Liontrust Global Technology Fund

H1 2020 review

The Liontrust Global Technology Fund returned 23.6% over the first half of the year, outperforming both the MSCI World/Information Technology Index and IA Technology & Telecoms sector respective gains of 22.1% and 20.3%*.

 

The first half of 2020 will be one remembered, discussed and analysed for a long time to come. After a promising start to 2020 for global markets and global equities, COVID-19, originating in Wuhan, China began to spread firstly through China and the neighbouring regions before spreading through Europe, America and across the world becoming a global Pandemic. Initially perceived to be largely a domestic Chinese issue with limited chance of a breakout beyond South East Asia, the Chinese market suffered as the country went into a lockdown and companies for whom China is a critical part of the supply chain or end market were hit as industrial action ground to a halt. As the virus spread beyond China and economies began shutdown, Governments and Central Banks across the world stepped in with historically aggressive fiscal and monetary action to help deal with the economic and financial impact of the virus. A further shock occurred in early March as a breakdown of relations between OPEC members Russia and Saudi Arabia on output triggered a crash in already low oil prices punching the already fragile energy sector, various energy reliant economies and skittish equity markets.

This has been followed by one of the strongest quarters in equity markets for decades, with most major indices up double digits, driven by a combination of reduced uncertainty around the trajectory and effects of the Covid-19 outbreak, early signs of solid economic recovery and unprecedented levels of Government and Central Bank stimulus in particular from the US Federal Reserve.

We continue to keep an eye on the news flow and listen to expert analysis and predictions, however, at least for now, to borrow a two and a half millennia old phrase, we know only that we know nothing. It clear there is increasing evidence of regional slowdowns in cases and fatalities around the world that show good promise, including the eradication of the virus in places like New Zealand and signs of a good economic recovery in parts of South East Asia. Many parts of Europe and North America have seen a slowdown in infection rates and lockdowns are being eased with some promising early signs of an economic bounce back however the threat of a second wave persists.  The sustainability of this recovery remains to be seen and for now uncertainty, and its cousin, volatility, reign.

While there has been much hand wringing over the past few years over valuations in the technology space, and many speculating that it would see a sharp downturn, especially with those high growth software companies that have been such stellar performers in recent times this doesn’t appear to have (so far) played out. In fact, as hoped, we have seen technology, in particular sub sectors like software, hold up far better than the wider market. Adoption trends we have seen developing over time like the shift to cloud computing solutions, the need for comprehensive communications software solutions and the necessity of airtight cybersecurity have all been accelerated by the need for businesses to shift operations to employees’ homes during lockdown. These unique situational tailwinds, alongside the strong cash generation, and clean balance sheets of many companies in the technology sector, as well as the excellent unit economics, sticky recurring revenue and mission critical nature of many software companies has meant that valuations in the sector held up in the wake of the crisis and have benefitted from the rebound since, providing investors with a potent source of alpha.

Finally, during a period of crisis, the first and most important factor for any asset manager to address is liquidity. The Fund remains in a very liquid position with a weighted average market cap of over £350bn compared to a Fund size of c.£90m, no position in a company with a market cap below the £1bn mark and stress testing indicates the Fund is easily able to be liquidated in its entirety within just 1 working day while remaining below the 20% Monthly ADV (Average Daily Volume) threshold even during the market stress seen in March.

Our approach, even during this crisis, is straightforward and hasn’t required adjustment. We continue to focus our investments on themes and companies already on solid growth trends for which, fortunately, the impact of the Covid-19 crisis will be minimal or even positive. For many of our portfolio companies, Covid-19 has so far served only to accelerate the product adoption curve forward 2-3 years. Many of these positions have yielded the strong returns that have driven the Funds recent outperformance.

Software remains a favoured sector in the Fund and remains an overweight against our benchmark and our largest sub sector exposure in absolute terms. Software products are uniquely positioned in this crisis in that they still serve mission critical functions for businesses to continue to operate, and a decentralised workforce need just as many, if not more, subscriptions and need more cloud capability as accessing on-premises functions from afar is complicated can incur latency issues, and may simply not be feasible. Thus, we have seen the current crisis as an accelerant not only to the ongoing shift to the cloud but also to software that allows greater efficiency and productivity to a decentralised workforce.

A great example of this is in communications software with a long time holding, RingCentral. RingCentral provides business with an easy to use cloud communications platform for employees. It is as simple as downloading an app on their own devices (or work devices) from which users can access a suite of own brand or 3rd party communications tools such as standard SMS messaging to Zoom video conferencing. RingCentral has been thriving off a trend to shift processes to the cloud and avoid unnecessary equipment capex by allowing employees to use their own, more familiar, devices for work purposes. Outlook for the company pre-Covid19 was significantly boosted after announcing a recent partnership deal with Avaya that gave it exclusive access to 100 million seats that Avaya sells to (to frame this potential impact, it is worth noting RingCentral had only 2 million seats prior to the deal). The shift of vast amounts of workers having to work from home due to Covid-19 means that communications software and platforms like RingCentral are in higher demand than ever to ensure seamless communication and coordination of employees.

Another portfolio company that has held strong during this crisis is Amazon. The source of this strength is twofold. First, the demand for its AWS cloud platform has remained high as client businesses continue to utilise cloud applications to manage a decentralise workforce as well as other internet clients such as Netflix and Ocado who have seen a surge in demand relying on AWS’s infrastructure. Secondly, there has been a jump in demand on its delivery platform as the US and other markets go into varying levels of lockdown, customers are forced rely on Amazon and its fulfilment infrastructure for provision of essential goods and commerce. This rise in demand has been so acute that Amazon recently put out a call for 100k new warehouse workers and boosted overtime pay from 1.5x to 2x. Amazon has also put many non-essential items on hold while it focuses on delivering essentials, this not only gives Amazon good PR credit as a corporate citizen, but also allows it to continue to operate while other non-essential goods providers (including many competitors) are forced to close.

