All change: investment company managers on tax, regulation, break-ups and valuations
Despite the economic turmoil, one sector has seemed immune to COVID concerns and continued to deliver remarkable gains. The performance of technology stocks has been eye-catching across the market cap spectrum and well documented in the financial press, most recently with impressive Q4 2020 earnings reported for some of the largest tech titans.
But will this seemingly unstoppable sector continue to grow, are we in bubble territory, where are the new exciting areas of technology and what are the prospects for taxes and break-ups? The Association of Investment Companies (AIC) has asked the managers of tech-focused investment companies.
How will technology continue to change our lives?
Ben Rogoff, Technology Director and Lead Manager of Polar Capital Technology Trust, said: “How will it evolve in the future? To answer that, I will actually look back in time. I like to lean on history having studied it at university and whilst I don’t think history repeats, it often rhymes. In this instance, I would draw a parallel with World War II. The end of WWII did not see a return to the pre-war world; it swept Winston Churchill from office and presaged a remarkable period of accelerated societal change. We believe the post COVID-19 world will follow a similar path with hopes of a return to normal likely to be replaced by the oft-mentioned ‘new normal’. Companies are already planning for this new reality with working from home efforts quickly morphing into working from anywhere. Technology is likely to prove central to this new reality.”
Helen Steers, Partner at Pantheon and Manager of Pantheon International, said: “We expect that technology will play an even bigger role in our lives as we look ahead, whether that be through companies adopting new, flexible ways of working, even more services delivered online or our increased use of technology for home entertainment and leisure purposes. As more of our lives move online, this will create an even greater requirement to focus on data awareness and protection, and the implementation of enhanced cybersecurity tools and processes.”
David Toms, Director of Research at Hg, the manager of HgCapital Trust, said: “Sometimes, it’s the small things that make the biggest difference. For example, automating those dull tasks that nobody likes to do – helping businesses keep track of payments and taxes, ensuring X-rays can be seamlessly transmitted to the most appropriate expert regardless of location, analysing data on drug development processes, or scheduling the medical staff at major hospitals. We think that incrementally, our lives will continue to get easier and more interesting as more of the ‘admin’ processes are handled automatically.”
Walter Price, Portfolio Manager of Allianz Technology Trust, said: “Globally, we are in a period of rapid change, where technology is key to prosperity for all industries, from manufacturing to finance. Cloud companies, collaboration software companies, and those enabling efficient manufacturing processes such as automation, are becoming critical infrastructure in our world. In the next five years, we expect these long-term trends to continue. We also expect the broader technology trends of 2020 to continue, such as the growth of electric vehicles. The electric vehicle market is competitive, so it is likely that only the larger incumbent auto companies, and Tesla, will do well in this area. The semiconductor industry will also benefit from its growth – given electric vehicles use about six times more than the usual car. Many of the companies in our portfolio are focused on making these components, and we think they will benefit from the growth of electric vehicles.”
Tax and break-ups
Walter Price, Portfolio Manager of Allianz Technology Trust, said: “There will undoubtedly be pressure from governments and agencies on large tech companies both in terms of taxation but also in regulation terms due to their size and influence. While this could force changes in some of these organisations, they have also become expert over the years in navigating these changing landscapes and adapting their businesses.”
Ben Rogoff, Technology Director and Lead Manager of Polar Capital Technology Trust, said: “We continue to monitor regulatory risk for all of the largest technology companies. While we believe worst-case scenarios like break-ups will be avoided, we think higher effective tax rates, and less permissive frameworks for M&A, are realistic base cases for these platforms, particularly with governments looking to recover record fiscal deficits post pandemic. However, absent a wholesale change in the basis of global taxation (profits, not revenues) this risk should prove manageable and may already be captured in some valuations.”
New and exciting areas
Tim Levene, CEO of Augmentum Fintech, said: “We recently announced our investment into open banking payments platform Volt.io, the leading provider of account-to-account payments connectivity for international merchants and payment service providers, gaining exposure to the fast growing open banking and digital payments opportunities. We also expect to see significant growth this year in the mainstreaming of crypto and decentralised finance (DeFi) and last month announced our investment in ParaFi. Through this partnership we will give our investors exposure to a diversified portfolio of pioneers in the DeFi and blockchain spaces.”
