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The tech sector: There could be bubble ahead…..

Investors say some areas of the tech sector show “bubble-like characteristics” while others offer fresh opportunities and value.

The recent popularity of technology stocks with investors may have sparked warnings that the tech sector could be entering bubble territory. But with others pointing to areas of value and fresh opportunities across the sector, is this tech bubble different?

The S&P 500 Internet Software & Services index has risen by 71.78 per cent over the last three years compared to 46.78 per cent for the broader S&P 500 index, while the tech-heavy NASDAQ index also hit a fresh 13-year high of 3,994.97 during November.
 
Tech has proven a favourite with asset allocators in recent months along with industrials, with the majority of global managers currently running an overweight position in the sub-sector, according to data from Bank of America Merrill Lynch.
 
But while some point to early signs of a bubble fund managers agree the sector is still able to throw up opportunities for both value and growth.

Standard Life Investments head of global equities Mikhail Zverev argues investors’ recent behaviour toward tech stocks including the Twitter IPO could imply the start of a bubble in the sector.
 
He says: “The first thing you should worry about ahead a bubble is people chasing names because it is perceived as a licence to make money. We are maybe seeing some of that at the moment.”
 
Zverev is particularly worried about the “very optimistic valuations” of social media companies that have come to the market recently, because he feels in many cases their business models have “yet to be proven.”
 
He says: “Since its IPO, Facebook has proved pretty fast that it can monetise its user base but Twitter’s business model has still to be proven and there are also lots of other smaller players in the social media space that are rumoured to be coming to market which are in even earlier stages of business development.”

However, Zverev adds the “more dangerous” sign of a bubble, where investors feel “under pressure” to invest in businesses they do not understand, has yet to occur.

 
He says: “What makes a bubble in my opinion is not just everybody looking with envy at the sort of profit that investors made on the first day after the Twitter IPO, it is more a pressure on everybody to participate in case they fall behind their benchmark if they do not participate.
 
“This is the more dangerous thing that is nowhere near happening yet. These tech stocks are still a small part of the benchmark.”

Bestinvest managing director Jason Hollands believes the social media market is becoming “frothy” but does not believe the sector is at risk of becoming a full-on bubble as previously seen in 2000.

He says: “There are bubble-like characteristics emerging in the social media space in particular, against a backdrop where risk assets have been underpinned by abnormally cheap liquidity and where US equity markets look expensive.

”However, we have not yet reached the levels of irrational exuberance we saw in 2000 and the flurry of interest in social media may continue for some time yet but investors should exercise caution. Indeed, that applies equally to US equities more generally.”

BlackRock chief investment strategist Russ Koesterich argues the “excitement” surrounding the sector is a positive and believes tech stocks currently represent good value.

He says: “While the tech sector’s growth is much slower than in the past, I see value, if not excitement, in the sector.
 
“Tech stocks are reasonably priced and typically carry little debt, making the sector less vulnerable to rising interest rates than its counterparts.”
 
Larger tech firms are currently favoured by Koesterich given his “general preference” for large and mega-cap stocks.
 
However Zverev says investors are giving software companies and social media “the benefit of the doubt on the continuity and longevity of their growth.”
 
He adds that by contrast, stocks like Hewlitt Packard which are perceived to be more challenged may have “very undemanding valuations”, but their share prices often disappoint.
 
Deputy manager of the Monks Investment Trust at Baillie Gifford, Tom Walsh, continues to find a variety of opportunities in the sector with two of the trust’s major investment themes currently being ‘technological change’ and disruptive internet and technology companies.
 
The portfolio does include some of what Walsh describes as the more “traditional” areas of the tech industry. Samsung Electronics currently features as part of the trust’s top 10 holdings alongside a smaller position in Facebook.
 
Beyond this Walsh also holds internet and technology companies with “disruptive” business models including mass media firm Naspers and e-commerce platform MercadoLibre as well as a young internet business incubator called Digital Garage.
 
Zverev has recently reduced exposure to the IT sector to its “lowest weighting in some time” as part of his £76m SLI Global Equity Unconstrained fund and is moving attention toward data analytics as a play on growth in the tech sector.
 
He says: “The latest company we have bought shares in for the fund is Alliance Data. This may not seem like cutting-edge tech but they are leaders in the field of data analytics.
 
“Social media and Google are telling the world that the value of data in your business is potentially huge so this business has the same fundamental drivers as Facebook and Google but it is at much more appealing valuation levels.” 

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