The promise of new technologies lies in their ability to drive costs down, increase efficiencies and create new ways of doing things. But this sector can be a difficult one for both financial advisors and investors to navigate.
The advances are not always easy to understand – and picking winners and avoiding the losers is a challenge in this rapidly changing sector. Unlocking that value takes time and the companies and products first out of the gate aren’t necessarily the ones that will win the race.
There are various ways to invest in technology. One approach is to focus on the companies that may be most affected by the changes. These are often global players that have today’s dominant products and services – the things we all know and use. For example, Microsoft Office software or an XBox, a Visa or MasterCard, or a Facebook account. These companies have the most to lose by not keeping pace and are motivated to find the solutions to remain on top.
Another way involves more risk and blends holdings of established, large-capitalization players with the smaller companies emerging in the space.
Two investment funds – one an exchange-traded fund (ETF) and the other a mutual fund – follow these different approaches that are worth considering for clients’ portfolios depending on their risk tolerance, the length of time they expect to hold the fund(s) and preferred balance between growth and income.
This ETF is actively managed and holds 20 technology stocks on an equally weighted basis. The companies must have a minimum market cap of US$10-billion and be leaders in their field. Most pay dividends. The ETF’s aim is to invest in the sector through a blend of growth and income, which is enhanced through a covered-call strategy.
The ETF’s allocations, by sector, were software (30 per cent), semiconductors and semiconductor equipment (29 per cent) and information technology services (20 per cent) as of July 31. The top stock holdings on that date were Apple Inc. (AAPL-Q), Automatic Data Processing Inc. (ADP-Q), International Business Machines Corp. (IBM-N), Facebook Inc. (FB-Q) and Intuit Inc. (INTU-Q), among others.
“The companies have to be large and have strong businesses, earnings growth and, in most cases, pay dividends,” says James Learmonth, senior portfolio manager at Harvest Portfolios Group Inc. in Oakville, Ont. “What we want are the most dominant players in each one of these areas.”
The technology sector is one in which most investors should have some holdings because the innovations are evolutionary and revolutionary, Mr. Learmonth says. The big themes include the digitization of consumer information, such as banking and health records, the growth in online advertising, the spread of electronic commerce and the processing of so-called “Big Data.”
The companies held in the ETF are those that are able to capitalize on these themes by investing in research and development (R&D), making acquisitions as needed and introducing new products to complement existing offerings, he says. They have track records of weathering business cycles, the financial wherewithal to acquire startups and the money to invest in R&D. In the meantime, they can rely on mainstream businesses to generate the cash to pay quarterly dividends.
“We are in the later stages of the cycle, so you want leading companies in a diversified fund,” Mr. Learmonth says.
As of July 31, the ETF, which has a risk rating of “medium,” had an average annual return of 11.6 per cent since inception on April 27, 2015. The one-year return was 10.2 per cent and the three-year return was 17.8 per cent.
The ETF had $70.9-million in assets under management, an average dividend yield of 1.12 per cent and an average price to earnings ratio of 27.4 as of July 31. The management fee is 0.85 per cent.
Malcolm White, vice-president, portfolio management, and portfolio manager at Signature Global Asset Management, a division of CI Investments Inc. in Toronto, and his team take a different approach for this mutual fund.
“We are on the leading edge of the risk curve,” he says. “We actually try and find these very risky new innovators. They are names the average investor wouldn’t have heard.”
Mr. White has co-managed the fund with Jeremy Yeung, also vice-president, portfolio management, and portfolio management at Signature Global Asset Management, since 2011.
The fund has its share of large-cap companies – many of which overlap with the Harvest ETF – but the philosophy is to balance these stocks with those of small- and mid-cap companies that offer higher growth potential. The performance of the less established players can be volatile, so the mature companies moderate the fluctuations.
“Nothing in tech is buy and hold,” Mr. White says. “We will have some of the tech giants, but we will balance them off against the high-growth opportunities.”
The fund has a broad view of technology. Its biggest allocations as of July 31 were pure technology companies (63 per cent), financial services (9 per cent) and consumer goods (8 per cent). More than 60 per cent of the companies held in the fund are based in the United States; 9 per cent are based in Canada, including Shopify Inc. (SHOP-T) and Lightspeed POS Inc. (LPSD-T), the latter of which sells point-of-sale systems.
The top five holdings were Apple, Microsoft Corp. (MSFT-Q), Lightspeed POS, Cisco Systems Inc. (CSCO-Q) and Advanced Micro Devices Inc. (AMD-Q). The top 15 holdings made up 54.6 per cent of the fund as of July 31.
As of July 31, the fund, which has a risk rating of “medium to high,” had an average annual compound return of 2.7 per cent since its inception on Aug. 8, 2000, but an impressive 10-year average annual return of 20 per cent. The one-year return was 9.5 per cent and the three-year return was 24 per cent.
The fund had $341.6-million in assets under management as of July 31, a quarterly distribution (about 13 cents a unit on June 21) and a combined fee of 1.5 per cent.
Adam Mayers is a contributing editor to the Internet Wealth Builder newsletter.