Investing in technology with investment trusts
How closed ended funds can support an active approach to the sector….
Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Allianz Technology Trust. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
Investing in technology has been the story of the last ten years in equities markets. Companies in Silicon Valley in particular have driven a huge proportion of the returns that the stock market has seen globally since the financial crisis of the late 2000s.
Market analysts at Ned Davis Research found that removing Facebook, Amazon, Netflix, and Google-parent company Alphabet from the S&P 500 reduced the index’s total return by almost 10% from 2015 to 2020.
Those four companies, along with others like Microsoft and Apple, vastly outperformed the wider US stock market during that time, along with almost all other major listed businesses across the globe.
The trouble with hype
Understandably, that has meant many investors want to get exposure to this segment of the market. Taking an active approach might even be seen as a must, given the potential for outperformance these companies are thought to possess.
Doing so arguably carries a higher level of risk with it though. Lots of technology companies that have emerged over the past decade are speculative and may have a high valuation predicated on future profitability.
If that profitability never arrives or isn’t in line with the markets expectations then share prices can fall dramatically. We saw this repeatedly in 2020 and 2021, two years that saw record amounts of cash being raised via new initial public offerings (IPOs).
Lots of these businesses had never turned a profit and still haven’t at the time of writing. With enthusiasm dampening for many of them, that has led to major sell-offs and companies losing a huge amount of value relative to their all-time highs.
Sorting the good from the bad
What this goes to show is how hard it can be to pick the winners from the losers, particularly in an area of the market that’s seeing a surge in interest.
Looking at technology’s historical outperformance, it’s easy to be duped into believing all companies in the industry are likely to do well and generate strong returns for shareholders as a result.
Not only is this not true, it’s arguably a much riskier area than others. As many listed technology businesses at the time of writing are valued highly based on future outcomes, there are arguably relatively more unknowns than in other areas of the market.
To give an example from the past, in the early 20th Century, there was a massive boom in the nascent US car industry. Thousands of companies were set up and received backing from investors. Today just three companies, Ford, Stellantis, and General Motors, control the overwhelming majority of the industry.
Identifying those three businesses at the beginning would have been a hard thing to do and, just like today, it’s easy to imagine investors thinking a rising tide would lift all ships when that ultimately wasn’t the case.
How investment trusts can support tech investors
One way investors can try to avoid these traps but still have an active exposure to the market is by buying shares in an investment trust that focuses on technology companies.
Investment trusts are pooled investment funds. They are set up as publicly traded companies and have shares listed on an exchange as a result. To get exposure to a trust’s investments, you just have to buy some of its shares.
For technology investors, the main benefit that a trust provides is that it gives you access to an actively managed portfolio, run by a team of professional fund managers.
There is obviously no guarantee they will generate returns, but it’s a simple way of handing over the investment process to a group of people that are typically experts in their field. Technology investors that want an active exposure to the market but don’t want to manage their own portfolio may find this appealing.
Aside from the approach they take to the market and the management skills they provide, investment trusts also have structural benefits that can make them more attractive than other types of funds.
For one thing, buying and selling an investment trust’s shares does not impact its underlying portfolio. The separation between the two means an investment trust does not have to hold a huge amount of cash and can generate a higher total return by putting more money into the market.
This is not true of open-ended funds. When investors take money out of them, open-ended fund managers have to use their own holdings to give them their cash back. To do this, they typically have to hold a larger amount of cash in case there is sudden demand from investors. Doing this creates a drag on performance because that cash is sitting in a bank account and not generating any returns, aside from any interest the bank may provide.
Aside from this, investment trusts can use gearing to enhance their returns. Gearing is borrowed money and can be used to make further investments that generate excess returns for a portfolio. It is worth noting that this can work the other way around too, as gearing will exacerbate investment falls.
Technology investment trusts in 2022
The Association of Investment Companies currently lists four investment trusts that specialise in technology companies. There are arguably a lot more than that if you factor in venture capital trusts that invest in earlier stage businesses, although it should be noted these are structured differently to investment trusts and typically invest in riskier, early-stage companies.
There are also investment trusts that don’t invest specifically in technology but may have a sizeable exposure to companies in the sector. These may suit some investors if they want to blend together some of their investment goals into one trust but are less likely to appeal to those looking for a tech-only fund.
In terms of performance, only two of the technology investment trusts have been active for more than five years – Allianz Technology Trust (ATT) and Polar Capital Technology (PCT). The former has generated total share price returns of 782.3% over the past 10 years up until March 31st 2022. Polar Capital generated 476.6% over the same period.
