In this podcast on the global technology landscape, Nigel Barnes spoke to Richard Clode, co-manager of the Janus Henderson Investors Horizon Global Technology Leaders Fund. They covered the trends we’ve seen in recent years, how technology enables sustainability and how Janus Henderson navigates the hype cycle to identify investment opportunities.
Today I’m joined by a special guest, Richard Clode, from Janus Henderson Investors. Richard started out in the industry back in 2003 and for a number of years has been analysing and looking at technology companies. Early on in his career he worked in emerging markets, and is now the co-manager of the Janus Henderson Investors Horizon Global Technology Leaders Fund – a strategy which is US$10 billion in size. Richard, you’ve been managing the portfolio with the team since 2014. Is that right?
That’s right, and they’ve been managing tech money even longer than me – going back before the the.com bubble.
Great. Well, thank you for joining us. Let’s start right at the beginning. Could you tell us what defines a technology company?
It’s a very simple question but the answer’s probably more complicated. We certainly don’t use GICS¹ or the MSCI to define what a technology company is – they seem to be on a mission to try and reduce the concentration of technology in the index as technology continues to take share of the global economy and, as a result, the stock market as well.
We view a technology company as any company that has a proprietary piece of technology (that could be software or hardware) that really is core to their franchise and is very important to their right to make money and to make profits – which really defines what they do. We’ve always kept that definition in the back of our minds, every time some new company comes to market and claims it’s a technology company. Back in the day that was GE (General Electric), but more recently I spent one of the more entertaining couple of hours of my life with Adam Newman, the founder of WeWork. He spent most of that time trying to convince me their company was a technology company rather than a real estate company. Our definition of technology has been a very useful lens to look at all of these new companies through.
During the course of the last couple of years and the period of the pandemic, there’s been a huge amount of noise around the technology sector. I believe there have been one or two unprofitable technology indices set up around the world. How do you think about what has happened and where we are today and, in terms of the management of the portfolio, how does that impact the way you do things?
We’ve used the word ‘unprecedented’ during the pandemic many, many times. When we saw those lockdowns around the world, we’d never seen anything like it before and we saw a huge acceleration in so many of the technology trends that we’ve been talking about for many years. And there are many new ones as well, as we suddenly had this mass global experiment of remote working and remote learning and having to do everything from the security of our homes. When you combine that acceleration of growth in technology with a scarcity of growth (given how hard hit the rest of the economy was) and then the Robin Hood crowd and the retail investors coming into the market too, it was the perfect storm to create this wild ride in these very unprofitable technology stocks that you mentioned.
The Morgan Stanley unprofitable tech basket was up 344% from the March 2020 lows to the peak in February 2021. Many market commentators and investors tried to paint this narrative that it was different this time and that ‘software was eating the world’ and ‘data is the new oil’. We have a chart, that goes back 40 years, that shows the performance of the most expensive versus the least expensive technology stocks. We had to completely rescale that chart as, even within the sector, those most expensive technology stocks outperformed so much – to the point where in early 2021 almost 40% of all technology companies were unprofitable.
We saw many fund managers making a name for themselves off the back of that, with Cathie Wood (ARK) being the most famous. There were many others on that bandwagon too, and many of those were actually not even really investing pre the global financial crisis, let alone the tech bubble. Fast forward to today where we don’t want to spend our lives on a Peloton – we want to get out and about we’re all a bit zoomed out. People were starting to ask: If these companies weren’t profitable during a lockdown and with insatiable demand for their services or products, would they ever be profitable? That’s when rates started to normalise, central banks started to taper, and we’ve now seen an over 60% drawdown in that unprofitable technology basket and unfortunately many funds – ETFs and active funds – see similar drawdowns off the back of that.
I suppose when we looked at that we felt that there were unnecessary risks being taken – we’ve been investing in tech for many years (my co-managers since pre-2000 and myself since 2003). There were many profitable beneficiaries of what happened during the pandemic. A great example of that is Apple, the largest company out there. Apple doubled its profits to over US$100 billion this year and has seen its stock rise over 140% – and it’s profitable. It’s on a price-earnings ratio (PE) of 30x, not 30x sales. We’ve always felt that, while technologies change and the technology companies change, one thing has stayed very constant: valuation does matter.
We like our history. Bernstein did a very good report that goes back 50 years, where they looked at buying companies on over 15x sales, not earnings. They found that in history, that really wasn’t a very profitable strategy. On average, you underperformed by 18% over the next three-year period and your hit rate was just over a quarter. We feel that hasn’t changed in the market. We want to be laser focused on having valuation discipline. The forward PE of our fund is 20x, we have about 3% of the portfolio that’s unprofitable – and that’s what’s really protected our clients’ capital, both in that major drawdown period and from February to April last year and then since November last year. If you look at our fund, we’re not down much versus that February 2021 peak while a lot of our peers have had 20-40% drawdowns since then.
