There are much better growth opportunities available in tech outside the FAANGs, according to Allianz Global Investors’ Walter Price, even though these are the stocks most investors flocked towards after this year’s crash.
Like many other fund managers, Price tilted his Allianz Technology Trust to stocks that were positioned to benefit from the economic lockdown as the threat posed by coronavirus became clear. This meant increasing his exposure to the FAANGs – Facebook, Apple, Amazon, Netflix and Alphabet (Google).
Yet while he brought Facebook into his top-10 and strengthened his position in Apple and another tech giant, Microsoft, their weightings in his portfolio represent between a half and one third of their position in the Dow Jones World Technology index.
Top-10 holdings of trust vs index
Source: Allianz
“We’re much less concentrated in mega caps than the indices that we measure ourselves against,” said Price
“The indices have 40 to 50 per cent in the top five or six stocks, and they have positions in Apple and Microsoft that are well over 10 per cent each.
“We’re just not comfortable having any stock in our portfolio that is more than 10 per cent. As a result, we are underweight mega caps.”
Protecting against concentration risk is not the only reason why Price is underweight the FAANGs. The manager divides his portfolio into three categories: high growth, meaning companies growing faster than 20 per cent a year; GARP [growth at a reasonable price], meaning companies that are growing between 5 and 20 per cent a year, but are on reasonable valuations; and value stocks in the semiconductor sector.
Despite the fact the likes of Apple and Microsoft have become synonymous with growth investing over the past decade, Price said they fit into the GARP section of his portfolio, rather than high growth. To find companies that fit into the latter category, he said you need to look further down the market cap scale.
“If you look at the heart of our portfolio, it’s these mid-cap stocks of between $5bn and $25bn that we think can go up multiple times. And usually these companies are growing very fast, meaning much more than 20 per cent,” he said.
“The thing that we look for is fast revenue growth and fast earnings growth. If you look at our portfolio relative to the benchmark, you’ll see that earnings growth is projected to be 25 per cent for the next 12 months. I think for the benchmark, it’s also probably 15 per cent.
“In any case, we’ve got a much higher growth rate over the next three to five years than the benchmark forecast.”
Price said this is why many of the stocks in his portfolio look expensive on traditional metrics such as price-to-earnings ratios. However, he pointed out that it is not difficult to see why it is worth “overpaying” for these companies.
“You’re paying a little bit more for that growth, because many of our companies are just becoming profitable,” the manager continued.
“Now they’re free-cash flow profitable, but their earnings are kind of growing into their cost structure. And as these companies become profitable, the earnings growth is going to be 50 to 100 per cent a year. That is what pulls the earnings growth rate up for these companies, it’s what causes the P/E [price-to-earnings ratio] to look high.
Source: Allianz
“But it only takes a few years of that kind of earnings growth to justify the valuation.”
By forcing people to stay at home and make greater use of technology, the coronavirus pandemic has accelerated the journey to profitability for many young companies in this area of the market.
Price said Netflix is a good example of this – the company was supposed to be cash-flow negative until the mid-2020s, but a surge in the number of subscribers over the past three months has brought this forward by about three years.
The manager is now looking further ahead to see which areas of the market are likely to benefit from the shift towards working from home, even if this is yet to be reflected in their bottom line. One of these is cybersecurity.
“Working from home involves new security threats, a much wider network of ‘attack surfaces’, the criminals call it, so you need new security tools on your endpoint,” he continued.
“You need ways to prevent malware getting from the device that you’re using in your home or your remote office and infecting the corporate network and providing access into cloud applications.
“With this new way of working, you need a new set of security tools. And many of the companies that have recently become public in the last year or two are the leaders in this.
“I looked at the portfolio recently and about 42 per cent is related to the cloud or cloud infrastructure, software and security. It is a very large weighting to this new way of working.”
Data from FE Analytics shows Allianz Technology Trust has made 661.08 per cent over the past decade, compared with 510.06 per cent from the IT Technology & Media sector.
Performance of trust vs sector over 10yrs
Source: FE Analytics
The trust is trading at a premium to NAV (net asset value) of 0.96 per cent compared with discounts of 0.48 and 0.93 per cent from its one- and three-year averages.
It has an ongoing charges figure of 0.88 per cent and is not currently geared.