Technology has been a relative outperformer during the downturn and while not unexpected to us, for some investors its defensive nature has proved surprising. Coming into the crisis there was speculation that the technology sector was in a bubble – a thesis with which we disagreed – and we think the crisis has been a tailwind for it. Without technology, a challenging situation would have been even worse than it is. For example, large numbers of people are now able to work from home who could not beforehand. The uptake of technology in this field looks likely to increase dramatically in some cases.
Technology remains an area that could see some stimulus investment despite an economic slowdown, particularly on the 5G and broadband infrastructure side. In addition, technology is the only sector with net cash at a time when most sectors are increasingly indebted.
Digital content is another core theme in the Fund. Netflix, Spotify and several video-gaming companies have performed strongly.
What has helped our Fund, in part, outperform has been the fact that we are very paranoid about debt. We have never liked high cash-burn models and prefer companies with strong net cash positions, no debt (ideally), and self-funding business models. Therefore, the vast majority of our holdings hold net cash. Furthermore, many of our core investment themes are well placed to benefit from this crisis, for example cloud infrastructure and security.
Social media is less of a beneficiary. Usage is increasing but the auction advertising market is weaker so companies will have to support greater demands on their infrastructure with less advertising revenue. We have therefore rotated more towards e-commerce and away from the advertising-driven models, favouring companies like Amazon over Facebook.
Digital content is another core theme in the Fund. Netflix, Spotify and several video-gaming companies have performed strongly. We have also benefited from positions in some of the content delivery networks (CDNs) that take pressure off when network traffic spikes.
Connectivity and 5G will be big areas of spend and, despite a soft patch during the past few months, we expect to see some stimulus there as we get into the back half of 2020, and proper network rollouts next year. We have seen huge progress in artificial intelligence and machine learning in the past 18 months and there will be a bigger focus on these areas as ways to reduce reliance on humans continues.
While we recognise there is an absolute risk from negative revisions or multiple compression, with exceptionally strong balance sheets, strong secular tailwinds and reasonable valuations we think the sector fares well on a relative basis here and continues to outperform.
What could make us more bullish? We have had the Fed bazooka and massive stimulus globally. A truce with Russia in terms of the oil price would also help. We would also like to see one or more of the following: cheap (trough) valuations; stocks rising on bad news; evidence the lockdown is working or the virus is fading; progress towards a treatment. A vaccine seems 18 months away but there does seem to be some good progress with certain companies working on drugs that could speed up the recovery of those patients who are more severely sick with COVID-19. Alternatively, we would welcome testing that could show that more people have had it and are immune to it and can get back to work.