Polar waits for thaw

Technology funds are still waiting for the next big spending cycle, says Brian Ashford-Russell, founder Polar Capital Partners.

That said, there is almost no sector that over the long-term has delivered equal returns, and is so geared to growth in global GDP, he says

”It is cyclical, but it is able to reinvent itself constantly.”

Examples of this evolutions includes the focus on office copiers in the 1960s and 1970s, through PCs in the 1980s, into communications technology in the 1990s.

The danger to investors is either they do not recognise this process of reinvention over time, and that they only look to invest in technology during the boom years, without doing their homework in the quiet periods ahead of the next big thing.

Ashford-Russell says he does not believe the current cycle has bottomed, but sees the next cycle starting in about two years’ time.

In the meantime, investors should realise the volatility of the sector “plays to savings schemes.”

Sticking with a former winning stock is seldom a good play because of the nature of innovation, which means “corporate obsolescence” offers chances for new companies to produce better returns for shareholders.

Examples of this obsolescence hitting leading stocks are names such as Atari, Palm, DEC and Netscape – all considered leaders in their niches, but since roundly beaten, sometimes out of existence altogether.

Ben Rogoff, senior fund manager technology Polar Capital Partners, says people need to maintain engagement in the sector over time because dipping in and out increases the risk the next good idea may be missed.

”It’s important not to pile in at the top of the cycle,” adds Ashford-Russell.

This explains Polar’s decision to increase the proportion of holdings it has in Asia and Japan, where Ashford-Russell feels the economic upturn is “well entrenched”.

Investors also need to understand the positives that have been put in place since the technology bubble burst in 2000, he says.

Capital starvation has forced technology companies to become much better at managing themselves as businesses, creating lean inventories, better balance sheets, and improved cash holdings.

”Fundamentally the industry has been cleaning up its act,” he says.

What is lacking is a major new “driver” – which in the 1990s consisted of the internet, wireless and other communications demand pushing demand for new technology.

The market is currently “between generations” of those drivers and future ones: what investors need to do is ensure they are tapping into the next generation of ideas that will result in companies on the market in three to five years’ time, Ashford-Russell says.

Adds Rogoff: “There is a lack of a ‘killer app’, which means technology spending is currently more correlated with GDP growth.”

Historical data suggest it takes five years for and industry – any industry – to start turning after falling from an investment peak.

That would make February 2005 the time for interest in technology to turn again, an idea supported by data showing technology as a percentage of the S&P500 index in the US is back to historical levels.

With the new issue (IPO) market quiet and investment funds sitting on cash, it may not be long before a turnaround is noted.

Ashford-Russell expects short-term upwards momentum in technology share prices, sparked by a historical trend of valuations increasing in the October-April period.

A fourth-quarter 2004-first quarter 2005 rally could take place, he adds.

Longer-term key driver themes include demographics and increasing resort to high-tech implants, the need to cut healthcare costs driving IT systems spending, more use of broadband internet services, growing sales of flat-panel television sets, and wireless data, says Rogoff.

US government figures show technology has increased its share of national GDP from less than 1% in 1960 to about 5% currently.

The Association of Investment Trust Companies notes the average TMT investment trust went from a premium of 9% in October 2000, to a discount of 29.8% in September 2002, before recovering to the current discount of 14.8%.