Walter Price, Portfolio Manager of Allianz Technology Trust, said “We think AI and cybersecurity are good high growth areas where we are increasing weightings. We are seeing venture capital investment going into ‘second generation cloud computing’ which will focus on how best to use data and artificial intelligence to enhance software services. Companies that had a cloud software infrastructure coped a lot better through the pandemic than those who didn’t, so we see this area growing and transitioning over the next decade. There are exciting developments such as intelligent algorithms to provide a to-do list for workers, who salespeople should call, HR software that says who should get a promotion and how soon. These are smart ways to run a company, they do not displace people, they make them more efficient.
“Cyber security is another area we are investing in. During COVID-19 lots of cities, hospitals and companies faced increased cyber threats so we need more solutions and a lot more security in this world.”
Valuations
Helen Steers, Partner at Pantheon and Manager of Pantheon International, said: “The higher valuations appear to be predominantly in the large cap stocks whereas Pantheon International’s exposure to technology is weighted towards small/mid-market buyout and growth where we see more normalised levels, even for higher growth companies. Whereas average earnings levels for most public market companies (S&P 500) have yet to recover to levels seen before the onset of the pandemic, in general earnings for software companies have shown impressive growth despite the broader underlying market volatility. Our private equity managers are focusing on businesses that have strong market positions in their sector niches that underpin sustainable, recurring revenues and where there are value creation opportunities through consolidation or M&A as well as through organic growth.”
Ben Rogoff, Technology Director and Lead Manager of Polar Capital Technology Trust, said: “Some commentators have suggested that the recent rise of technology stocks is approaching its peak. We acknowledge the rise in valuations but we remain supportive of the sector on a medium-term outlook. Tech fundamentals are very strong as evidenced by Q4 earnings season while the long-term opportunity set looks as exciting as it ever has. Our enthusiasm is only tempered by valuations that have continued to expand and some evidence of investor exuberance in pockets. Therefore, risk management is important. Our approach has as much to do with identifying winners as it has with avoiding losers and surrendering less ground than our racier peers during setbacks. Our approach to the benchmark is also key when considering risk because we are neither beholden, nor blind to it. Instead, we construct our portfolio with an eye to our benchmark and aim to outperform it by around 3% per annum with active share that has typically ranged between 40% and 50%. We also limit the size of our overweight positions to around 3% relative to the benchmark and use gearing very selectively which helps us further control risk. This leads to a diversified portfolio which we believe is an important consideration when mitigating risk.”
Walter Price, Portfolio Manager of Allianz Technology Trust, said: “During the tech bubble, tech valuations were not rational and were not supported by earnings and cash flows. Today, tech valuations are far more reasonable. Tech companies are now producing tangible earnings and cash flows. Last year was not a normal year but even with some multiple degradation we still expect good returns from the sector. The breaking up of businesses is a possibility but is not a definite outcome at the moment.”
Outlook
Tim Levene, CEO of Augmentum Fintech, said: “The UK tech industry, in which fintech is leading the charge, is starting to mature and the opportunity is immense. Within the financial services sector, fintech has less than 10% market share, so there is still a great deal of growth to come. Fintech challengers will continue to play a crucial role in supporting economic recovery in the UK post-pandemic and we expect 2021 to be a record year for investment in UK fintech, building on the $4.1bn venture capital inflows from 2020. We expect B2B, software-as-a-service and infrastructure within banking and insurance to become the subject of significant start-up and investment activity. Building on the accelerated digital adoption seen across financial services we will continue to see increasing appetite from incumbents engaging with and investing in fintechs to help solve some of their legacy challenges.”
David Toms, Director of Research at Hg, the manager of HgCapital Trust, said: “We see significant runway ahead for the software and services industry – COVID has demonstrated that the businesses in which we invest are mission-critical in tough times as well as in good times. Changes in working habits, greater interconnectivity, an accelerating shift to cloud technologies and a desire to automate business processes all underpin strong future prospects.”
Walter Price, Portfolio Manager of Allianz Technology Trust, said: “Technology continues to benefit from strong tailwinds which should continue to drive attractive long-term appreciation. There is no question in our minds that the present events will spur the use of technology and change how we live and work in the future. As companies adjust budgets due to supply and/or demand disruptions, the need for companies to reduce costs should accelerate the move to cheaper and more productive solutions such as cloud, software-as-a-service, artificial intelligence and cyber security. We continue to believe the technology sector can provide some of the best absolute and relative return opportunities in the equity markets – especially for bottom-up stock pickers.”
