The unique role of technology in investment portfolios

Over recent decades we have born witness to an incredible modern era of entrepreneurial innovation and creativity within the technology universe. This article seeks to provide an overview of the unique and evolving role technology plays within investment portfolios, including its benefits, drawbacks as well as the potential structural impacts brought upon by COVID-19.

The pervasiveness of Technology

Today, virtually every industry is now being (or has been) “consumed” by technology, with technology permeating into every part of the global economy, as well as our daily lives. Ground-breaking developments in cloud computing, artificial intelligence, automation/robotics and mobile technologies are giving rise to an entirely new technology ecosystem. Innovation is pushing out in all directions simultaneously such that no sector is truly safe from disruption.

Indeed, you would be hard pressed to find a recent market entrant that has built market share without using a new or rebuilt technology.

Significant growth in technology is far from unexpected. Technology companies frequently have the advantage of being asset-light businesses, requiring less capital to scale, and often achieving rapid growth. Furthermore, technology often represents key and growing infrastructure for companies across all industries, which has often enabled sizeable efficiencies, structural changes and transformational growth to occur.

Technology’s disruptive impact

What is also well acknowledged is technology’s often disruptive impact on existing “incumbent” business models. Sectors economy wide, including the Information Technology (IT) sectors itself, have been invaded by “disrupters”, overturning established industry structures. The introduction of the smartphone is just one notable example of this.

The case for an exposure to Technology

In terms of an investment portfolio, an exposure to information technology, has materially outperformed, compared to other global sectors.

This out performance has been partly driven by secular post-GFC market dynamics. This include structurally declining interest rates, and an intense investor preference for areas of perceived certainty. This has ultimately favoured long duration and the perceived safety of strongly growing technology companies. As well as more recently, the unique nature of COVID-19, has in certain instances provided tailwinds for predominately online technology companies.

You can certainly question how overdone this rally has been.

However, recent strong performance aside, a technology exposure today can provide an effective risk management tool to hedge against disruption destroying value across traditional businesses in existing holdings. Thus, potentially assisting in long term capital preservation as much as long term growth generation.

Furthermore, the pace of disruption is increasing. The following diagram illustrates the adoption of new technologies which typically follows an “S-Curve”. With accelerated technological growth and more efficient supply chains, S-Curves have steepened, reflecting society’s rapid mass adoption of new technologies, and hence the increased risk of disruption for incumbents.

This is particularly pertinent in today’s environment, as COVID-19 driven containment measures have caused the acceleration of digital technology adoption by both businesses and consumers. This will likely be sustained post the pandemic. In a June 2020 survey of 220 CEOs conducted by Fortune and Deloitte, 77% of CEOs said their company’s digital transformation was significantly accelerated during the COVID-19 crisis, and 40% are spending more on IT infrastructure/platforms.

Ways to access Technology

A technology exposure can be obtained through numerous asset classes, each offering varying degrees of risk/return and potential as a hedge to disruption.
Whilst investing in technology via listed markets is certainty easier to access (and typically cheaper), Private Equity (“PE”) and Venture Capital (“VC”) have been the traditional route for investing in innovation and disruption. PE buyout, growth and VC strategies offers unique opportunities to access a greater range of technology companies, as the universe of private companies is greater, as well as access these companies earlier in their life. Companies have tended to stay private for longer, accordingly much of the potential upside in these companies has shifted from the public markets to private markets.

Risks, drawbacks and other considerations

An exposure to technology, is of course, not without its own unique risks and drawbacks. The 2000s technology bubble and bust being a salient example.

The technology sector is subject to rapid and significant changes such that it can effectively, and continuously disrupt itself. Investment in newer technologies over more developed will involve a higher degree of risk, including actual technology risks (will it work), market-adoption risks (will there be a market for the product or service), security risk, regulatory and legal risk (e.g. patents).

Furthermore, technology, particularly if accessed through public markets today are typically already at high valuations, and if accessed through private market strategies typically come with higher fees and illiquidity.

However, whilst acknowledging these risks, institutional investors with long-term horizons and broadly diversified portfolios are often well placed to manage these risks, as well as to keenly benefit from the technology sector’s unique return upside and portfolio hedging benefits, and be in the forefront of new advancement that affect our lives.