Many of the secular trends within technology remain underappreciated by investors with a number of tech businesses exhibiting the potential for further growth, according to some experts behind trusts investing in technological innovation and disruption.
Not only is the technology sector home to many companies with the potential to grow profits, but these businesses will also keep disrupting other industries, a reason why investors should continue to pay attention to the sector.
Performance of stocks over 10yrs
Source: Google Finance
On Tuesday, online retail giant Amazon.com became the second company in the world to reach the $1trn valuation, just weeks after Apple, another of Wall Street’s most popular and best-performing tech stocks reached the landmark.
The valuations symbolise the strong rise many technology stocks have recorded over the past few years, with companies hitting record highs and representing a growing portion of indices.
While some have likened the striking performance of these stocks to that of many tech companies leading to the dotcom bubble of 2000, others believe the underlying fundamentals behind today’s tech winners have nothing to do with the dotcom companies of the nineties.
Indeed, investors continue to back tech stocks and increase their allocation to the sector, believing this is just the beginning of the story.
This is the case for Mid Wynd International Investment Trust, which has a 26.5 per cent weighting to information technology and invests in themes such as online services or automation.
“Investing in technology is key for Mid Wynd as innovation drives growth and keeps companies competitive,” said co-manager Simon Edelsten.
“We seem to be going through a period of particularly rapid change from developments in the internet and further adaptations of cheap computing power such as artificial intelligence and data processing.”
These changes are challenging many established business models – such as high street retailers – and are opening new investment opportunities, Edelsten pointed out.
Although Scottish Mortgage Investment Trust’s Catharine Flood noted that the widespread belief the trust is a technology strategy is a “misconception”, the closed-ended fund is tilted heavily towards the sector
The £8bn trust – led by James Anderson – has some of the well-known stocks usually labelled as ‘tech’ among its top ten holdings, including e-commerce giants Amazon.com and Alibaba, internet-related services providers Baidu and Tencent or internet entertainment service Netflix.
Performance of trust vs sector & benchmark over 10yrs
Source: FE Trustnet
As the above chart shows, the trust’s long-term performance has been strong. Over 10 years, Scottish Mortgage is up 467.40 per cent compared with a gain of 186.95 per cent for its average peer in the IT Global sector and a 192.72 per cent gain for the FTSE All World index.
“We do tend to invest in companies which create or utilise new technologies to develop deep, long-term competitive advantages in addressing large opportunity sets, though we will invest in any business which has this strong asymmetry to their potential long-run returns,” the client services director said.
“We simply look for any and all companies with sufficient potential to be the standout growth companies of the coming decade.
“The large platform companies such as Amazon.com, Google and Facebook in the US and Chinese giants Alibaba, Tencent and Baidu, have created a paradigm shift in the global economy to a ubiquitously mobile, digitally interconnected world,” Flood explained.
But tech and growth are not just about the FAANG – Facebook, Amazon.com, Apple, Netflix and Google-parent Alphabet – or BAT – Baidu, Alibaba and Tencent – stocks.
Indeed, there are other areas of growth within the sector.
“Being global investors, we find we can move on to less well-known areas of growth and reinvest our profits at more comfortable valuations,” said Mid Wynd’s Edelsten.
The team sold their holding in Amazon last year and they also recently sold Facebook.
“Selling some of our FAANG holdings came at a time when we could invest in Japanese companies which are global leaders in robotics and automation,” he explained.
“These proved fine replacements for our internet investments and continue to convince us they have very strong longer-term growth prospects while trading at very reasonable valuations. “
Of interest to the team behind the Scottish Mortgage’s strategy are the next generation of companies building their businesses on top digital infrastructures like Twitter.
These, Scottish Mortgage’s Catharine Flood said, are addressing specific and large markets such as financial services, digital media, food consumption and transportation.
In his outlook for the sector, Alex Crooke – manager of the Bankers Investment Trust – noted many secular trends within tech haven’t been appreciated by the wider market yet.
An example, the trust’s manager said, is the disintermediation of bricks & mortar retail stores by e-commerce.
US e-commerce retail sales since 2000
Source: St. Louis Fred
“Whilst we are all quite familiar with ordering goods online, it is important to note we are still in the early stages of adoption,” Crooke said.
“In the US, e-commerce accounts for just 13 per cent of retail sales and its growth rate has actually been increasing in the last two years.
A major beneficiary of this is Amazon, which although looks expensive on near-term valuation multiples, Crooke noted has the potential to substantially grow its profitability in the years ahead.
Scottish Mortgage’s Flood also shares the belief these businesses’ returns still doesn’t reflect the extent of the changes they have set in motion.
However, she acknowledged tech disruptors will also keep posing challenges and impacting other sectors, including some traditional defensive ones.
“More value was immediately destroyed in aggregate in the businesses disrupted than was created in Amazon and the businesses it acquired, such as WholeFoods, as it broadened the application of its strengths into new areas,” she noted.
“However, many of the established business models in a range of industries have come through previous technological revolutions in the twentieth century unscathed, as these had not touched them directly.”