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Smart tech investing

Photo of Paul Wilson By Paul Wilson

min read

Buying shares in the information technology sector can produce exceptional returns, but can also come with a high level of risk.

What do Uber, AirBnb, Twitter, Workday and DropBox have in common? They are all valued at more than $10 billion but were formed less than a decade ago.

Technology companies can get very big very quickly, reflecting the size of the global markets they are addressing and their ability to scale rapidly.

Australian technology companies also have had rapid rises in fortunes, with names such as Atlassian, the global software developer, OzForex Group, the currency transfer business that is challenging a traditional domain of the banks, and Freelancer, the world’s largest outsourcing marketplace.

Australian emerging software as a service (SaaS) businesses such as SiteMinder are already world leaders. These companies are all addressing very large opportunities by utilising technology to provide a more efficient service.

Naturally, Australian investors want the opportunity to participate in such businesses that have the potential to achieve such phenomenal growth and global reach. Some investors want to diversify their portfolios to include technology as an asset class. They also want to manage the downside risk of technology.

Solid foundations

Today’s technology sector businesses are a long way from the dot-com bubble of the late 1990s. The underlying foundations for the growth in the technology sector have been progressively laid over some time. Key elements include:

  • Digitisation of information.
  • Increased computing power.
  • Broadband proliferation.
  • Widespread use of smart devices.
  • The development of cloud computing services.

These elements are driving structural shifts in the way business is being conducted in almost every industry. Some companies are failing to adapt quickly enough and are at risk of value erosion. This, however, provides an opportunity for tremendous value creation for those companies nimble enough to embrace the change and allow it to drive their growth.

These industry structural shifts are sizeable enough to override underlying economic conditions for companies taking advantage of them. Investments can perform well even if the overall economy does not. Because of this, the technology sector is an interesting counterbalance to the historical portfolio weighting of most Australian investors (many investors have a high weighing to banks and resource stocks).

Technology sector well established

In larger markets such as the US, technology is very well established. The IT sector now makes up 20 per cent of the S&P 500 index and is a larger sector than financials or healthcare.

Sector Schwab sector view Share of the S&P 500 Index
Information technology Outperform 20%
Financials Outperform 17%
Healthcare Marketperform 15%
Consumer Discretionary Marketperform 13%
Consumer Staples Marketperform 10%
Industrials Marketperform 10%
Energy Marketperform 7%
Materials Marketperform 3%
Utilities Underperform 3%
Telecom Underperform 2%

Source: Schwab Centre for Financial Research and Standard and Poor’s as of 31/7/2015

The NASDAQ Internet Index has returned 17.9 per cent per annum over the past four years and IT is one of only two sectors rated Outperform by Schwab.

The overseas experience is that technology is well and truly established as a credible asset allocation, and also that the sector can be an important hedge against disruption to legacy businesses in an investment portfolio.

Investment opportunities in Australia

The market capitalisation of companies in the IT sector listed on ASX and NZX has more than tripled over the past five years, but still represents only 0.7 per cent of the ASX 200. This compares to financials comprising 47.7 per cent of the ASX 200 at August 31, 2015, using S&P indices data.

Many investors in Australia are looking to gain some exposure to the technology sector, recognising that the industry balance in Australia is likely to trend towards other developed markets over time. Some portfolio allocation to IT is a way to obtain exposure to potentially high-return investments while providing some industry balance to portfolios.

Several technology companies have recently listed on ASX. Some have had a stellar performance, others less so. A number are perhaps not fully understood by the market. There is no question that investment in the technology sector can produce exceptional returns, but also comes with a level of risk.

How to reduce risk

A number of measures can reduce risk in technology investing. They include:

  1. Specialist technology sector expertise. A manager who focuses only on the technology sector will have the experience of reviewing hundreds of potential opportunities of a similar nature. This means experience and a deep understanding of relevant technologies, business models, management teams and appropriate valuations.
  2. The appropriate stage of company development. Companies that are past the start-up or early stage will have a dramatically greater chance of success. This means several million dollars of annual revenue, repeat customers, proven globally competitive technology, proven business model, and a seasoned management team. This is referred to as the expansion stage, where businesses are looking to accelerate growth of a proven model.
  3. Capital structure and contractual protections. Investing in private companies at the expansion stage allows for bespoke shareholders agreements providing substantial protections and rights for investors. These include investing through convertible preference shares, which provide all of the equity upside and have the benefit of a priority return of all of the principal before any other cash goes out of the company
  4. Diversification through a portfolio of investments. Having exposure to a number of investments in this space is a sensible diversification of risk, a well-established principle.

How to get access

Traditionally, expansion capital investing in the technology sector has been the domain of ultra high net worth individuals and Silicon Valley firms. Bailador Technology Investments (ASX Code: BTI), which listed on ASX in November 2014, gives retail and institutional investors access a portfolio of technology companies at the expansion stage.

Acquiring BTI shares gives investors exposure to a portfolio of investments in six high-growth private companies in the technology sector, which have been made according to the principles outlined in this article.

About the author

Paul Wilson is co-founder and partner of Bailador Technology Investments This article has been extracted from ‘Investing in Technology the Smart Way’, which was presented to the Australian Shareholders’ Association Big Day Out conference and is available at www.bailador.com.au

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The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

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