Thank you, Richard. When you run through some of those numbers, it’s quite a scary and interesting period. I know that your team uses the phrase ‘hype cycle’. Could you open up a little bit on what you mean by that?
Sure. That’s been a core part of philosophy going back over 20 years now. There are two parts to that.
One is that we’re not just looking for growth. Anyone can find growth in the tech sector, hopefully! What we are looking for is unexpected growth, so growth that’s not already priced in to a stock. When we talk about growth, we’re talking about earnings and profit growth and cash flow growth. There’s been this over-obsession with revenue growth more recently but revenues mean nothing. I could give away a bunch of iPhones tomorrow – that doesn’t make me a good company. We’ve seen these billion dollar cheques being written by SoftBank to all these companies around the world. That’s effectively what they’ve been doing. They’ve basically been subsidising sales. We are looking for companies where we have very high conviction that they’re going to be the profitable and dominant leaders of the future. To think about that, you’ve got to think about various elements there: If they’re the best company and have the best technology today, is that technology ready for adoption now? Or are there some pain points to adoption, which mean actually it’s not going to take off for a few years? Have we actually hit the inflection point? If they have the best technology now, are they going to have the best technology in three or five years’ time? Because that’s going to be when we are actually basing that valuation on some profits and cash flow. So do we have conviction that they’re going to have those profits and cash flow in three to five years’ time? We certainly don’t do DCFs². We certainly don’t look out 10 years, given how dynamic and fast moving the technology market is.
The other element to navigating the hype cycle is putting a reasonable valuation framework around those profits and cash flow. We don’t do price to sales or look at terminal values in a DCF. We’re looking at real profits and cash flow on a three- to five-year view, putting a reasonable multiple around that and thinking: What we would be willing to pay for those stocks today? That’s something that we’ve been doing consistently for the last 20 years because we learnt the lesson the hard way in the dotcom crash. You know, just because you had a website and were selling online didn’t mean that you were worth US$10 billion or US$100 billion. We’ve kept that very much in the back of our minds when we’ve looked at any new technology or any time the market tells us that it’s different this time.
I’d like to get into one of the core areas that investors are focusing on right now, and we don’t see this changing going forward: Impact and sustainability of investing. Richard, in terms of the technology sector and technology companies, how is technology enabling sustainability?
That’s a really good question because clients tend to focus on the mega caps in tech, the FAANG stocks, and a lot of that is revolving around the negative things that some big tech is doing. We spend a lot of time with a lot of technology companies around the world that we really think are having a positive impact on the world and really providing solutions to some of the global challenges that we face. We very much see technology as the science of solving problems and there are some biggies out there that need to be solved! We’ve already seen some of that happen.
Today we’re looking at US coal consumption which is down almost 60% in the last 13 years and approaching levels last seen in the 19th century. You’ve got to remember that during those 13 years, for four of those they had a president who didn’t believe in climate change. Coal consumption being down is because of technology. The price and cost of solar panels collapsed over 80% and wind power by almost 50%, because of technology. You can get some very good stock returns out of that as well. SolarEdge, which is one of the leading solar inverter companies globally, actually outperformed Amazon by 400% during that period. So getting these trends right, and finding these technology solutions to some of these global challenges, can be very profitable in the stock market too. We’re seeing something very similar with electric vehicles today. But I think when we look beyond that, we see that the global challenges we face are so broad that they need a great breadth of technology innovation to provide solutions to them (beyond just climate change).
We’ve got to think about smarter cities. We need to leverage 5G, internet of things and AI to make cities more efficient – to have less congestion and less wastage. We need to create circular economies that need asset tracking technologies like RFID (radio-frequency identification). We need to have more efficient, secure, and a hundred percent renewable data centres. We need to automate processes in a carbon neutral way and we need to democratise access to quality education and healthcare and promote financial inclusion. In every case we think that technology is key to providing that innovation – those exponential leaps, to provide those solutions and to do that in a low carbon way. We think by doing that, we’re naturally going to access some of the largest and longest runway growth markets out there. So if we can navigate the hype cycle in those growth markets, we think we’re going to be able to deliver both some very attractive, long-term capital returns but also have that positive impact on the world. There’s a very natural synergy in technology investing in sustainability.
From what you’re saying it sounds like the technology opportunity is becoming more global and not just US focused, perhaps as it has been or has been perceived in the past. Is that fair?
Yeah, I think that’s fair for a variety of reasons. We’re seeing the natural evolution of the world to being less US centric – whether that be China or some of the emerging markets. Then we’re seeing the progress of capital markets, where before if you wanted to set up a tech business it had to be in Silicon Valley. That’s where the venture capitalists were. I think increasingly, now we have venture capital and private equity funds in China, Southeast Asia and Latin America. So you can go home and then build these businesses in other bits of the world, and then there are stock markets there to support the public life of those companies as well.
