Investing in technology stocks has become vital for returns

He is perhaps the world’s most influential investor, yet Warren Buffett could learn a thing or two about technology.

The CEO of Berkshire Hathaway is famous for his refusal to invest in technology stocks. While his company recently acquired shares in Apple, its vast portfolio is conspicuously lacking shares in Alphabet (the holding company of Google), Microsoft, Amazon and Facebook.

Ignoring these forerunners of the technological acceleration megatrend comes at a price. In 2017, Apple became the first company to breach a market capitalisation of $800bn.

Alphabet, the second-biggest company in the world, is not far behind. The next three largest firms in the world are also tech companies: Microsoft, Amazon and Facebook.

Technology is changing the way we invest and what we are investing in. Technology offers major clues about what will drive growth in 20 or 30 years, so can investors afford to ignore tech stocks?

According to IBM, 90% of the world’s data was created in just the past two years.

Understanding technological advances is becoming more critical to understanding the world we live in and the world in which markets and companies compete.

Technology helps us better to understand the opportunities for investing so companies can be identified that not only provide great short-term returns, but will also generate positive returns in the long run.

By understanding the transformative and disruptive power of technologies, it may be possible to identify themes for longer-term investing.

Buffett is famous for saying that he does not invest in businesses he doesn’t understand. His frame of reference comes from when real-world investing meant buying shares in a company that produced goods you could touch and feel.

Real-world investing now is increasingly becoming intangible. For the average investor, not investing in technology stocks is becoming higher risk from a returns perspective.

Apple, Microsoft, Facebook and Amazon collectively make up more than 10% of the S&P500. Multinational internet and media group Naspers, Africa’s largest company and the world’s seventh-largest internet company, made up a staggering 17.43% of the JSE all share index as at the end of September.

Fund managers who have not invested in the company yet have increasingly seen their alpha (outperformance) from other good stocks diminished because of Naspers’s overwhelming dominance.

Facebook was revolutionary when it started as a social media platform, changing daily interactions. Other technologies set to disrupt markets include Blockchain, a digital ledger that records just about any transaction. With endless uses from recording money transfers and payments to sales of goods and services, Blockchain could overhaul how record-keeping is managed and eliminate intermediaries such as traditional banks from the process.

Cryptocurrencies such as bitcoin, Monero, Ethereum, Litecoin and Ripple are digital currencies that are increasingly being traded like shares. The original cryptocurrency, bitcoin, was started in 2009. In March 2017, the value of one bitcoin surpassed the price of gold.

Digital currencies have some way to go before they become completely mainstream and their potential effect on finance systems fully understood, but change is happening fast. Since 2015, more than 100,000 merchants globally have accepted some form of digital currency.

Apart from investment opportunities, technology is changing how investment takes place by shifting the way information is used in investment decisions. Artificial intelligence (AI) and machine learning change how fund managers manage portfolios and analyse data and how they respond to investment opportunities.

Given the sheer volume of data available, AI provides enhanced tools and research methodologies in order to provide investment insights.

This includes real-time market insights, improved economic indicators and greater understanding of investor sentiment.

Human beings are simply incapable of processing all the information available. AI can be used to understand how seemingly unrelated shares may move together.

Given the global investment universe of more than 15,000 companies, AI can find shares that tend to move together from different sectors and geographies. This relationship can be used when two related stocks diverge for no apparent reason, providing managers with an opportunity to exploit short-term pricing discrepancies.

This relationship can also be used to understand whether a trade is crowded, which can assist asset managers in deciding when to change from a long position to a short position.

The increased focus on technology, machine learning and AI is gaining pace because it is only in the past decade that computing power has reached the point where vast data sources can be analysed at speeds that make it useful and actionable.

In asset management, hedge funds have led the way with
quantitative funds, which use systems-based models as well as algorithms to identify tiny stock price anomalies and act
on them.

At Stanlib Multi-Manager, we design and build solutions for many clients. We are increasingly considering machine learning to assist with several parts of the investment process, from design to asset allocation and from manager-selection to portfolio-construction.

Technology companies and stocks are no longer an esoteric area of investment. They dominate mainstream exchanges as globally leading multinationals.

Not including tech stocks in portfolios has increasingly become a radical and risky move. Meanwhile, the use of technology continues to change the way fund managers analyse markets and generate alpha.

Understanding these new areas of the market and making connections that count across technology uses and investment opportunities will be fundamental to ensuring active managers can outperform in a rapidly advancing world.

• By Joao Frasco, a chief investment officer at Stanlib Multi-Manager