In comparison, open-ended companies averaged total returns of 393.4% over the past decade, substantially below the two trusts.
Case Study: Allianz Technology Trust
Company: Allianz Global Investors
Managers: Walter Price, Huachen Chen, Mike Seidenberg, Danny Su
Ongoing charges: 0.69%
Dividend policy: The trust does not currently pay a dividend
Benchmark: Dow Jones World Technology Index (sterling adjusted, total return)
Allianz Technology (ATT) is a London-listed investment trust that invests in technology companies. It invests heavily in mid- and large-cap companies that the trust managers believe display strong future growth potential.
ATT is run by a San Francisco-based team of analysts, led by Walter Price, a portfolio manager with over 40 years of experience investing in tech firms.
Over the past 10 years the trust has been a standout performer, generating total share price returns of just under 840% at the time of writing. This makes it the second-best performer in the entire UK investment trust sector in that time, according to data provided by the Association for Investment Companies. Investors should note that this is not a guarantee of future returns.
Price and the other trust managers tend to take a growth-oriented approach to the market. The stocks they hold typically have higher valuations than many other sectors. They do this as they believe those companies will bear fruit in the future and thus justify their higher share price today.
The trust has a global remit, meaning it can invest in companies listed anywhere. That being said, the nature of the technology industry, dominated as it is by US firms, means that ATT’s portfolio has historically skewed more towards the US than any other region.
ATT does not currently pay a dividend and the trust’s managers have not expressed a desire to begin doing so. That partly reflects the underlying portfolio, which contains many companies that don’t pay dividends, but also the trust’s goal of delivering long-term capital growth to shareholders.
1) What is ATT’s goal?
ATT invests in listed technology companies with the goal of providing long-term capital growth in excess of the Dow Jones World Technology Index.
2) What kind of stocks do the managers like?
ATT’s managers tend to look for companies that are using technology to gain a competitive edge of some description. They particularly like businesses which address some sort of growth trend and are either using new technology to do so or are using technology to change the way in which products and services are being provided.
The investment trust managers tend to see technology companies as either ‘traditional’ telecommunications, media and technology businesses, which would include software businesses or semiconductor firms, or as ‘non-traditional’ companies, which are firms using technology in a new way to gain a competitive edge.
3) Are investment decisions driven by a particular investment style?
A big part of what ATT does is to invest in companies that it believes will be able to deliver substantial future growth. In that sense, the trust is more skewed towards growth stocks. Having said that, it wouldn’t be fair to say that the trust makes investment decisions on the basis that doing so would fit with a particular style. It’s more that the trust managers believe companies which can see large-scale growth are more likely to deliver higher returns for shareholders. In some instances, that can mean buying at high valuations.
4) How many stocks does the trust typically hold?
The trust is broadly diversified but does not hold a specific number of stocks in order to achieve that. As such, the number of stocks can fluctuate over time.
5) What is the investment trust’s dividend policy?
ATT does not currently pay a dividend, nor are there plans to instate one in the near future. This reflects the trust’s goal of producing long-term capital growth, as opposed to producing an income for shareholders.
6) What are the trust’s ongoing charges?
The investment trust’s current ongoing charges are 0.69%.
7) Are there any performance fees?
Yes, these are calculated as 10% of outperformance against the benchmark, after adjusting for changes in share capital and are capped at 1.75% of the Company’s average daily net asset value (NAV) over the relevant year. There is also a ‘high watermark’ which is reset upwards whenever a performance fee is earned, being the new level of the NAV which has to be exceeded for a fee to be earned. Any underperformance also has to be ‘made back’ in performance terms before a new fee can start to be accrued.
8) How much attention do the managers pay to their benchmark, and to what extent are absolute returns important?
The ATT managers are aware of the benchmark but are not constrained by it, nor does it have an influence on their investment decisions. Relative returns are important to the trust managers, who strive to outperform their benchmark index.
9) How much does ATT differ from its benchmark?
ATT’s focus on high growth, mid- and large-cap companies means it differs markedly from its benchmark which is dominated by a handful of so-called Mega-cap companies.
10) Does the investment trust use gearing and if so is it structural or opportunity led?
Under normal circumstances the trust would not use gearing in excess of 10% of NAV, though this can rise to 20%. Gearing is opportunity led, rather than structural. To date the managers have chosen not to employ gearing, being of the opinion that the often-volatile nature of technology investing would have been exacerbated by its usage.