News & analysis INVESTORS TURN COLD ON US TECH STOCKS


Is the perception that rate hikes are bad news for big tech justified? Mona Dohle takes a look.


Tech stocks are the segment of the US equity markets which is seen as being particularly vulnerable to rising interest rates. It is no surprise then that they have performed badly since the beginning of this year. And that is bad news for UK pension funds – growth-oriented defined contribution (DC) schemes, in particular – as tech is often the biggest holding in their portfolios. But why are tech stocks perceived to be as vulnerable to rising rates and could the real impact be a bit more nuanced?


Big on tech


There are two types of tech investors. Those who, like Ark Invest chief executive Cathie Wood, believe in the power of technological innovation with messianic fervour and are pre- pared to go all out with calculated bets against the market. And the pragmatists, who simply have a high allocation to developed market stocks and, therefore, by default have a heavier exposure to tech. After all, the eight biggest tech firms now account for almost half of the trading value on Nasdaq and feature heavily in other market-cap weighted indices, such as the S&P500. The latter applies to UK institutional investors, DC schemes in particular, who tend to have most of their growth-oriented default fund invested in developed market equities. Take Nest’s 2040 retirement fund, for example. Developed market equities account for half of its portfolio, and just under 15% of that is invested with the six biggest tech firms. The picture is similar across most DC default funds.


Bumpy start


While investments in tech paid off during the past two years, it has been a different story in 2022. The tech-heavy Nasdaq is down 11.7% since the start of January. Yet the index perfor- mance masks some variation across tech companies, which cover a broad array of sectors. It’s biggest constituent, Apple, is down more than 15%, Microsoft by 9.4% and Facebook an eyewatering 35%. At the same time, Alphabet, formerly known as Google, has also slipped, but its share price is only down 3%, year to date. Many tech firms have already held the first round of their earnings calls and for the first time in years, the results missed analysts’ expectations. Facebook, now known as Meta Platforms, reported its figures in February. While revenue and monthly active users were in line with forecasts, earnings per share failed to meet expecta-


tions. Investors responded by wiping $220bn (£165.5bn) off the social networking site’s market cap within a matter of hours.


The news has been particularly grim for the former stars of the pandemic. While Zoom shot to fame due to the impact of Covid, it has lost around a third of its value this year. Similarly, Peloton’s share price plunged as investors expected people to start returning to the gym.


Duration challenge


While these short-term troubles might be secondary for insti- tutional investors, who tend to stay invested for the longer term, the main reason for the slide in prices is a more funda- mental trend with tech stocks seen as particularly vulnerable to a rising rate environment.


There are multiple explanations for this theory. One argu- ment is that larger companies benefit disproportionally from cheaper borrowing costs, allowing them to invest more and introduce share buybacks. This is an argument put forward in a working paper by the US National Bureau of Economic Research and backed by empirical data stretching back 30 years.


Another explanation lies in the duration of some stocks. Just as bonds with a longer duration will struggle in an inflation- ary environment, so will stocks that pay most of their cash- flow in the more distant future. Many tech companies are seen as a prime example of that. However, the empirical evidence for this theory is weak as there appears to be no direct correlation between interest rate rises and tech stock slumps during the past 13 years, accord- ing to BCA Research.


And for my next trick… Some of the biggest firms are planning to tackle investor pes- simism through classic hat tricks such as share buybacks and share splits. Amazon, for example, announced a $10bn (£7.5bn) buyback in March and a 20:1 stock split, a move that would increase the number of shares twentyfold. Alphabet has also announced that it will increase the total number of its shares in circulation while Tesla is expected to announce a similar move.


These hat tricks might steer back investor caution for the short term, but where do they leave tech stocks beyond that? Tech investor Cathie Wood remains optimistic that demand for innovation will persist. Despite her funds booking heavy outflows, she insists that companies like Tesla will ultimately benefit from surging energy costs. But for institutional inves- tors, who are in the business of fiduciary obligation to pru- dence, the answer may well be reducing exposure to some tech giants.


Issue 112 | April 2022 | portfolio institutional | 7


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