Technology returning to the fore

At the height of the dotcom boom the forward price/earnings ratio on the Dow Jones Global Technology index (DJGTI) was three times what it was on the US S&P 500 index.

Few companies could fulfill such high expectations, so the bubble burst and the sector has struggled for 10 years to regain investor confidence.

A bounce in 2003 was followed by five years of sideways or downward drift in the DJGTI. Muted progress this year, following a 44% gain in 2009, casts doubt on whether technology can progress now global economic recovery is less assured.

With the DJGTI no longer trading on a premium rating, investors are taking little for granted.

Grounds for optimism

Ben Rogoff, who manages Polar Capital Technology Trust, is optimistic. He says technology products and services are absorbing a growing proportion of corporate and consumer spending for the first time since the 1990s, and this should continue if global growth is maintained.

Polar Capital has the best five-year record of the three technology trusts and the highest market capitalisation. Two-thirds of its portfolio is in US companies, a fifth is in Asia, and the rest is in Europe.

It focuses mainly on larger companies, but Rogoff expects to increase exposure to medium and smaller companies to 50%, citing strengths in new areas such as "virtualisation" and "mobile computing".
"With a new [technology] cycle beginning to gather pace, made pertinent by substantially obsolescent capital stock and companies once again focused on delivering productivity, we are confident that this is the beginning rather than the end of a sector renaissance following years of purgatory," he says.
RCM Technology Trust has picked up since Walter Price took charge in April 2007. Three quarters of its portfolio is in US companies, and Price says it differs from the index, with an emphasis on cloud computing, for example.

He is optimistic about technology's role as a cost-cutter. "The world faces a difficult transition from easy access to credit, but we are hopeful that technology will help to smooth the transition by allowing more efficient use of resources."

Some non-specialist investment trust managers see above-average upside in technology. Mark Urquhart, manager of Baillie Gifford's Edinburgh Worldwide Investment Trust, attempts to identify the best 45 long-term holdings on world stockmarkets.

Half his top 10 holdings are technology stocks namely, Apple, Baidu, Google and Tencent.

However, Jeroen Huysinga, who transformed the fortunes of JPMorgan Overseas Investment Trust, has only 6% in technology. If managers like him can be converted, the sector could really fly.

Spotlight on Herald investment trust

Herald has the best one and 10-year net asset value total returns in the sector, and more assets under management than Polar Capital. Yet its shares sell on a disparagingly wide discount of 22%.

Manager Katie Potts believes its low rating reflects fears that its bias to smaller companies makes it riskier, and its focus on the UK, which makes up more than half of its portfolio, makes it less exciting than trusts more exposed to the US. She considers both views ill-founded.

Potts points out that the indices for large and small US technology companies have moved closely in line since the end of 2000, and that Herald has outperformed both.

She admits its three-year returns have been the worst in the sector, but says this is largely because dollar strength has enhanced the sterling-converted returns of the RCM and Polar trusts, which are US-biased.

"Leaving aside currency considerations, the UK has been an easier place to make money," she declares.

Potts says valuations of smaller technology companies are compelling despite last year's strong recovery, and she expects a wave of takeovers by large, cash-rich US companies.

More than half of Herald's portfolio is invested in defensively positioned companies with recurring revenues, and many trade on single-digit p/e ratios. The balance is in higher-risk companies focused on emerging markets.

Potts stopped investing Herald's gearing in March as she expected worries about the economy to unsettle the market over the summer.

But she says many technology companies are comparatively immune to problems in the wider economy, and products such as the iPad are providing opportunities for a lengthy supply chain.

This article was originally published in Money Observer - Moneywise's sister publication - in August 2010

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