Tech’s enduring role in an investment portfolio

Below is a commentary I wrote that was published by The Straits Times?here .

“Any sufficiently advanced technology is indistinguishable from magic,” said British science fiction writer Arthur C. Clarke.

This is largely why it is exciting to invest in tech, a sector with a profound impact on the way we live, work and interact with one another.

Artificial intelligence (AI), for example, is touted as the next seminal moment that can unlock new business models, transform industries and boost economic productivity on a scale comparable to the mass adoption of the Internet in the 1990s.

While AI’s longer-term consequences remain to be seen, its stock market impact has already been swift and powerful, contributing around one-third to the global tech sector rally in 2023 despite headwinds from high interest rates.

Tech’s outperformance, however, is nothing new, with annual share price returns in the mid-teens over the past few decades versus high single-digit gains for the broader equity market. In fact, staying invested in the sector after the dot.com crash would’ve returned a stunning 800 per cent in 12 years.???

Because tech now comprises around a third of global equity markets (and over 35 per cent in Asia), exposure is a necessity for any portfolio.

But this doesn’t come without complexities. The sector universe is huge, encompassing the Internet, hardware, software, semiconductor and IT services. And each segment is valued differently – from low-hanging legacy names to frontier technologies with eye-popping valuations.

Globally, tech is trading at a 30 per cent premium to history, and a 45 per cent premium to the broad equity market.

Investors also need to be aware of volatility. It’s not uncommon for the sector to be hit harder in bear markets, with tech stocks tumbling more than 30 per cent in 2022 (versus a 20 per cent decline in the S&P 500). Market darlings, too, can suddenly fall out of favour due to disruption.

How, then, can investors position for tech’s potential while contending with the reality of current and future risks? Our playbook focuses on thematic opportunities that arise from both the near-term tech cycle and medium-term tech disruption.

Watch for software and Internet

First, we think AI’s transformative nature is anything but artificial. Important use cases across swathes of applications and industries mean the theme is likely to be one of the fastest-growing and most enduring tech segments over the next decade.

We recently raised our forecast for AI’s addressable market to US$300 billion (S$406 billion) by 2027, from US$28 billion in 2022, implying a compound annual growth rate of over 60 per cent, up from 20 per cent during 2020 to 2025.

The impact will likely be keenly felt by businesses, with improvements in products and services leading to higher revenues, greater operational cost efficiencies, and hence, better margins.

But advances will not come cheap and the runway to monetisation varies from company to company. Given strong year-to-date returns and premium valuations, selectivity within AI is key.?

To position over the next six to 12 months, we favour AI beneficiaries with clear monetisation trends and reasonable valuations.

In particular, established software and Internet companies should see strong double-digit earnings growth in the coming quarters as AI-related spend sharply rises, with applications integrated with existing offerings.

Our call is to rotate from early-cycle beneficiaries (semiconductors, hardware) into mid-cycle ones (software, Internet).

Beyond AI, product cycles should act as a near-term catalyst for select tech segments. On average, the fourth quarter typically contributes about 30 per cent to the full-year revenue for many tech companies, driven by year-end holiday demand.

The quarter is also associated with major product refreshes. Hence, we think consumer electronics-related and enterprise IT stocks should benefit as tailwinds such as pent-up demand and repricing further drive earnings upgrades.

Seasonality also matters. Over the past 15 years, September has been a bad month for tech, generating mostly modest negative returns. To take advantage, we would look to tech laggards with catalysts around price increases and addressable market expansion strategies.

Other medium-term opportunities

Further out into 2024 and beyond, the broadening out of AI demand should greatly benefit supply chain companies in Asia exposed to AI servers, networking and other related demand.

Meanwhile, investing in cyber security, which has been a lagging segment in the year to date, should become even more relevant as strong digitalisation trends continue.

Research shows that average data breach costs are elevated, both globally (US$4.45 million on average per breach) and in the Asean region (US$3.05 million on average). Within cyber security, we believe companies with diversified offerings should benefit from the wave of generative AI.

Geographically, we would also highlight India as a key growth market for tech. By some estimates, the size of India’s Internet economy is poised to expand sixfold to US$1 trillion by 2030, or 12 per cent to 13 per cent of gross domestic product from mid-single-digit penetration levels today.

To participate in what would likely be one of the fastest-growing tech markets globally, we think some of the best opportunities can be found in major local industry leaders and key global players in Internet, consumer electronics and IT services.

Thanks to its outsized role as a proxy to innovation and societal progress, tech will likely continue to play an enduring role in portfolios.

The key is to understand the risks involved, and the need to diversify across the sector. Investors who do so should continue to enjoy the fruits of tech’s long-term growth.

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