The technology sector has experienced considerable industry change over the last three decades. In the 1980s we saw the move from the mainframe computer to the PC; in the 1990s we witnessed the advent of the Internet, with this period characterised by the dramatic appreciation in the stock prices of technology-related companies. During this period, from its IPO to the end of 1999, Amazon (AMZN) surged over 300% and other names, such as Yahoo! (YHOO), posted similar returns. However, this value was subsequently destroyed when the dotcom bubble spectacularly burst, with the MSCI World Information Technology index falling by over 80% by early October 2002. Despite a short-term bounce from these oversold levels the sector then experienced a period of consolidation underperforming the MSCI World Index during the equity bull market from March 2003 until 2007.
However, over recent years, the sector has seen both strong absolute and relative performance. According to IMA sector data, the average technology fund is ahead of all other equity sectors, with the exception of the US small cap sector over five years to the end of March 2013. The past five years have seen some interesting developments in the sector, with themes such as cloud computing, mobile computing and social networking coming to the fore. At the same time, the more mature Internet retailing revolution has continued to march apace.
The strength of the technology investment theme from 2009 came from the combination of these growth opportunities and the strong industry-wide company dynamics. Many technology companies learned from the crisis of 2000, and went into the market turmoil of 2007/08 with strong management and robust balance sheets. Against an economic outlook that was—and remains—uncertain, the sector has benefited not just from these factors but also from its ability to respond quickly to change with constant innovation in a broadly deflationary environment. The sector delivered strong absolute and relative performance in the market recovery of 2009/10. Fast-forward to 2012/13 and technology continues to offer the combination of growth potential and company quality with a number of key technology companies having robust balance sheets and high levels of cash. This also supports the prospects for dividend growth.
As we enter 2013, there are several prominent themes, such as social networking, content and cloud computing. While not a new theme, the increasing use of social networking in our day-to-day lives accompanied by the potential for more connected devices means that this continues to be an appealing investment theme for fund managers. However, there are few successful social networks, thus making this a difficult theme to gain exposure to. Owning multi-media content is another theme that is at the forefront of fund managers’ minds with companies such as Amazon offering the Kindle Fire, which has negative operating margins relying on content for their profit streams. This is putting pressure on existing, low margin, high volume hardware manufacturers who may need to respond by revising their business models if they are to survive. Another interesting theme is cloud computing, the use of a network of remote servers hosted on the Internet to store, manage and process data rather than using a local server. It is a theme that fund managers are excited about as they are seeing providers either investing to protect their position or attacking this new market.
From these themes it is clear that growth opportunities create losers as well as winners at the company level. The speed of change and innovation means the technology sector can be brutal for companies who do not keep up with progress; an example of this is the impact Apple’s (AAPL) iPhone has had on Nokia and more recently the impact of the iPad on the notebook market. Within the technology sector there are different investment approaches and philosophies that try to capture the characteristics of the industry. Among those funds in the technology sector that have earned our highest Morningstar Analyst Ratings are funds that are managed by experienced managers with differing investment approaches.
The Henderson Global Technology fund has a Morningstar OBSR Analyst Rating of 
Silver and is managed as a more large-cap, benchmark aware offering. The fund is managed by Stuart O’Gorman and Gordon Happell, who form part of a dedicated technology team at Henderson. We like their thematic approach and ability to combine high-quality stock research in a risk aware manner at the portfolio construction stage of the process. Their investment approach has delivered attractive absolute and relative returns over five and ten years. The fund has seen considerable inflows and is admittedly large in size but we believe it is able to cope with its scale due to its focus on large-caps.
The GLG Technology fund is managed by two experienced hedge fund managers, Philip Pearson and Anthony Burton and has a Morningstar OBSR Analyst Rating of Bronze. Pearson and Burton use their in-depth knowledge of the sector and their total return mentality in managing the fund. Their approach encompasses an analysis of long-term industry growth themes and rigorous stock level research. We have high regard for their ability to combine insightful sector and stock analysis with a strong portfolio construction discipline that has been developed through their hedge fund backgrounds. The portfolio is concentrated and stock specific in nature which is likely to result in a reasonably volatile outcome, but this should be mitigated to some degree by the index-level hedges held in the portfolio.
The Polar Capital Global Technology fund has a Morningstar OBSR Analyst Rating of Bronze and incorporates a meaningful focus on smaller, higher-growth stocks. The fund is managed by Nick Evans, supported by Ben Rogoff and a well-resourced dedicated technology team at Polar Capital. The investment approach is characterised by the managers’ belief that they can add value by investing in companies that offer new, disruptive technologies. We believe they are skilled at identifying changing industry trends and the companies poised to benefit as a result. We have high regard for their thematic approach that focuses on areas of growth combining company research with their short and longer-term expectations for the industry development. The portfolio will incorporate a bias towards smaller companies that can result in performance being lumpy relative to the large-cap dominated index but we expect investors to be rewarded over time.
This Morningstar article first appeared in Professional Adviser.
