How fund managers are playing the AI-fuelled tech rally

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Technology stocks took a thrashing in 2022 amid sharply rising interest rates, but a wave of enthusiasm over artificial intelligence (AI) has helped power this year’s blistering rally.

The tech-heavy Nasdaq Composite index, which shed 33 per cent last year, has gained 28 per cent this year. The Nasdaq 100, which excludes financials, has surged 34 per cent. And the S&P 500 index, which includes some mega-cap tech names driving the recovery, is up 12 per cent.

Some fund managers now suggest some caution may be warranted given tech’s strong run-up and a potential recession, but they still see a longer-term bullish trend for the sector.

“I was surprised at how quickly [tech] has come back,” says Peter Hofstra, senior vice president and co-head of equities at Toronto-based CI Global Asset Management.

“We positioned well,” says Mr. Hofstra, who oversees CI Global Alpha Innovators Corporate Class, which is 65 per cent invested in technology names. “Our view was that money would come back to risk and stick to quality and liquidity first, as it looks for growth.”

Tech’s rebound has been fuelled not only by an AI boom but also by wagers of a more dovish U.S. Federal Reserve Board and better-than-expected financial results from firms such as software giant Microsoft Inc. MSFT-Q.

The generative AI rally got a boost last November after Microsoft-backed OpenAI launched ChatGPT, an AI chatbot that can give human-like answers to queries and became an internet sensation.

Shares of Nvidia Corp. NVDA-Q, whose semiconductor chips power ChatGPT and other AI, soared recently after it forecast that second-quarter sales would more than double Wall Street estimates. It joined the US$1-trillion market-cap club before pulling back to $US957.6-billon.

“We’re certainly getting more cautious” and volatility can be expected given the risk of a recession, Mr. Hofstra says. “We have actually been picking up some health care names to be a little bit more defensive.”

Longer term, tech continues to win, he says.

“Think about how much cheaper flat-panel TVs get every year but are more capable. It’s the same with cell phones and computers,” he says.

“That productivity element just continues to drive tech forward so the cheaper that computing, storage, and communication get, the higher the utilization. There’s lots happening in the technology sector, and we remain bullish.”

Still, he’s avoiding early-stage, speculative tech stocks – such as those related to the metaverse and bitcoin mining – because they will have a tough time getting financing.

“Self-funded growth is absolutely critical here,” and that means sticking with larger-cap names, he adds.

Mr. Hofstra owns Nvidia despite its sharp rally but also plays AI through communications chip manufacturer Marvell Technology Inc. MRVL-Q.

Despite China’s threats to annex Taiwan, he likes Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC) TSM-N, which makes chips designed by Nvidia and others.

“It’s a concern but it is fully priced in [the stock],” he says.

He also favours Applied Materials Inc. AMAT-Q and ASML Holding NV ASML-Q, which provide equipment to manufacture semiconductors. Both are suppliers to TSMC and Intel Corp. INTC-Q.

Robotics will “find their day in the sun” in personal or factory robots, he says. He likes Rockwell Automation Inc. ROK-N and Japan-based Keyence Corp. KYCCF, which focus on industrial automation.

‘Own companies indefinitely’

Shane Obata, portfolio manager at Middlefield Capital Corp. in Toronto, is bullish on the tech sector over the long term but expects volatility after a strong rally.

“I do think the trend is higher,” says Mr. Obata, who runs Middlefield Innovation Dividend ETF MINN-T and a similarly run mutual fund whose stocks mostly pay distributions.

“We want to own companies indefinitely,” he says, adding his funds are more than 50 per cent in technology stocks. “If we get any significant pullbacks, you have to look to add more exposure.”

Tech giants have embarked on cost-cutting, which provides a “huge potential for protecting margins,” he adds. In a more optimistic scenario for the economy, “they’re going to be positioned better.”

With Nvidia’s recent guidance, this generative AI trend is real in that the spending is there, Mr. Obata adds. “From an investment standpoint, that’s very good for the space.”

His fund continues to own Nvidia stock despite its massive gains.

“If you want to start an AI company tomorrow, you would be going to Nvidia to buy the graphics processing units,” he says.

Within the semiconductor space, he also likes Advanced Micro Devices Inc. AMD-Q, a direct competitor to Nvidia, and Broadcom Inc. AVGO-Q, which also benefits from growing AI demand.

Within the cybersecurity software space, he favours Palto Alto Networks Inc. PANW-Q. It benefits from growing concerns about cyberattacks by bad actors, he adds.

Hardware giant Apple Inc. AAPL-Q is also attractive, but it’s more for its revenue from subscription services such as iCloud and Apple Music, as opposed to focusing on quarterly iPhone deliveries, he says.

In the current environment, he focuses on larger-cap stocks. He avoids companies that are unprofitable or almost profitable and is cautious about the personal computer (PC) space.

“I do have some concerns about PCs on the commercial side” if businesses are cutting costs and delaying upgrades, he says.

Opportunities in mid-cap tech names

Nick Mersch, portfolio manager with Purpose Investments Inc. in Toronto, says he was surprised by the magnitude of the tech rally given his playbook – like many peers – was to play defence.

“I would definitely label myself as cautious,” says Mr. Mersch, co-manager of Purpose Global Innovators Fund PINV-T.

His funds have been 45 per cent invested in health care names. Holdings include Biogen Inc. BIIB-Q, AstraZeneca PLC ADR AZN-Q, Boston Scientific Corp. BSX-N and Merck & Co. Inc. MRK-N.

“Health care stocks are great defensive names because [their products are] necessary spending that’s rarely cut back in a recession and tend to be more immune to inflationary pressures,” he says.

Although he plays the AI theme through names, such as Microsoft, he sold his Nvidia stock near the start of the year.

“We were uncomfortable with valuation levels,” he says. “But it’s not something I would short because some of these momentum rallies can really catch you offside.”

Instead, he sees better opportunities in mid-cap tech names.

Within cybersecurity software, he likes CrowdStrike Holdings Inc. CRWD-Q, which also uses AI technology to combat cyberattacks. Firms may cut their technology budgets, but not on the security side, he says.

Snowflake Inc. SNOW-N, a cloud-based data warehouse firm, is also very attractive, he adds. “What it does is gain from the overall increase in cloud usage … and there’s going to be more data in AI.”

He also likes business communications software provider Twilio Inc. TWLO-N. Its stock got a boost after activist investor Legion Partners Asset Management LLC recently pushed Twilio for board changes and to consider divestitures.

Twilio’s stock, which has since lost steam, trades at about 2.1 times revenue – a steep discount to peers at around 8 times, he says.

However, Mr. Mersch is avoiding e-commerce names susceptible to an economic and post-COVID-19 slowdown.

Etsy Inc. ETSY-Q, an online market for vintage or handcrafted goods that benefited from a surging demand during the pandemic, “is more exposed to a downturn,” he says.

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