The tech shares fund managers are backing to bounce back

It has been a challenging year for tech shares, but this has now opened up opportunities to buy at lower prices. Faith Glasgow speaks to professional investors to find out which shares they are finding value in.

What shape will tech recovery take? Following the Covid-ridden, locked-down depths of 2020 and 2021, when life moved online and digitalised services became a lifeline, many technology-focused companies saw a dramatic hike in their valuations.

By the second half of 2021, commentators were warning of overstretched valuations and canny investors were trimming their tech and other growth holdings; still, by the end of the year the Nasdaq 100 index of the largest US tech businesses sat on a price/earnings ratio of 38x against the broader S&P 500’s 24x.

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Inevitably, this year’s toxic mix of rising inflation compounded by war in Ukraine, plus a series of painful interest rate hikes by central banks, means the growth-focused sectors that thrived in the previous prolonged era of cheap money have suffered a substantial and painful sell-off.

In the US, the Nasdaq 100 has lost nearly 30% year-to-date (to 28 November), and its price to earnings (p/e) ratio has fallen to 25x, much more closely in line with the S&P 500’s 21x.

UK investors have felt the impact too, of course: even after the rally of recent weeks, fund and investment trust technology sectors are down around 25% over the year, according to FE Fundinfo.  

But our world has not reverted to pre-Covid times. Technological solutions have become increasingly embedded throughout everyday life – just think about how much you do on your smartphone, for example. In addition, technological innovations are a key hope for overcoming a host of major global problems, from climate change to ageing populations and global labour shortages.

Indeed, as Ben James, US equities investment specialist with Baillie Gifford, observes: “Today, everything could be classed as being in the ‘tech world’. Every company in every industry will have some technology-enabled part of its business.”

Opportunity knocks following this year’s sell-off

It’s hardly surprising, then, that growth-focused investment managers have been looking at the correction as a rare opportunity to buy strong, future-facing companies of all sorts at relatively attractive prices.

At the same time, however, the pros are having to be mindful of the likelihood of prolonged recession for the UK, which is bound to impact on most households’ spending and lifestyle choices looking ahead. Clearly, some caveats have to come into play in their stock-picking processes.

For a start, says Will McIntosh-Whyte of the Rathbone Multi-Asset Strategic Growth fund, it’s important to look at companies on a case by case basis rather than treat them “as the FAANG collective they once were”, because the drivers and risks can vary hugely.

He makes the additional point that despite the “fantastic long-term tailwinds” and resiliency of many tech businesses, most have some degree of cyclicality. He points out: “The key here for us is in the degree of resiliency.”

Search for the ‘true disruptors’

For Clare Pleydell-Bouverie, co-manager on the Liontrust Global Innovation team, the secret is to seek out “innovative market leaders or true disruptors, and avoid the vast majority of companies stuck in the middle”.

The Baillie Gifford team’s focus, meanwhile, is on five- to 10-year performance prospects, so James is looking for “companies that address a significant and dynamic market opportunity at an early stage relative to their market cap”, with a sustainable competitive advantage further strengthened by “an influential culture”.

Where do the best opportunities lie? Managers have many different ideas, but one strong message is that, given the continuing spread of digitalisation into more corners of our lives, it makes sense to have exposure to the hardware components underpinning technology.

“We think companies such as NVIDIA Corp (NASDAQ:NVDA), the GPU chip maker, will play an essential role as the world continues to digitise,” says James. “We also think the ongoing issues between the US and China will potentially disrupt the hardware and semiconductor industries” – boosting demand for US suppliers.

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Jamie Ross, portfolio manager of Henderson EuroTrust (LSE:HNE), has been focusing on semiconductors, and especially the European companies that provide equipment to the semiconductor manufacturers. 

“We have positions in ASML (EURONEXT:ASML), a provider of lithography equipment, ASM International (EURONEXT:ASM), a company that sells atomic layer deposition tools and Besi, which sells advanced packaging equipment. All three companies own niche, well-entrenched technology, compete with only a small handful of other companies and generate high gross margins and return on invested capital as a result,” he says.

Pleydell-Bouverie also picks out ASML as “a global leader in hardware” with a virtual monopoly in the production of components for the chips that enable smartphones and other electronics devices. As she explains: “No other company can make these machines, so chip makers have to go to ASML if they want to be able to produce the smallest possible chips. This creates phenomenal pricing power.”

At Allianz Technology Trust (LSE:ATT), manager Mike Seidenberg has reduced his exposure to semiconductor manufacturers, on the grounds that semiconductors have become ‘commoditised’ and therefore don’t have the pricing strength or market dominance he is looking for. However, when there is evidence of an economic upturn he expects to increase exposure to specialist manufacturers, which will be more resilient in a tougher macroeconomic climate.

The big tech themes the pros are playing

The pros also cite a number of increasingly powerful themes they are looking to exploit, including data storage and the cloud, artificial intelligence (AI), the internet of things, electronic vehicles, cybersecurity and the personalisation of healthcare.

Baillie Gifford’s James is particularly excited about the opportunities to buy into cloud-focused businesses, pointing out that cloud computing is likely to underpin digital expansion in industries across the board. “In 2021, the cloud was only 17% of business IT spending – a multi-trillion-dollar market – and there is every reason to think it could be 50% in a few years, with a long way to go after that,” he says.

James picks out three ‘software as a service’ businesses he likes for their “agility and resiliency, particularly in during challenging times”: Snowflake (NYSE:SNOW), HashiCorp (NASDAQ:HCP) and Datadog (NASDAQ:DDOG).

“Snowflake is a single platform for data warehousing that allows data storage, processing and analysis in the cloud. HashiCorp provides various tools that enable businesses to build, deploy and manage their operations across different operating environments. And Datadog helps companies to monitor and analyse their IT and cloud services, helping them to operate at peak performance.”

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In the same arena, Rathbone’s McIntosh-Whyte says he has been adding to Alphabet (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN) and Microsoft Corp (NASDAQ:MSFT), having taken profits in 2021 when valuations looked overcooked.

“Although cloud growth figures for the latest financial year were lower than projected as clients delayed decisions and sought to optimise their spend, at 36% for Google Cloud and 46% for Microsoft’s Azure platform they were still impressive, underscoring the tailwinds supporting these businesses,” he comments.

Cybersecurity is a long-term winning theme for Seidenberg. He argues that it has become “an ongoing requirement in the digital world”, and that a tougher economic climate means companies have to prioritise needs over wants when it comes to investment. Seidenberg has added businesses such as US cloud security firm Fortinet Inc (NASDAQ:FTNT) in recent months.

The pros on the lookout for tech bargains

However, other managers have recently been picking up technology-focused bargains across a wide range of sectors. For instance, Mark Slater, manager of Slater Growth, has topped up his holding of communications group Next Fifteen (LSE:NFC) in the face of “an undeserved de-rating”, partly around recession fears. “

“We believe the business, which is focused on technology clients and digital transformation, will prove highly resilient and will continue to grow rapidly in the years to come,” he comments.

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Meanwhile, at Liontrust, Netflix (NASDAQ:NFLX) has attracted the attention of Playdell-Bouverie as “acompany with innovation embedded in its DNA, which has had a difficult time recently with slowing subscriber growth, but has responded as great innovators do with a plan to create more value for customers and drive growth”.

Although there remains an element of cyclicality in companies’ and individuals’ tech spend, there is a strong argument that that is declining generally, as we become increasingly dependent on digital solutions in work and private life.

But tech-focused fund managers are clearly very mindful that market strength and resilience are key characteristics when it comes to the businesses best placed to weather the coming downturn.