Our notable underperforming positions include CME (-12%) and Disney (-17%). CME, the Chicago Mercantile Exchange, is a company that has effectively cornered the market in various financial instruments, notably including various forms of oil derivatives. CME not only benefits from the network effects associated with providing the sole liquid market for these instruments, it also gains from exclusive access to some of the richest associated data sources in the financial sector. Unfortunately, CME has taken a substantial hit during the recent crisis, particularly in the wake of turbulence in its key oil futures market that has CME unable to extract the same level of value it has in prior volatility.

Disney was a fairly recent addition to the portfolio and had been showing signs of great promise. Our investment thesis centred around the launch of Disney+ as a fantastic opportunity to directly monetise its unique, and frankly dominant, intellectual property as well as help spin the flywheel of the wider Disney corporation that can then further monetise this engagement through the sale of merchandise, park tickets and experiences. Unfortunately, it is in these latter parts of the Disney corporation, Parks and Experiences, that the coronavirus has managed to inflict a heavy toll on the company. This began with the shutdown of its Shanghai Disneyland resort (now partially reopened) then Hong Kong and Tokyo, followed by the rest of its parks in the US and Europe for an indefinite period. These parks have been maintained and it seems will reopen soon, however they have been a great drain on the company’s overall finances as Disney continues to pay a great deal of fixed operating costs. It remains to be seen to what extent the parks will be able to begin to recoup losses in the near term with global tourism severely reduced and required measures such as temperature checks (currently mandatory in the Shanghai resort), enhanced hygiene protocols and overall capacity limitations in place putting off potential visitors. Despite this uncertainty, we remain confident in the long-term investment thesis in Disney. Disney+ has well passed the 50m subscriber mark (an incredible feat in mere months) and continues to grow, the underlying IP remains robust, and the accompanying parks and experiences will begin the long road of recovery.

In order to focus on these companies and themes we have exited our positions in Xilinx, Nintendo and Mimecast. Xilinx has been under a great deal of strain due to its reliance on business partners in China that has come under pressure during the US/China trade conflict and a rise in regulatory pressure, particularly on the US side. This along with the fallout from coronavirus first in China then other markets for hardware sales has, in our view, severely compromised Xilinx long term prospects. Similarly, while a great business, we exited Nintendo over concerns on its hardware supply chain and viability in the current climate. Mimecast has been a consistent relative underperformer in our portfolio with recent operational difficulties, and after careful analysis, we decided to concentrate our position in cybersecurity to our more favoured, higher conviction portfolio cybersecurity companies such as Fortinet.

In terms of additions, we have opened a position in a software company called Okta. Okta provides identity and access management software solution APIs similar to Twilio which provides solutions for embedding communication APIs for developers. Okta, like Twilio stands to benefit from the explosion of newly developed web applications and software as businesses inside and outside tech are forced to adapt and adopt new technology with Okta providing a key component of any solution in the form of identity management (e.g only giving the correct people access to a new web portal).

The outlook on equity markets appears optimistic however there remains a real risk that the markets may overextend this recent rally in the face of what appears to remain a fairly torrid economic backdrop based on overly optimistic recovery hopes and unsustainable central bank stimulus. A pull back is always possible, perhaps catalysed by a reduction in central bank support, a lack of real short-term economic recovery or a resurgence of Covid-19 in a second wave.

As said before, our honest outlook on overall equity markets is that we don’t know the shape of things to come and that we continue to face and unprecedented level of uncertainty. What we do know is that technology companies continue to be a fantastic place to invest. Many of them benefit from trends that have been taking place for decades and will continue to take place for many years to come including trends accelerated by the recent outbreak such as ecommerce, cybersecurity, and the shift to the cloud. Thus, technology companies have given portfolios invaluable resilience during the recent market downturn as well as benefiting strongly from the recovery so far. We also continue to believe that by focussing on a company’s key financial metrics supporting a strong investment narrative and a discounted cash flow valuation we can continue to provide long term outperformance in this exciting sector through careful and attentive active management.

Discrete years' performance** (%), to previous quarter-end:

 

 

Jun-20

Jun-19

Jun-18

Jun-17

Liontrust Global Technology C Acc GBP

27.4

15.2

32.9

40.9

MSCI World Information Technology

36.7

16.9

26.4

37.2

IA Technology & Telecommunications

30.7

12.3

19.6

36.3

Quartile

4

2

1

2

 

*Source: Financial Express, as at 30.06.20, total return (net of fees and income reinvested). Non fund-related return data sourced from Bloomberg.

 

**Source: Financial Express, as at 30.06.20, total return (net of fees and income reinvested) primary class.

 

For a comprehensive list of common financial words and terms, see our glossary here.

  

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in funds managed by the Global Equity (GE) team may involve investment in smaller companies - these stocks may be less liquid and the price swings greater than those in, for example, larger companies. Investment in funds managed by the GE team may involve foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The team may invest in emerging markets/soft currencies or in financial derivative instruments, both of which may have the effect of increasing volatility. Some of the funds managed by the GE team hold a concentrated portfolio of stocks, meaning that if the price of one of these stocks should move significantly, this may have a notable effect on the value of that portfolio.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Thursday, July 16, 2020, 3:28 PM