For the five years to the end of October, the Stonehage Fleming Global Best Ideas Equity fund delivered annualised growth of 9.8% in US dollars. That is substantially ahead of the -2.4% annualised return from the MSCI All Country World index over the same period.
A large portion of this performance has accrued from the fund’s exposure to technology stocks. Currently 23.6% of the fund is held in this sector. PayPal, Microsoft, Amazon, Tencent, Alphabet and Adobe are all in its top 10 holdings.
Given how hard these stocks have run, and in light of the market reaction to Pfizer’s vaccine announcement earlier this week in which many tech stocks sold off sharply, investors would be forgiven for wondering whether this level of exposure carries heightened risk.
Their primary concern would be the valuations on these counters. According to Bloomberg, PayPal is currently trading on a price-to-earnings (PE) multiple of 84, and Amazon on a PE of 92.
However, portfolio manager Gerrit Smit has actually been adding to the fund’s Amazon holding this year and remains confident of the investment case in the sector.
‘We don’t need to fear a tech bubble,’ said Citywire AAA-rated Smit. ‘A bubble has material risk if there is not the earnings, growth, or cash flow supporting it. That is a critical point to make. Today’s technology leaders are the earnings and cash flow generators of the economy, and that supports these businesses and their share prices.’
He added that there is also a good deal of clarity on their prospects.
It’s about growth
‘In a way, I’m more certain about the growth of many of these technology companies than I am of some staples businesses,’ said Smit. ‘The growth that we expect for the technology companies in the portfolio for the next three years is 16% per annum. That is more than double what one can expect under a positive scenario from the so-called market – the average of other companies.
‘If you then take that growth number and divide it into the earnings multiple to get the PEG (price/earnings to growth) ratio, we have a number of 3.1 for our technology basket. The PEG ratio for our overall core universe of very high quality companies qualified to be in the Global Best Ideas fund is 4.1.
‘So our technology leaders are actually a quarter less expensive than the valuation of the highest-quality universe of companies,’ said Smit. ‘That is the issue that many struggle to make peace with. It is about that growth and we believe in that structural growth in these companies.’
A second big concern for investors is the threat of regulation, and how authorities might step in to restrict their growth or even split them up. Here, again, Smit is sanguine.
‘What we have seen so far is clearly that regulators are looking at companies that, with particular actions, try to eliminate competition,’ said Smit. ‘Those types of issues will be addressed.’
This is the focus of the antitrust charges filed against Google in the US last month. It is accused of harming competition in internet search and search advertising, where it has a market share of about 90%.
‘Part of the way they get that is by having a sort of exclusive arrangement with Apple to be the search engine of choice on their tablets and phones,’ said Smit. ‘I won’t be surprised if the regulator then questions that, because that is eliminating others from using their search engines.
‘The regulator may get to that point, but I wonder what other search engines the public would then prefer to use on their phones or tablets. I don’t think Google is going to lose that much from it.’
He added that forcing the tech giants to separate out different businesses would also not necessarily be bad for investors.
‘There may be fears about companies having to split or be unbundled in some cases, but in the case of Alphabet or perhaps Amazon, we believe that the sums of those parts are worth more than they are currently valued at,’ said Smit. ‘So we don’t really fear that that much.
‘It is a topical issue, especially now with a new government in the US. But even the suit filed against Google is actually less severe than what the market expectations were, and so Alphabets’ price has actually picked up. We are very conscious of this, but we don’t fear it too much.’