Tech Titans vs. Hidden Innovators

Juliet Schooling Latter 19/06/2024 in Specialist investing

Artificial intelligence may change the world. On the other hand, anyone who has interacted with their bank’s chatbot might argue that it’s got some way to go. At the same time, there are a whole raft of exciting technology companies that are actually changing the world. In many cases, they are being overlooked by investors in the scramble to embrace AI.

The chances are that most investors already have plenty of exposure to AI. The first movers have been the mega-cap technology stocks such as Microsoft, Amazon, Nvidia, Meta and Alphabet. These will form a chunk of an S&P 500 or MSCI World tracker fund. Popular active funds, such as Scottish Mortgage Investment Trust, Baillie Gifford American and Rathbone Global Opportunities, also hold a decent weighting in some or all of these companies. Listen to why the Guinness Global Innovators fund is reducing their holding in Nvidia on the Investing on the go podcast.

These mega-cap technology names are undoubtedly great companies, with a significant pathway of growth. However, they have become hugely popular and, in some cases, look ‘priced for perfection’. If there is any hint of disappointment, there is a danger that the share prices will be hit hard. This has been seen with Tesla this year, where the share price is down around 26% for the year to date*.

It is a good time to look beyond these giants to other parts of the technology sector. These may have equally exciting growth prospects, but fly under the radar. Getting access to these different types of technology requires a bit more planning. Investors can plump for a straight technology fund, but that will often give even more exposure to the mega-cap technology giants. Instead, we’d suggest looking at the following areas.

Non-US technology

Technology is not a purely Silicon Valley phenomenon. There are plenty of countries around the world with thriving technology sectors, delivering innovation every bit as exciting as that emerging from California. Asia is a good example. There are social media giants such as Alibaba and Tencent in China, plus crucial semiconductor manufacturing groups. Chip giant TSMC is “arguably the most important company in the world”, according to the New York Times.

Yet, because these companies are in Asia rather than the US, they generally trade at lower valuations. Investors can get access through a fund such as the Matthews Pacific Tiger fund, where the top three holdings are TSMC, Tencent and Samsung. Information technology forms just under one-third (29.3%) of the overall portfolio**.

Small-cap technology

Small-cap technology is another option. Funds such as the IFSL Marlborough Global Innovation fund focus on a small, carefully-selected portfolio of fast-growing, innovative companies. The fund was previously a pure technology fund, but now invests in disruptive companies from any sector. This type of fund can provide real diversification from large-cap technology companies.

The Marlborough fund includes holdings such as Xylem**, a smart water technology company, designed to promote efficient water usage across public utilities, residential, commercial, agricultural or industrial settings. IQE supplies advanced wafer products and materials to the semiconductor industry, while Altair Engineering provides software and cloud solutions. Importantly, only around 40% of the fund is invested in the US, compared with 80-90% for a traditional technology fund**. These funds can capture growth at an earlier stage. They have had a tough time more recently, with smaller companies – even technology companies – significantly out of favour.

North American growth funds with a mid-cap focus

That may sound like a mouthful, but these funds can be a way to access interesting technology companies outside the mega-caps. Including mid-cap companies – which would be pretty large in UK terms – brings in new sectors such as the cyber security companies, which are crucial in an era of growing cyber threats. These can be overlooked.

The AXA Framlington American Growth fund fits the bill. Around a third of the portfolio is typically invested in technology stocks and the fund tends to have a considerable weighting in mid-cap stocks. Manager Stephen Kelly is looking for innovation, unique brands and intellectual property.

The fund is not a pure technology fund, but has been topping up its technology holdings recently. Manager Stephen Kelly, recently purchased Snowflake, a cloud-based data-warehousing company, after a sharp fall in its share price following its year-end results***. Natera is another recent purchase***. This is a clinical genetic testing company based in Austin, Texas, specialising in DNA testing technology. It also holds cyber security group Palo Alto Networks and robotic surgical systems group Intuitive Surgical.

Mega-cap technology has had an astonishing run, and investors have been right to stick with it. However, it is worth branching out and looking beyond the largest, US-based technology companies. Investors can find companies that are often every bit as important, and growing every bit as fast. However, they are cheaper and may hold more potential.

*Source: MarketWatch, at 18 June 2024

**Source: fund factsheet, May 2024

***Source: AXA Investment Managers

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