Is talk of a bubble premature?
Thursday 23 Jul 2020 Author: Steven Frazer

Investors have been piling into technology stocks this year in volumes not seen since the dotcom bubble of 1999/2000. Things did not work out very well for investors back then, so it is quite reasonable to ponder whether we are headed for a similarly disastrous outcome.

Managing to limit losses during any stock market downswing while staying keyed in to important growth opportunities is never an easy task but, in this feature, we try to help investors come to their own rational conclusions about how they can manage portfolios and their exposure to tech themes through the coming months.


The enthusiasm for tech stocks has intensified this year, getting a massive boost during Covid-19 lockdown. This was an extraordinary time for us all but for many ordinary investors, this was the first time they had used video calling to stay in touch with family and friends, shopped for groceries and other necessities online or had to run work meetings on their smartphone.

Recent data shows we have vaulted five years forward in consumer and business digital adoption in a matter of around eight weeks, says a report by business consultancy McKinsey.

The share price rallies in Zoom Video, Microsoft and Ocado (OCDO) are good examples of how changes to our old routines have impacted stocks.

The new way of life involving video conferencing, work collaboration tools and online grocery ordering, among other factors, has sparked huge investor demand for many popular tech stocks reckoned to have prospered from lockdown.

‘2020 has so far proven to be the latest episode in a long period of technology outperformance,’ says William Heathcoat Amory, an analyst at investment trust researcher Kepler.

Since the start of 2020, Zoom Video’s share price has rattled more than 260% higher. Tesla has jumped almost as much and now carries a $278 billion market value, the sixth biggest on Nasdaq. You would have to look in the healthcare sector to find a stock that’s done better, such as Covid-19 vaccine hopeful Moderna which has jumped 385% this year.

Netflix is up nearly 50%, Microsoft has enjoyed a near-30% rise partly thanks to its Teams online meetings and collaboration tool. Even the previously lacklustre share price of workplace collaboration platform Slack has sprung to life this year, still up 38% in 2020 even after falling 20% from year highs in June.


This surge in demand has sent technology indices to soaring levels despite the obvious challenges to growth that the pandemic has created.

Technology sector revenue growth is forecast to decline by 1.2% in 2020, says Polar Capital fund manager Ben Rogoff, but that compares to an anticipated 11.3% slump for the broader market.

‘The combination of positive sector returns and negative earnings revisions saw the technology sector continue to re-rate over the past year leaving it trading on a forward price-to-earnings (PE) ratio of 22.5, compared to 18.9 at the previous year end (30 April),’ comments Rogoff, who runs Polar Capital Global Technology Fund (B42W4J8) and Polar Capital Technology Trust (PCT). His reference point for the technology sector is the Dow Jones World Technology index.

Investors have gravitated towards stocks able to deliver growth against a more uncertain economic backdrop and to sectors perceived to win (or lose less) from Covid-19 disruption, according to the fund manager.

By his own admission, this represents one of the highest forward multiples enjoyed by the sector since 2005 and is well ahead of five-year (17.8) and 10-year (15.4) averages.


Seen by many as the benchmark for technology stocks, the US-based Nasdaq Composite has been on an almighty run since the global market sell-off in February and March as the widespread impact of the Covid-19 virus struck home.

Since bottoming out at 6,860.67 on 23 March the index has soared 53%, recovering all of its pandemic losses by early June, and setting a new record of 10,767 on 20 July.

That has pushed the Nasdaq Composite’s price-to-earnings multiple to 31.5 according to Refinitiv data, and the Nasdaq 100 (the biggest 100 Nasdaq stocks) to a PE of 34.3. This time last year the equivalent Nasdaq 100 PE was 25, according to data from US research house      Birinyi Associates.

Sceptics have been eagerly waiting for what they claim will be the bursting of a bubble inflated by the irrational exuberance of investors.

‘This is nuts,’ proclaimed Lance Roberts, chief portfolio strategist for RIA Advisors in the US in an 11 July client newsletter. ‘For the second time in a single year, we have begun the profit-taking process within our most profitable stocks,’ he added, referencing many big tech names plus several tech-themed ETFs.

Others take a more sanguine view. ‘We are firm believers in learning the lessons from history but calling the present day a tech bubble is taking the wrong leaf out of the history book,’ said Stephen Yiu, lead manager of the £440 million Blue Whale Growth Fund (BD6PG78).

He draws on adoption curve parallels of electricity, which was not embraced overnight but eventually became widespread across all industries. This transition is being played out in internet-based technologies, like cloud computing and digital payments, which have matured into enterprise-grade tools to help businesses with digital transformation, according to Yiu.

Still, tech bears who study charts talk about the 2% Nasdaq ‘reversal’ on 13 July, when having opened more than 1% higher, changed tack mid-session to fall 2.1% by the close of the trading day. As it stands, Nasdaq has shown little real sign of meltdown.


Given the strength of the US market overall, the tech premium is not really that wide. ‘The sector’s relative rating represents only a circa 5% premium to the broader market,’ calculates Rogoff.

‘In early February, this premium exceeded 20% but has been ameliorated by subsequent earnings revisions that have been less negative than the broader market,’ he says.

