All hands on Tech: how long-term growth opportunities can help weather volatile markets

Key Points:

• Focusing on long-term trends in tech may help avoid the pitfalls of near-term volatility distractions
• We believe finding quality companies, with solid fundamentals and growth potential, is the best route to target broad equity market outperformance over meaningful time horizons
• The tech sector offers myriad exciting opportunities today through constant innovation in digitalisation, automation and artificial intelligence (AI)

What next for tech?

As summer ends, investor attention naturally turns to speculating over what the remainder of the year may have in store. For equity investors, growth sectors like technology have been a key focus of both the challenging performance of 2022 and the impressive recovery over the first half of this year - as well as the more recent pull-back - as sentiment has swung back and forth amid a complicated macro backdrop to unpick.

Unfortunately, there is little reason to believe the coming months will bring any more certainty – or less volatility – to markets. Inflationary pressures across the major economies of the world continue to soften but are still high leading to concerns around still higher interest rate prospects. Economic indicators have been resilient, particularly in the US, further pushing out the risk of an imminent recession, however, the growth outlook for China remains weak. There are also ongoing geopolitical issues to contend with.

Whilst investors shouldn’t fully discount the ongoing impacts of the global and macro-economic headwinds that markets continue to face, we believe there are still many long-term opportunities in interesting areas of tech to explore, particularly for investors with the fortitude to withstand short-term volatility and ability to focus less on arbitrary measurement periods like single calendar years in favour of long-term growth across market cycles.

In managing tech-focused strategies at AXA IM, our approach has always aimed to identify companies with strong fundamentals exposed to significant long-term themes. We have always believed that investing in quality, growth companies that are exposed to multi-decade secular trends offers better potential to outperform broader equity markets versus chasing niches or fads or seeking to anticipate macro events with short-term trading. This is pertinent when considering how rising interest rates could impact the growth potential of equities in the immediate future.

Key areas of opportunity

In our view, demand for new technology from enterprises and consumers continues to support growth in areas such as generative AI, automation to address labour shortages, and rapidly increasing digital connectivity across society. Each of these opportunities are covered by our key tech themes: the digital economy, robotech and the Metaverse.

Digital Economy

Jeremy Gleeson, Portfolio Manager

The digital economy has two powerful drivers supporting long-term growth: namely technology, as we are all increasingly connected and better-informed consumers; and demographics, as a generation of ‘digital natives’ are yet to hit their peak spending years, and as their disposable income increases, more of this is likely to be spent via digital channels and subscription-based revenue models.

This means businesses increasingly need to adopt a digital mindset when engaging with partners, customers, and employees. The digitisation of data, software-as-a-service (SaaS), analytics and artificial intelligence, and cybersecurity all play an important role in this opportunity.

The results can be seen across a variety of industries. For example, Workday is a provider of enterprise cloud applications for finance and human resources meeting the demands of a modern labour force. The company offers payroll, hiring, financials and analytics cloud solutions for various companies, educational institutions and government agencies looking to modernise their back-office capabilities such as human capital management and adjacent markets including financials, planning and procurement. Meanwhile, a company like Goodman, who develop and manage industrial real estate such logistics facilities, warehouses and business parks, has been benefitting from the increasing need for datacentres for AI.

Robotech

Tom Riley, Portfolio Manager

Investment opportunities in robotics are provided by exciting, disruptive technology trends ranging from factory automation, machine vision and autonomous vehicles.  Robotics was traditionally thought of as being focussed on the manufacturing of automobiles or in aerospace applications, but over the last decade, we have seen substantial growth into other areas.  This growth has been driven by new technologies making robotics more capable, more flexible, and easier to implement which has broadened the use cases. This diversification of end market demand into areas like robotic surgery, electronics assembly and warehouse automation has created new investment opportunities and driven growth.

