Investing Knowledge

The technology sector has not been a popular destination for private investors' funds in recent years. For some, whose experience goes back to the dot-com boom, that's because they'll never look at a technology share again. For many, though, it's because the technology sector is a relatively small part of the UK market and receives little attention from advisers or the mainstream press. That's a little strange when, according to Lipper, the Technology sector has outperformed the UK All Companies sector over one, three and seven years. It's time to redress the balance.

Not for the classic "buy and hold" investor

Companies in the technology sector are growth oriented and either do not pay dividends or pay insignificant dividends. Earnings are re-invested into R&D and marketing and not doled out to shareholders. 

For investors in many market segments, dividends can constitute 50% of their total long-term returns and provide compensation and consolation in bear markets. With the technology sector, that is emphatically not the case; the only way you're going to make money is selling at a higher price than you bought at. Buying at the right time is crucial and here are five reasons why I think that time is now.

1. The right time in the economic cycle

Tech stocks are growth cyclicals. They benefit when recessions end and companies start investing in productivity enhancing technologies, increasing efficiency without hiring people. The next two or three years should be very good for sales and earnings growth.

2. Better balance sheets

Tech stocks didn't benefit from the credit-fuelled insanity that drove housing, construction and banking in the last boom. As a result they have more cash and less debt than any other sector. In fact, technology represents 17% of the S&P 500 (news) but contains 35% of its cash. Because the industry is relatively young, it is also not plagued by the pension liabilities that threaten the health of some our largest companies.

3. Good prospects for mergers and acquisitions

There have been some high profile mergers and acquisitions recently (HP has bought EDS, Oracle (NASDAQ: ORCL - news) purchased Sun Microsystems (NASDAQ: JAVAD - news) , and Dell (NASDAQ: DELL - news) has recruited an M&A chief from IBM (NYSE: IBM - news) ). That is likely to continue as the larger companies can acquire intellectual property and high growth through smaller players at reasonable prices.

4. Attractive valuations

The top ten holdings in the Polar Capital Technology Trust (LSE: PCT), one of the three investment trusts operating in this sector, are actually trading at a discount to the broader market. That's quite attractive given the greater long-term earnings potential of the sector.

5. A new technology cycle

Arguably one of the reasons the sector did not shine so brightly in the last bull market was the absence of industry-changing technologies (the 'client-server' cycle expired, 2G mobile penetration completed etc). That has all changed with the advent of 'cloud computing', reducing the need to compute (expensively) locally by using low-cost remote servers exploiting the internet and plentiful bandwidth. Increasing use of mobile broadband will also create opportunities.

Take the plunge with funds

So, I rather like the look of the sector and the question then becomes how best to gain exposure to these companies. Although I'm not always a great fan of managed funds, I believe this is the best way for a UK investor to proceed for two reasons -- first, the most attractive candidates are listed in the US and Asia. Second, this sector is risky and a wide spread of holdings is advisable.

The next decision is whether to use a closed-end fund (i.e. investment trusts) or an open ended fund (i.e unit trusts and OEICs). Here I would favour one of the three investment trusts focused on the sector as they are all sitting on discounts to net asset value: Herald Investment Trust (LSE: HRI), Polar Capital Technology (LSE: PCT) or RCM Investment Trust (LSE: RTT). 

Given the volatility of the sector and the massive price rises of the last six months, I would drip feed funds over the next few months. And for those of you who completely disagree with my views on the sector, there is always db x-trackers DJ STOXX 600 Technology Short ETF (XS8S).