While some market commentators have expressed concerns over the sustainability of valuations in the technology sector, opinion remains divided on whether this warrants an underweight position in portfolios.
Over the last decade the MSCI AC World Information Technology index has been outperformed the wider MSCI AC World index by 175.03 percentage points, as the below chart shows.
While earnings of the underlying companies have improved over this time, price-to-earnings (P/E) multiples have risen to extremely high levels.
Performance of indices over 10yrs
Source: FE Analytics
Indeed, the tech sector outperformed the wider index in each of the past five calendar years and last year returned 29.5 per cent versus the MSCI AC World’s 13.24 per cent.
Below FE Trustnet asks fund managers and advisors if now is the to underweight technology sector or whether it still has further to run.
“It depends on the risk profile of the investor”
Nick Ford, co-manager of the five FE Crown-rated LF Miton US Opportunities fund alongside Hugh Grieves, said such a decision would depend on an investor’s risk profile and time horizon.
For example, a short-term investor should be underweight technology as the risk-return profile of the sector is not as attractive as it has been much of the last decade.
“Valuations are very high and the risks of the impact of any slight slowdown in economic activity or maybe some slight disappointments on earnings results can produce some fairly nasty capital losses in terms of P/E contraction and heavy investor selling of specific names,” he explained.
Additionally, any potential slowdown in earnings may impact the research and innovation spending of tech companies, while also causing other firms to reduce their tech spending.
“The scary bit about technology at the moment is the fact that if people suddenly do lose confidence in the economic outlook they might defer spending plans on their technology budget,” Ford noted.
However, for those with a longer-term perspective the asset class still remains an attractive proposition.
“On a longer-term basis for people who are prepared to tolerate the risks, we would say that the outlook for the sector is still very strong because we have in the US some really innovative, fast-growing, exciting companies within the space,” he said.
“For investors taking a longer-term view and thinking about their retirement you are still going to get a tremendous top and bottom-line growth from the technology sector.”
“We’ve gone from overweight to underweight”
Indeed, fund managers are mixed on the technology sector, with RWC Global Emerging Markets manager John Malloy noting he had made it a material underweight in the portfolio over the past year.
“We are underweight technology and if you look back a year ago at this time we were probably market weight to slightly overweight technology,” he said.
“Our performance was very strong last year – we were up 45 per cent – and that was driven by our exposure to technology.”
The fund returned 31.13 per cent last year versus the IA Global Emerging Markets sector’s 24.43 per cent and MSCI Emerging Markets index’s 25.3 per cent. It was up 43.56 per cent in dollar terms.
Performance of fund vs sector and benchmark in 2017
Source: FE Analytics
“What happened is you had the market do really well and stocks were up 80-100 per cent and valuations became fair to, in some cases, rich,” said Malloy.
“It is not really a view that we think that the companies and management teams are bad, it is just that we believe that in some of those securities the valuations are fairly-to-overvalued.”
However, the RWC manager said investors should watch the market closely as there are signs that it is not just fund managers that are making large sales.
“Naspers, which is listed in South Africa, has a big position in Tencent – they own multi-billion dollar position in the company. They sold $10bn of stock last week and Tencent has corrected since then and the stock is under pressure,” Malloy said.
“So you are starting to see signs where it is not just investors like ourselves who are selling but it is insiders as well and people who are very knowledgeable about the industry are selling.”
“We’ve reduced our underweight to the US”
However, Ahmer Tirmizi, Investment Manager at Seven Investment Management, said he has moved to a less underweight position, after the sector contributed 20 per cent of the S&P 500 returns last year.
“Whilst underweight technology, we have moderated the underweight by increasing our exposure to US equities [tech makes up 25 per cent of the index],” the manager of the passive model portfolio solution said.
“The outlook for the sector is generally positive given that these companies represent the future.
“However, US tech firms have targets on their backs from the authorities – whether it be the recent Facebook scandal or Amazon’s impact on the decline of the bricks and mortar retail sector, these larger companies could face regulatory or tax headwinds in the near future.”
Instead, Tirmizi said investors could look at Chinese tech firms, who do not face the same regulatory burdens currently.
“Invest selectively – don’t tar every firm with the same brush”
Zak Smerczak, portfolio manager of Comgest’s global strategy, said the best way to approach the sector is through a bottom-up selection approach rather than a passive vehicle.
“As a result of our stockpicking, the Comgest Growth World fund currently has over 30 per cent exposure to the Technology sector, however investors may be surprised to learn that we do not own many of “the usual suspects” in this space,” said Smerczak.
“For example we have very little – circa 1 per cent – exposure to the FAANGs [Facebook, Amazon, Apple, Netflix, and Google] today, with a small position in Google, a company we’ve invested in for close to a decade.”
“Whilst valuations in certain areas of the technology sector are undoubtedly stretched, we do think there are still attractive opportunities for the careful stockpicker. One should be careful not to paint all companies with the same brush.”
“Future returns will be more grounded but there won’t be big falls in valuations” 
The technology story is still very solid and growth in the sector is still way above other industries, according to Architas investment director Adrian Lowcock, but investor perception is changing.
“Where once they were seen as unstoppable forces that were destined to dominate any industry they choose to investors are now becoming aware of the risks in the sector, reputational risk is huge and regulation has looked long overdue,” he said.
“These are now at the forefront of investor’s minds and are beginning to be reflected in valuations.”
Previously, many of the large tech stocks were being priced for perfection, but have recently had a “reality check” and are beginning to come back down.
However, not all tech companies had stratospheric valuations even within the FAANGs the likes of Apple looked reasonably valued, argued Lowcock (pictured).
And given the recent excitement around technology for the past two years, the adjustment is likely to continue for some time. Although that might not mean big falls in valuations, it could mean future returns are more grounded.
“Long term there is still the opportunity for some technology firms to deliver above market growth and returns for investors. Companies where valuations were rich are likely to be more vulnerable to a sell-off in tech as are areas such as robotics and AI which have attracted a lot of hot money,” Lowcock said.
“Over all given the volatility with technology sector we prefer to get exposure through regional asset managers such as US, Japanese or Asian managers who can choose technology companies based on their stock analysis and are not forced just to buy tech.”