At the height of the dotcom boom in the late 1990s, investment guru Michael Mauboussin asked rhetorically whether it was rational that Amazon had a market value four times that of booksellers Borders and Barnes & Noble combined. In retrospect, this valuation proved far too low, as James Anderson, manager of Scottish Mortgage Trust, points out. Amazon’s share price has subsequently soared and the firm’s shares have now risen by more than 50,000% since it listed on the stockmarket 20 years ago. Borders, meanwhile, has gone bust.
Yet Amazon’s recent purchase of food retailer Whole Foods Market for $13.7bn has increased the nervousness that already hung around the tech sector following spectacular returns for large-cap tech stocks in recent years. This is the sort of diversification that rings alarm bells, say those investors who are still haunted by memories of the crash that followed the boom of the late 1990s.
Sceptics note also that in 2000 the technology, media and telecoms sectors accounted for seven of the ten largest companies in the world by market valuation. Today, technology again accounts for seven, with the top five slots taken by US companies: Apple, Alphabet (Google’s parent), Microsoft, Amazon and Facebook. The top ten has a record of reflecting investors’ overconfidence, as Louis Gave of Gavekal, an investment research firm, points out. In 1980, six were oil firms. In 1990, eight were Japanese. In 2010, Chinese stocks and commodities firms accounted for seven.
However, the dominance of technology is not necessarily temporary and irrational. These are high-margin, cash-generative and knowledge-based companies. Their capital-light business models have let them go from a standing start to domination of fast-growing markets, and they haven’t stopped innovating. What’s more, behind the big names are a host of other companies, from the well-established to recent start-ups, many experiencing explosive growth.
So it’s doubtful that the sector is heading for a fall as it was in March 2000, says investment strategist Edward Yardeni, of Yardeni Research. The tech sector now accounts for 23% of the S&P 500 index, compared with 33% back then. Moreover, tech peaked in 2000 on 48.3 times forward earnings, more than twice that of the S&P 500. Now, the forward rating is 18.1, compared with 17.3 for the S&P 500. If cash – which accounts for $250bn of Apple’s $800bn of market value – is stripped out, the valuations are lower, while earnings growth justifies a premium to the market. Only if this growth fails to materialise could the sector look expensive.
There are two mainstream investment trusts in the sector: Polar Capital Technology Trust (LSE: PCT) with £1.4bn of assets and Allianz Technology Trust (LSE: ATT) with £273m. In the five years to the end of May, Polar Capital returned 168% and Allianz Technology returned 205%, while the one-year returns were 56% and 58% respectively. This compares with the sector benchmark return of 160% over five years and 53% over one year.
Both trusts are attractive in the long term. However, given the performance in the last year, new investors may need to be patient. A crash in valuations looks very unlikely, but don’t be surprised if there is a setback or a period of dull performance in the next year.
In the news this week…
• The UK’s financial regulator has been criticised for not doing enough to crack down on “closet trackers” – funds that charge for active management, but which in reality just track an index. As much as £109bn of investors’ money is held in potential closet trackers, according to the Financial Conduct Authority’s (FCA) report on the asset-management market. This practice is “widely considered fraudulent”, says Madison Marriage in the Financial Times. Yet despite finding evidence of the problem, the FCA has not penalised any company for selling a closet tracker, unlike regulators in Sweden and Norway. The FCA also reported that investors paid an average annual fee of 0.69% for an actively managed fund in 2015 – three times the average fee paid by large institutions, says Chris Flood, also in the Financial Times.
• UK asset managers and pension schemes are among a coalition of investors managing a total of $7.9trn (£6.1trn) who have called for firms to disclose more details about how they manage their workforce, says Angus Peters in Pensions Expert. The Workforce Disclosure Initiative plans to send a survey on workforce policy to 50 of the largest UK companies and 25 international mega-caps. Research has found that firms with good workplace practices and employee engagement tend to outperform those with poor policies.
Glenview Capital Management has joined other large investors, including Daniel Loeb’s Third Point, in calling for revisions to the proposed $60bn plan to merge chemical giants Dow Chemical and DuPont and split the new entity into three separate companies. Third Point suggested in May that Dow Chemical and DuPont should even consider splitting into six parts to improve the investment potential of each. Glenview Capital, which owns $1bn of Dow stock, amounting to less than 1% of the company’s total value, has also criticised Dow’s decision to delay the retirement of chief executive Andrew Liveris, saying that it believes the delay and current split plan will affect Dow’s ability to find a new leader.