Investment companies comment on the opportunities and outlook.
Last month Apple became the first public company in history to reach a market capitalisation of $1 trillion. Apple’s growth from a share price of $1 in 1999 to $225 in 2018 is symbolic of the rapid expansion of technology in the twenty-first century and the strong returns that have been achieved.* But with technology companies hitting record highs and making up a growing portion of indices, how are investment companies approaching this theme in their portfolios?
The Association of Investment Companies (AIC) has collated comments from investment companies investing in technological innovation and disruption including Scottish Mortgage, Bankers, Brunner and Mid Wynd International.
Simon Edelsten, fund manager of Mid Wynd International Investment Trust said: “Investing in technology is key for Mid Wynd as innovation drives growth and keeps companies competitive. 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 challenge many established business models – such as high street retailing – while opening new investment opportunities.”
Catharine Flood, client service director of Scottish Mortgage Investment Trust said: “It is a common misconception that Scottish Mortgage invests in ‘technology’. We don’t. 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, 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. Gene sequencing company Illumina’s technology dovetails with this and is underpinning a global drive towards a personalised genomic-based revolution in healthcare. Tesla is facing the challenge of driving a shift away from fossil fuels.
“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. Often therefore what we are really doing for Scottish Mortgage is investing in those businesses which are driving progress.”
Alex Crooke, manager of The Bankers Investment Trust said: “As a general rule, we are looking to invest in undervalued companies which have an enduring franchise in a structurally growing end market. The technology sector contains many well-run global leaders which are increasingly taking share from other areas of the economy.”
Where are the opportunities?
Lucy Macdonald, portfolio manager of The Brunner Investment Trust said: “Brunner has a dual objective of real income and capital growth. The broad technology universe offers opportunities for fulfilling both objectives, offering long-term capital growth and some growing dividend yields. IT budgets across the corporate sector are growing strongly, fuelled by robust corporate profits and the urgent threat of disruptive change. End markets favoured for spending, and where we have active exposure, are digital transformation, cloud computing and the Internet of Things. We also favour online travel and digital payments.”
Simon Edelsten, fund manager of Mid Wynd International Investment Trust said: “Our philosophy in Mid Wynd is safety first and if we find, as in Amazon last year, that the share price has moved beyond reasonable forecasts of future cash flows, we sell our holding. In this case we have been shown to be much too early, though our sale of Facebook now looks more prudent.
“Generally, being global investors, we find we can move on to less well known areas of growth and reinvest our profits at more comfortable valuations. Selling some of our FANG holdings came at a time when we could invest in Japanese companies which are global leaders in robotics and automation. 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.”
Catharine Flood, client service director of Scottish Mortgage Investment Trust said: “The initial creative crisis phase has already shifted into a new normal, a digitally interconnected paradigm powered by the data it creates. Those second order companies, such as Twitter, which tried to compete directly only bought incremental changes to the paradigm and their returns have reflected their more limited impact. Of more interest to us are the next generation of companies building their businesses on top of this digital infrastructure. They are addressing specific and large markets such as financial services (Ant International), digital media (Netflix, Spotify), food consumption (Meituan, Delivery Hero and Grub Hub) and transportation (NIO, Full Truck Alliance and Lyft).”
What’s the outlook?
Alex Crooke, manager of The Bankers Investment Trust said: “As long-term focused investors we still believe many of the more powerful secular trends within technology remain underappreciated by the wider market, for example, the disintermediation of bricks and mortar retail stores by e-commerce. Whilst we are all quite familiar with ordering goods online, it is important to note we are still in the early stages of adoption. In the US, e-commerce accounts for just 13% 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 it looks expensive on near-term valuation multiples has the potential to substantially grow its profitability in the years ahead as its growth investments naturally begin to subside.
“Another point to mention is the very strong balance sheets many of the more mature technology holdings within our portfolio possess. Apple, Microsoft, Cognizant and Activision Blizzard all boast net cash balance sheets and growing dividends, an attractive combination of resilience and cash distributions for the patient investor.”
Lucy Macdonald, portfolio manager of The Brunner Investment Trust said: “After the strong equity performance we have seen since the financial crisis, there are pockets of overvaluation but in areas of accelerating growth, valuation can remain optically high for extended periods. So what do we avoid? Overvaluation coupled with low quality, decelerating growth or potential obsolescence.”
Catharine Flood, client service director of Scottish Mortgage Investment Trust said: “The scale of the returns from each of these platform businesses so far barely reflects the scope of the changes they have set in motion. They remain at the forefront of progress, with a long way yet to go. The challenge for us is always to think about the potential of what might happen from here as the application of this information technology expands into new industries.
“Though more commonly noted for our optimism, we do have some concerns over the risk of the destructive power of these companies on many of the traditional large incumbents, particularly in the traditional ‘defensive’ sectors. For example, 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. 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. The managers of Scottish Mortgage are questioning whether the breadth of today’s paradigm shift might now lead to a greater period of stress. Exponential development rates require an ability to embrace uncertainty and change in a way many of the challenged incumbents in a wide range of industries are simply unaccustomed to. The managers of Scottish Mortgage believe in the coming decade returns are likely to go to those businesses best able to embrace progress and invest accordingly.”
Ian Sayers, chief executive of The Association of Investment Companies said: “Whilst it's well known that investment companies in Sector Specialist: Tech Media & Telecomm offer investors access to the technology sector in a targeted way, it's interesting that investment companies in other sectors can provide investors with exposure to technology too. Investment companies' closed-ended structure, active management and ability to spread risk across a variety of countries and companies makes them well suited to harnessing the opportunities of the future.”
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- *Source: Morningstar and SIX Financial Information.
- The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment. Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. The AIC has 354 members and the industry has total assets of approximately £187 billion.
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