Technology still offers the promise of good returns for investors. Here's why it's worth investing in technology ETFs and what the key risks are.
Nevertheless, technology still offers the promise of outsized returns for investors. Every year, the reach and influence of technology grows, spreading into new industries and taking over more of our lives. It helps businesses run more efficiently and individuals to live, work and communicate.
The speed at which technology can come into a new industry and change it forever means there are always opportunities to make money. Investors will have been lured to the sector by examples such as Amazon, now around 200x its level in 2001, or Netflix, up 55x in the past eight years and want a piece of that growth for themselves.
Of course, these are the winners. Technology is competitive and for every Amazon and Netflix, there is an also-ran, now lost to the annuls of history. Technology stories aren’t always as compelling as they first appear and companies need to be able to execute successfully on their ideas.
That said, in today’s environment, technology has become more important than ever and there are probably more structural growth opportunities within technology than in any other sector. Most investors have long-term goals for their savings: they may be saving for retirement, or for their children’s university fees. It makes sense, therefore, to future-proof an investment portfolio by aligning it with enduring structural trends. An investment in technology helps keep a portfolio focused firmly on the future.
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ETFs offer a range of options for both diversified and specialised exposure to technology. While technology ETFs are more expensive than index ETFs, they will usually come with a lower ongoing fee than an active funds. They are one of the cheapest ways to take broad exposure to a basket of technology companies.
At the same time, technology ETFs trade on an exchange. That means they have daily pricing and can be bought and sold moment to moment for a given price. This is different to mutual funds, which only trade once a day and where the sale price may not be clear. This means ETFs can be useful for taking quick decisions – such as selling out during a market crisis.
Diversification – ETF investors can get access to a broad range of technology shares or bonds with a relatively small upfront commitment. Depending on the brokerage platform, investors may only need a £50-£100 to get started. This means investors don’t have to pick individual technology shares, which can be risky.
Why a specialist ETF?
Anyone who holds an S&P 500 ETF will already have a significant chunk of their portfolio in technology. Around 30% of the index is in the technology sector, with Apple, Amazon, Microsoft and Facebook all among its top 10 holdings. However, if investors want faster growth, then a specialist ETF can be an alternative option.
It should be said that many of the technology ETFs are market-capitalisation weighted. That means you’re unlikely to get access to the next Amazon from its earliest point but would only have meaningful exposure once it had hit a certain size. Nevertheless, technology ETFs have served investors well during in both buoyant market conditions and in the sell-off following the pandemic, providing far more resilient than many would have believed.
Technology will have its winners and losers. As such, it can be easier to hold a diversified portfolio of technology names rather than trying to pick individual winners.
The key generalist technology ETF are as follows:
- Technology Select Sector SPDR ETF – State Street’s technology ETF has an expense ratio of 0.13%. It aims to replicate the technology sector of the S&P 500 Index investing across technology hardware, storage, and peripherals; software and communications. Apple is 23% of the index and Microsoft 20%.
- iShares Expanded Tech-Software Sector ETF – This ETF replicates an index comprising North American equities in the software industry, interactive home entertainment and interactive media and services industries. It has an expense ratio of 0.49%.
- Vanguard Information Technology ETF – The ETF uses a composite index of MSCI Information Technology indices. Apple and Microsoft are the largest holdings. The expense ratio is 0.1%.
- Fidelity MSCI Information Technology Index ETF – This vast $4.3bn ETF is based on the MSCI Information Technology index and has an expense ratio of 0.08%.
- iShares U.S. Technology ETF – This ETF tracks the Dow Jones US Technology Capped Index. Microsoft and Apple are the largest holdings, but the ETF also includes social media names such as Facebook, plus Alphabet.
- iShares NASDAQ 100 UCITS ETF – The Fund tracks the performance of an index comprising 100 of the largest non-financial companies listed on the NASDAQ. It has an ongoing charge of 0.33%.