As we came into late last year, we saw a growing dislocation between some of those US companies in technology and some of their Asian counterparts that were very much playing to the same themes or, in some cases, actually suppliers to the same companies that were going up a hundred percent or more in the US. So, we shifted the portfolio late last year to very much increase our Asian exposure. We stepped back into some of the Chinese internet stocks – notably Tencent, which we’d sold earlier in 2021. We increased our position in TSMC. We added to our ‘memory’ exposure because we felt that there was a huge dislocation between some of those Asian semiconductor companies and their US SOXX counterparts like Nvidia and AMD.
Let’s bring it to today, and looking forward. We sit in a period of rapidly rising inflation. Lots of questions about that, about oil price, rising rates to combat inflation on a global basis. Richard, how do you see this year are panning out? Is there one particular area that really excites you, that you think will break through over the next year or so through the sector?
Sure. We retain a positive outlook for the technology sector. Everywhere we look, we’re seeing some very strong trends. I mean, there is some normalization for some of those pandemic beneficiaries that are now lapping some very difficult comps³. Generally, we’re seeing some very strong trends across most of our core technology themes. As technology investors, we don’t just get seduced by the technology and the growth. We are remaining laser focused on those valuations given, as you said, rising interest rates and rising inflation expectations. Ultimately, as long as we’re laser focused on valuation and maintain that discipline, we think inflationary forces are very beneficial to technology adoption. That’s because technology is the ultimate deflationary force and often the biggest impediment to adopting new technology is status quo and incumbency.
So, no one wants to update their factory because it costs a lot of money. And why would you, if everything’s going fine? But then you end up with not being able to get any labour, huge wage inflation, COVID scares… that’s when you start making hard decisions to automate your factory or to adopt AI. We’re seeing this time and time again around the world, that suddenly these hard decisions are being made and that’s generally leading to more technology adoption. So the backdrop is pretty strong but when we think about where know we want to be exposed to, as I said, we want to be laser focused on valuation. So we increased our Asian exposure. We think those Chinese internet companies are too cheap. We thought some of those Asian semiconductor areas were too cheap. We’re generally overweight semis and that cyclical side of technology, as we see that economic recovery coming out of the pandemic.
There’s this myth that all technology companies benefited universally from the pandemic and that’s not true. There are many areas of technology that were pretty hard hit. So, again, we want to have more exposure to that heading into 2022 – which we think is actually going to be the year that we expected in 2021 (coming out of COVID and ending up with slightly more normal lives through year and beyond).
I think there are many names, whether in online advertising or in payments or in ride hailing, that got very hard hit by the restriction to travel and then weren’t advertising. We think that those areas will recover through 2022 and then see a resumption of strong growth beyond that as well.
And then, we think about those longer term secular growth areas. Everyone’s talking about the metaverse and people are talking about new metaverse ETFs or new metaverse funds. We always remind people that, if you look at the biggest metaverse ETF today, five of their top 10 are in our top 10 of our broad based technology fund. Actually, most of the main metaverse players are in many cases large or mega cap tech companies that are already held in generalist tech funds.
So, we remain very positive on both the near term and longer term trends. When you think about what you want to invest in, do you really want to invest in oil or banks longer term (probably not) or mining companies? We do think the trends in technology are much more sustainable over the longer term. And, as long as we can provide our clients with access to that very exciting secular growth, with some discipline around the valuation, we’re going to be a lot less sensitive to interest rate expectations from here. That’s how we can provide that consistency and that’s really what we’re trying to provide clients with through this fund. This is a core technology fund that really is trying to provide long-term access to the exciting new technology themes and secular growth, but with a consistency of return because we’re not exposed to incredibly high duration, unprofitable tech companies that are going to see significant drawdowns any time the winds of interest rates change.
Richard, thank you. That’s a great way of finishing off. We’ve covered a lot here: definitions of technology companies; looking back at what’s happened over the last couple of years; sustainability and the impact that technology has and can make positively on our lives; and we talked about the global opportunity and how you’re positioned.
The Janus Henderson Investors Horizon Global Technology Leaders Fund is available here in South Africa through Denker Capital. We act as the distributor and we are very proud of our partnership with Janus Henderson. If anyone has any queries, please contact us and we’ll get back to you.
Richard, thank you very much for your time.
¹ Global Industry Classification Standard
² Discounted cash flow valuations
³ Comparable company analysis
The opinions expressed in this podcast are those of the participants and do not necessarily represent those of Denker Capital. This podcast does not take the circumstances of a particular person or entity into account and is not advice in relation to an investment. Please do not rely on any information without appropriate advice from an independent financial adviser. The value of investments may go down as well as up, and past performance is not a guide to future performance. Denker Capital is an authorised financial services provider in South Africa (FSP number 47075).