubble, when “tech valuations were not rational and were not supported by earnings and cash flow”.
Seidenberg, whose area of expertise revolves around software as well as internet communications and services, predicted that digital transformation will be a strong driver for technology companies over the next several years.
One such area, where the portfolio manager sees the largest growth opportunity within the sector is in cloud computing.
“We’re likely at an inflection point where we could see massive growth as the adoption of cloud and software-as-a-service accelerates,” he said.
Performance of indices over 10yrs
Source: FE Analytics
The analyst further noted that there were other “exciting opportunities” including artificial intelligence, autonomous driving, and robotics/automation.
“All these themes are likely to provide attractive opportunities over the next few years,” he explained.
Allianz Technology Trust, on which Seidenberg works with veteran investor Walter Price, targets long-term capital growth in excess of the benchmark Dow Jones World Technology index through a portfolio of global technology companies.
He describes the four-member team as bottom-up investors, explaining that they focus on a concentrated portfolio of mid-cap companies “which has been a key contributor to the outperformance of the fund”.
The investment team also concentrates on finding themes as well as companies that can ride those themes or trends within technology.
As such, the team focuses on one or two major players in a given sub-sector.
“The reason why we’re focused on the number one and two players versus the number three player, which arguably could be cheaper from a valuation perspective, is because the number one and two companies tend to take a disproportionate share of the market in any given sector,” he said.
Once the team finds such winners, it tends to hold them for a number of years.
“We believe the good/great companies will find additional things to sell to companies as they go down the road,” said Seidenberg. “These companies often have happy customers for their first products. They interact with them and learn about their needs and wants. Then, they learn what is the second opportunity, and the third or fourth, that the customer may be interested in.”
Seidenberg said the basis of every good business is a happy customer base, adding: “In the software business, especially, where there’s a history of companies not having great customer service, when you find happy customers, you also find customer loyalty. Happy customers buy more stuff.”
The analyst said the team uses another technique to enhance its process: the Allianz Grassroots Research division, which commissions investigative market research.
“For example, I had a thesis that people who were buying iPads 6 or 8 years ago would also subscribe to Netflix,” he said. “So, I took this to the Grassroots organisation, and they went out and talked to people leaving the Apple Stores, and asked them. ‘Are you going to subscribe to Netflix? Why or why not?’ These surveys allow us to have more or less conviction in a given idea.”
Over time, he said, these surveys have saved them from costly mistakes.
“I once had an incorrect thesis: About three years ago, I thought the Star Wars game from Electronic Arts was going to be big,” he said. “So, we went out and talked to video game buyers, and found they weren’t very excited about it. So, we ended up selling the stock.”
Today, said the portfolio manager, technology is also a mature industry in many segments. “What you see is more opportunities in more value-based companies,” he said. “Maybe it’s a product cycle like Sisco moving from traditional selling to subscription.”
Seidenberg said his team sees opportunities across the entire spectrum of company types, from high-growth companies to value companies.
The team seeks out companies that Seidenberg calls enablers. “These are the facilitators, companies that enable others to do better.”
The portfolio’s outperformance in 2019 has been driven mostly by smaller high-growth companies. Among the top contributors to relative returns is Okta, a company that provides cloud software helping companies manage and secure user authentication.
Zscaler, another top performer, is a global cloud-based information security company that provides internet security.
Others include: Paycom Software, an online payroll and human resource technology provider; MongoDB, a database provider for apps; and, Twilio, a cloud communications platform.
So far this year, the investment trust has made a total return of 31.31 per cent compared with an 18.79 per cent gain for the average IT Technology & Media sector peer.
Performance of trust vs sector YTD
Source: FE Analytics
The £565.3m Allianz Technology Trust is not geared, currently trades at a 0.3 per cent premium to net asset value (NAV), with ongoing charges of 0.91 per cent, according to the Association of Investment Companies (AIC). It does carry a performance fee, however, of 12.5 per cent outperformance of the NAV compared with the indexed NAV. It will only be paid if the NAV is higher than the level a which any previous performance fee was paid and if performance is ahead of the benchmark on a cumulative basis. Last year, the fund charged a performance fee of 0.27 per cent.