Most of these generalist technology ETFs will have the largest weightings in familiar names. The MSCI Information Technology index, which forms the basis for the Fidelity ETF for example, has a 22% weighting in Apple and another 16% in Microsoft. Other holdings include Visa, Nvidia, Mastercard and Salesforce.com. It is worth noting that it doesn’t include Amazon, Facebook or Alphabet (owner of Google), bypassing the social media and ecommerce giants.
The Nasdaq has a slightly different composition. Apple and Microsoft are only 14% and 11% respectively. Amazon, Facebook and Alphabet are all included, along with Tesla. Investors need to look closely at the composition of each ETF to understand whether they provide the technology exposure they want.
Specialist ETFs are increasingly common. These can be a means to access niche areas and, potentially, uncover the next wave of growth. There are now ETFs available in the following areas:
- Cloud computing – Companies are increasingly using the cloud, a remote server hosted on the internet, to store, manage, and process data. This gives them greater flexibility and control over their technology costs.
- Artificial Intelligence – The use of artificial intelligence is becoming increasingly widespread. Companies see its potential for automating time-consuming manual processes. Its uses are myriad: healthcare company may use it to read scans, for example, while logistics companies can use it for efficient route management.
- Internet and ecommerce – The pandemic has accelerated the adoption of online shopping, but the ecommerce trend was firmly in place even before people were forced to stay at home. There are also ETFs specialising in emerging market ecommerce trends, such as the Emerging Markets Internet & Ecommerce ETF (EMQQ).
- Robotics – The use of robotics is increasingly widespread. Lower development costs, evolving technology and rising cost of labour are encouraging companies to make use of automation and robotics across their businesses. Robotics and automation ETFs will include some familiar companies such as semiconductor groups Advanced Micro Devices or smartphone giant Apple, but also smaller specialist robotic companies.
- Fintech – Technology is also providing disruptive in the financial sector. There has been a proliferation of payment systems, particularly in emerging markets where many people are bypassing mainstream banks altogether. Fintech ETFs focus on key financial technology companies such as Paypal or Square.
- Cyber security – Cybercrime has become a pressing problem for many companies. Hackers have grown more sophisticated and ambitious. Companies are increasingly willing to spend money protecting their systems from attack, which has created a compelling environment for cybersecurity companies.
- Digital transformation – Digitisation has continued to build momentum through the pandemic as companies have recognised the commercial imperative in using technology to rethink existing business practices. In a slow-growth, competitive world, digitisation allows businesses to squeeze out stronger returns and improve productivity. Spending on digital transformation is forecast to reach almost $2 trillion by 2022.
The technology sector’s dramatic rise and fall may be 20 years ago, but it still looms large for many investors who lost money as technology stocks rose to stratospheric levels and then slumped. It has left an impression of a volatile sector, which is vulnerable to shifts in sentiment.
In recent years, that hasn’t been the case. Not only have technology stocks shown more reliable growth than many other sectors, they have benefited from a low interest rate environment. This is because the ‘risk-free’ rate in the market – the rate investors can hope to achieve without taking any investment risk – is lower. This pushes up the value of future cash flows and therefore higher growth stocks. In fact, technology stocks have performed well throughout each stage of the cycle. In the recent crisis, they have outperformed other sectors both as markets sold off and as they recovered. This is unusual for any sector and particularly technology.
As such, technology stocks can look invulnerable. However, they are not immune to falls. As the largest and most liquid stocks in the market, technology names can be the first to sell off when markets wobble. Equally, it is worth noting that any technology investment will be significantly skewed to the US market, where most of the major technology names are listed. This can leave the sector vulnerable when sentiment towards the US shifts. Equally, technology companies tend to have high growth expectations built into their prices. As such, share prices can fall if company earnings don’t keep pace with market opinion.
Technology has been a hugely successful investment in recent years. It remains relatively volatile, but recently it has performed well through a variety of market conditions. As technology becomes a larger part of the way we live and work, it becomes a more important part of the US stock market. Although the sector can look expensive relative to other sectors, its faster growth justifies a premium to the wider market. That said, there will be winners and losers, so it is worth taking a diversified approach. Technology investment is a useful way to ‘future proof’ your portfolio.
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