Over the last couple of years, the theme of reshoring has become very important for the robotics industry - most notably in the US, but also elsewhere in the world.  Significant government support in the US from legislative acts such as the Infrastructure Investment and Jobs Act, the Chips and Science Act and the Inflation Reduction Act are providing large incentives for businesses to invest in domestic manufacturing capacity. What is important here is that this capital expenditure is underpinned by the government, so is less economically sensitive and it is also in long term projects, which should support the durability of this growth.

In many parts of the world, the labour market continues to be tight where continued labour shortages present a real challenge for businesses. For instance, in the manufacturing space or warehousing space, we see fewer workers – particularly younger demographics – that are willing to do certain jobs, given the nature of the roles and salaries. Companies facing labour inflation and labour shortages are increasingly incorporating technology and automation in their processes to increase efficiency and productivity with their existing, or even shrinking, workforce. In simple terms, we anticipate that labour shortages and wage inflation are substantial drivers of automation demand over the next few years. As labour costs go up, the payback periods become quicker from introducing automation, meaning that more and more areas are considered for automation.  For example, Japanese company Keyence provides sensors and vision systems that are used in factory applications around the world to help with precision, inspection, and efficiency.  Meanwhile companies like Siemens have a dedicated a significant amount of development to a digital factory business linking digitalisation and automation in the manufacturing process.

Metaverse

Pauline Llandric, Portfolio Manager

The Metaverse has evolved from an emerging concept to an exciting, investible opportunity. It is a continuation of the ground-breaking and increasingly sophisticated advances in technologies available to consumers and businesses alike, accelerated by the significant demographic shift towards online entertainment, socialising, working, and communicating. We believe we are the early stages of a long-term trend which spans opportunities in almost every aspect of our lives, and we expect innovation to continue at a rapid pace.

In our view, we are likely to see an increasing number of companies presenting Metaverse related products or services. Recently we have seen significant progress being made on the AI topic. We expect generative AI to be a key accelerator enabling the metaverse. Virtual, shared, and immersive spaces require a large amount of content for users to interact with and explore. This has been a significant barrier to widespread adoption, as generating a large amount of content is time consuming and labour intensive. Generative AI is offering promising solutions to this challenge and could empower anyone with a creative idea to bring it to life. Quite a number of companies in the Metaverse are already using AI in their products and services. What is exciting is the future direction which could provide more processing power, more powerful AI, and interesting applications to enhance experiences in the Metaverse.

For example, gaming engine companies like Unity, whose software helps build immersive Metaverse experiences using Augmented Reality and Virtual Reality, this year announced plans to offer two generative AI tools to its game developers. Meanwhile, semi-conductor company Nvidia has recently benefitted from surging demand for chips to power generative AI and large language models. With Metaverse and immersive experiences relying on cloud-based AI acceleration, we believe that the company is potentially positioned at the forefront of enabling the next generation of the internet.

Outlook

Technology stocks are often regarded as long duration investments due in part to their research and development cycles and capex requirements, and as such can be more sensitive to a high-rate environment. This is not so relevant to the current environment, as technology companies today are increasingly cash generative with strong balance sheets, and have less need to borrow; in fact, the most cash-rich companies may even benefit from a higher rate environment. Indeed, the latest corporate earnings results have been broadly good in the areas we invest.

The connected consumer and future of automation provide attractive, long-term growth opportunities. Macro events such as rate cycles will have some effect and short periods of volatility will need to be weathered, but this is not new, as seen during previous bouts of volatility such as in 2017 following the Trump election, the 2018 US/ China trade war, and more recently the pandemic which in many ways has benefitted the long-term trajectory of the technology sector. Whilst markets may continue to be volatile, we believe that our investment philosophy around identifying long term themes and the companies that will benefit from these themes remains intact despite the near-term challenges. This philosophy gives us the freedom to look through short-term market volatility and invest in exciting, disruptive technology trends.

Companies shown are for illustrative purposes only as of 02/10/2023. It does not constitute investment research or financial analysis relating to transactions in financial instruments, nor does it constitute an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalised recommendation to buy or sell securities.