21 January 2020
When no industry is immune to disruption, can the tech sector exist within its own vacuum? GAM Investments’ Mark Hawtin considers the omnipresent nature of today’s technology and questions the effectiveness of current benchmark indices.
The last 10 years have seen significant changes in the use of technology across every industry. With the advent of the smartphone, the world has become connected by billions of devices, creating the opportunity for large, new, platform-based businesses to disrupt traditional business models. Amazon dominates the retail world; Google and Facebook have taken a significant piece of the global advertising industry; Netflix has changed the face of media consumption and Tesla the way we drive. Over the last decade, technology has moved from being a vertical dominated by software and hardware vendors to an economic horizontal, where the way technology is used is far more significant than the technology itself.
We always look to use technology as a way to invest in the fastest growing themes in the world. The combination of a traditional driver in Moore’s law (that states the speed and capability of computers will increase, while the cost declines) with the more recent effect of Metcalfe's law (which measures the growth of a telecommunications network) means that technology is no longer a predominant driver of efficiency and productivity in existing business models. Instead, it affords the opportunity for companies to start from ground zero and develop truly disruptive competitive new models across every sector in consumer and enterprise. In short, technology is permeating everywhere, and it is no longer reasonable to look at the technology sector itself as a sensible benchmark for what technology offers today. In fact, if a fund chooses to actively benchmark against the technology sector, then it may miss many of the most disruptive companies in the world today.
This point has not gone unrecognised by index providers S&P and MSCI, who made the biggest ever change to their indices in Q4 2018. To better reflect the end market for technology, they moved Facebook and Google from the technology sector to the communications sector. Netflix and Disney also moved from consumer discretionary to communications. In all, 10% of the indices by market capitalisation were reclassified, which represents the clearest sign so far of the impact that technology is having. In the broadest thinking, the total market represents the true benchmark for technology and its disruptive nature; however, we believe that the global growth index is the clear subset into which lie investments that champion technology as their lifeblood for growth.
It is our view that the network effect, coupled with newer and fast growing technologies like artificial intelligence, the internet of things, big data and blockchain, will drive the disruptive power of technology even more, and the polarisation between winners and losers will intensify. Imagine the last 10 years for retail, where e-commerce has destroyed traditional businesses and where substantial chunks of the advertising market have migrated to digital players like Facebook and Google. Now imagine that level of change in financial services, healthcare, consumer staples and other sectors. Under that backdrop, why would the technology vertical make any sense as a representation for the theme? We believe it just is not valid anymore.
The picture is complicated slightly by the apparent super-performance of the technology sector over the last few years. This is driven by a relentless (and misguided, we believe) rising of all boats on the tide of disruption. We strongly feel that this does not take into account the fact that there has not been an economic downturn for 10 years now; therefore, there is no way to measure the cyclical component that will be a certain part of, in particular, semiconductors and hardware as the cycle turns down. It is our view that any downturn and full cycle will show even more clearly that the most valuable and effective investments in technology no longer sit in the technology vertical, and consequently the technology index is no longer an appropriate benchmark.
As an attempt to illustrate this, we looked at the performance of key names since the S&P 500 peaked before the great financial crisis. That was on 11 October 2007 – the period since represents a near full cycle from peak to trough to peak. The much vaunted semiconductor index has risen 3.6x since that date, a faster level of growth than the broader MSCI World Technology index, which has risen by 2.6x (in both cases on a dividends reinvested basis).
Now consider the performance of the most disruptive models of this 12 year cycle: Apple as the leader in smartphones has risen by 11x over that period; Netflix, the creator of a totally new model for the consumption of media, up an astonishing 97x. Digital sales disruptor Amazon is up 19x, while Visa and Mastercard, disruptors of cash payments, are up 12x and 17x, respectively. They have all eclipsed the sub-sectors (such as semis) that attract so much attention now as we indulge in the binge of a 10 year bull market. Compare the performance of mature technologies, the pre-smartphone mobile world: Nokia and Ericsson down 87% and 35%; Blackberry, almost wiped out, down 93%. Long-standing titans of incumbent technology have not fared much better, with Cisco +40%, Intel + 120%, Dell +11% and IBM +14%, and Juniper and HP Inc down over that 12 year period.
Ultimately, technology is no longer about what technology is. It is not about chips, boxes and basic software – the sectors that make up so much of the technology index. It is about the way these technologies and newer iterations are actually used in the creation of business models and enterprises that leverage the investment in these ‘raw materials’ to deliver many times higher returns. It is for this reason that we strongly believe a wider index is not only relevant, but critical. It is also why we believe that the ‘old’ technology sector will soon be seen as just another version of basic materials, perhaps with a little more pizazz than copper or iron ore, yet cyclical at heart, and without the disruptive characteristics of today’s real winners.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The companies listed were selected from the universe of companies covered by the portfolio managers to assist the reader in better understanding the themes presented. The companies included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice.