Why are investors shunning UK technology stocks?

The UK is often regarded as a champion of engineering and innovation, but when it comes to tech stocks, it is often passed over for the global giants.

‘I hold ARM (ARM), but as a large cap investor the UK, and indeed Europe in general, is very deficient when it comes to high quality tech stocks,’ said Tom Walker, investment director of global equities for Martin Currie.

Some investors recognise the value of early-stage UK start-ups but argue there are still barriers to entry. The £671 million Herald (HRI) investment trust invests in technology with the bulk of exposure in the UK, but its board recently proposed steering the fund more towards Silicon Valley.

Noting that there has been some helpful mergers and acquisitions activity in the UK tech sector, Herald investment trust chair Julian Cazalet admitted pickings were still slim in Britain.

‘Unfortunately, while some consolidation is appropriate and helpful, the serious shortage of capital in the UK market has meant that there have been no UK consolidators, so most companies have been sold to overseas buyers and a few to private equity,’ wrote Cazalet in the trust’s recent annual report.

‘The flight of capital from the quoted UK equity market has reached a point where we must consider reallocating capital. There is no shortage of entrepreneurialism and innovation in the UK, but an evident shortage of capital, so it seems perverse that we may be forced to exacerbate matters by reducing our own exposure to the UK.

‘Having long been evangelists for the UK, and having achieved an annualised internal rate of return on the UK element of the portfolio of 17.7% since inception in 1994, it is a depressing conclusion to reach.’

Challenging market

Jeremy Thomas, manager of the Brunner (BUT) investment trust, is a heavy backer of the technology sector and says it is a good, but challenging, market for stock pickers. However with a global mandate, he too has been led overseas despite the potential he sees in the UK.

‘There are a lot of interesting start-ups in the UK, however tech is a tiny part of the market,’ said Thomas.

‘What I tend to find is there is a real tendency for start-ups in the UK to sell themselves before they list and get to maturity. If they do list, they will usually do it in the US. It can make sense for them to sell, as the likes of Google (GOOGL.O) and Facebook (FB.O) have unlimited firepower when it comes to acquisitions.’

Part of the tendency to go overseas for technology exposure was due to bad memories investors have of the dotcom bubble, said Hargreaves Lansdown senior analyst Laith Khalaf.

‘It is a global game and it is difficult to invest in this sector and look purely at the UK. There is probably a hangover and people tread carefully with tech stocks because these stocks were on such huge overvaluations,’ said Khalaf.

‘You could say we have the same problem today with some companies that have very high valuations but have not posted any profits yet. The tech sector is very innovative and fast moving so it is easy to get left behind. This is not just a problem for smaller companies. Look at Nokia (NOKIA.HE), they got left behind and they’re huge. It is healthy to have a dose of realism when investing in technology.’

Fast growth

Tech start-ups are renowned for growing spectacularly quickly when things go well, but unwinding just as quickly if they don’t. With a high failure rate, Khalaf believes it is better to dilute exposure in general global equity funds rather than technology funds.

‘Unless you have a very strong sense that the tech sector will take off, I would probably devolve that decision to a fund manager,’ he said.

Thomas agrees it is a difficult sector to add invest in. ‘We try to split tech names into two groups: the large mature companies and the other expensive but fast-growing firms,’ he said.

‘The former includes Apple (AAPL.O), and with that, we have to consider how long they can keep going. With the latter we have the likes of Facebook and it can come down to monetisation and how much they can realise their potential. We have to be more imaginative with these companies.’

This article was written by Jonathan Yarker and published on CityWire.co.uk on 23rd April, 2016.