Today’s modest premium looks well supported, says the fund manager, by the tech sector’s relative earnings profile, profitability (net margins that in the first quarter of 2020 were twice that of the S&P at 20.8% and 9.4% respectively) and balance sheet strength. ‘As in previous years, the technology sector is unique in boasting net cash.’

The technology sector, like any other, has its mix of weak and strong. By its nature it tends to see lots of young start-up businesses yet to prove their products or models, others that have built scale but have yet to see that convert to profits, or mature technology businesses that have moved past their real growth phase, such as IBM, Dell and Oracle.

But within the sector are stocks that have proven their growth and profit credentials over the years, and have continued to deliver strong returns for investors, such as Microsoft, Amazon and Alphabet. They are essentially digital, flexible, platform businesses that can control costs, maintain service standards and still fulfil customer needs even during these difficult times.


‘Tech businesses do not automatically generate good returns: they have to earn it,’ says Blue Whale’s Stephen Yiu. ‘Most of the technology companies in our portfolio have done so. Some, like Microsoft, have even seen upward earnings revisions despite the economic impact from Covid-19 and lockdown. On the other hand, there are plenty of household tech names that have not done as well: IBM, Sage (SGE), Oracle and Hewlett Packard to name a few.’

The technology sector contains a relatively wide range of different companies, all loosely defined as being technology businesses.

It’s little wonder that businesses like these are being chased by an increasingly deep pool of investors. ‘Over the past decade, technology-related companies have tended to perform like consumer staples or defensives on the downside, and like high-growth discretionary stocks on the upside: an ideal combination from the investor’s point of view,’ said Kepler’s William Heathcoat Amory.

As a result, the indices, and fund managers’ portfolios, are increasingly correlated to big tech.

It’s important to understand that Microsoft, Apple, Amazon, Alphabet, Facebook, Netflix and many other stocks may not charge on forever, like tech goliaths of the past (IBM, Oracle and Yahoo, for example). Each may be forced to pass the torch to new companies with new ideas and technologies.

As Polar Capital’s Ben Rogoff says, investors need to ask themselves ‘what do I want to hold’ and look beyond short-term market caprice.


Staying on the right side of this creative destruction cycle may be beyond the average DIY investor. But they can build a portfolio of funds and investment trusts to deal with the shift in companies being at the top of their game and others coming in to replace them.

There are some very talented fund managers in the tech space and paying them an annual management fee could be a small price if it means benefiting from their stock picking skills. You are effectively outsourcing all the hard work, in-depth research and analysis, meaning you get exposure while also being able to get on with your life.

Investing in collectives also introduces more diversification into investing without reducing the potential for growth.

Allianz Technology Trust (ATT) and Polar Capital Technology Trust, for instance, are both run by tech specialist managers,’ says Kepler’s Heathcoat Amory.

The Allianz trust differs from Polar’s product by having a more concentrated portfolio and at times greater exposure to mid-caps. ‘This combination of features means that Allianz Technology can be more volatile and deviate from the benchmark to a greater extent, from time to time,’ says the Kepler analyst.

Nonetheless, over the last five years, these two aspects of Allianz Technology have paid off for its shareholders, having outperformed Polar Capital Technology by a total of 15% in net asset value (NAV) terms, according to Kepler’s calculations.

There are good reasons why the quality characteristics which technology stocks display give them the potential to outperform for years to come. But nothing lasts forever.

We would not bet against the technology sector performing strongly in absolute terms over the medium term, but it might be that sector leadership could be handed over elsewhere.

Our view is that investors should stay with the tech sector but appreciate it won’t always enjoy such a rapid rally as it is now experiencing.


The accompanying table shows the best performing funds tech funds over the last five years, on an annualised total return basis, which should give investors a good starting point in their search for ideas.

Three funds catch our eye and are good way to get exposure to the sector. First is Polar Capital Global Technology Fund where lead manager Ben Rogoff has proven himself as a very smart reader of the tech space, mixing exciting mid-cap growth potential with many of the sector’s goliaths.


He’s been supportive of trends like internet shopping and digital payments for years, both really shining through during Covid-19, while he keeps the fund as flexible as possible to take advantage of emerging opportunities, both in and outside the US.

With a consistent strong track record, Rogoff’s regular investment newsletters are among the most valuable investor communications in the sector.

Herald Worldwide Technology Fund (B51DS86) blends the best of mega-cap tech with some of the great little tech companies in the UK and elsewhere by retaining a stake (currently 3.2% of its funds) in the Herald Investment Trust (HRI), both run by investing grandee Katie Potts.

That means companies like Amazon, Apple and Advanced Micro Devices sit side by side with small caps like fraud prevention and ID management software firm GB Group (GBG:AIM).

Legal & General Global Technology Index Trust (B0CNH16) is arguably a lower risk way into the tech world since it acts as a virtual tracker. It manages its portfolio to largely match the tech niche among the FTSE World Index, balancing weightings generally to constituent market caps. Key names in the fund include Facebook, Apple, Alphabet and Samsung, the South Korean electronics and tech giant.

DISCLAIMER – The author owns shares in Polar Capital Technology Trust and Allianz Technology Trust

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