Fund manager update: AXA Framlington Global Technology Fund
- 12 January 2022 (5 min read)
Equity markets are experiencing a volatile start to 2022 as concerns over the new strain of Covid-19 (Omicron), fears around inflation and pending interest rate hikes weigh on investors’ sentiment. Hence we are experiencing a period of “risk-off” leading to profit taking in equities, especially growth centric stocks, in a repeat of what we experienced in the first half of 2021.
In short, the rotation is being driven by expectations that there will be rate rises this year. This shouldn’t be a surprise given the US economy is in good health and rates are at artificially low levels, put in place for the pandemic.
When the subject of rate rises started to get attention in Feb 2021, we saw the start of a significant rotation from growth into value; most of the rotation took place in Feb/Mar and there has been another wave since Nov and accelerating since the start of 2022.
Clearly there are views that higher interest rates will be negative for the broader economy and therefore also for companies with a growth mindset. Despite this backdrop, the S&P500 Infotech index climbed 33% in 2021 surpassing the 27% gain for the S&P500 itself. In fact, on a quarterly basis, the S&P500 Info Tech index outperformed the S&P500 Index in all but the first quarter of 2021.
So whilst the rotation has felt brutal at times, and some stocks (especially unprofitable high valuation names, which we have little exposure to) have really suffered, the broader sector has held up well supported by strong fundamentals, strong financial results and a healthy outlook for spending on the sector. The main issue for our investment approach has been that the uncertainty drives more capital into the mega cap tech names to which we are under-indexed – our performance in 2021 relative to our peer group was good but we and almost all our peers underperformed the global tech benchmark index (MSCI World IT index) in 2021.
With regards to the ultimate impact from rate rises (as opposed to the spectre of eventual rate rises), I would argue that post Global Financial Crisis, the Fed have been very mindful of the impact that rate rises has on the economy, and actually when implemented it has been because they have a high level of confidence that the economic strength can withstand them. It is important for the Fed to get rates back up to a more normalised level as soon as they can, so they will again have that lever to use when the economy next needs it.
They’ve been willing to pause tightening if there are signs that it could derail economic expansion; for example at the start of the last upward rate cycle in 2016, there was just the one rate rise in 2016 when initial expectations had been there would be two or three. I would expect the Fed to continue in this manner when they do commence the next upward rate cycle.
Looking back to see the impact the last rate cycle had from late 2015 through summer 2019; the S&P500 rose 46% during this time and the S&P Info Tech index rose 96%.
Looking out to 2022, in many ways it feels very similar to how it did at the beginning of 2021. We still face uncertainties around Covid19, the spectre of inflation lingers and it remains to be seen if this is transitory or something more structural, whilst the likelihood for interest rates to be lifted from their current levels is almost a certainty at some point. Therefore, it is hard to suggest that 2022 will be any less volatile than 2021.
Nevertheless, we note that our investments within the Fund have continued to report robust growth and generate healthy amounts of cash and present strong balance sheets. Demand for new technology from enterprises and consumers continues to be supportive. We believe that the fund is well positioned to benefit from the continued adoption of several innovations, such as all parts of the proliferation of semiconductors into more end markets and the digital transformation of business processes.
In terms of set up for 2022, we believe the drivers supporting further growth in the tech sector are in place and as we progress through the year, growth will become more normalised versus the tough year on year comparisons that many of our companies faced in 2021 (especially the second half). Recent estimates from Gartner suggest that spending on IT in 2022 will be 5.1% higher than 2021, which is very healthy growth given that 2021 already delivered a significant uplift on 2020 (and 2019). From a valuation perspective, the S&P500 Info Tech index forward P/E ended 2021 roughly where it started the year, suggesting the 33% returns mentioned above was all driven by earnings growth rather than valuation expansion.
However, whilst we are waiting for rate rises, I think volatility will persist, until we have evidence from companies that they continue to deliver growth despite a rising rate environment, so market timing remains a challenge and hence I feel more surety that our long term investment approach is appropriate focusing on high quality businesses with long term drivers supporting their growth rather than attempting to trade in and out of stocks on a short term basis.
Given the US centricity of the fund and the focus around US rate rises, the S&P500 and the S&P500 Information Technology Index have been used in these comments; these are not the comparative benchmarks for the fund, and are for illustrative purposes only. All Performance figures referenced are sourced from Bloomberg.
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