Endowus Satellite Portfolios: On technology — a 2022 update

What’s the outlook ahead for tech stocks?

This is a time marked by aggressive interest rate hikes, as the US Federal Reserve looks to tamp down surging inflation. 

The valuation of a company is based on the present value of its future earnings. This means that rising interest rates make growth stocks less attractive in the short run, as the present value of the company’s cash flow from its future earnings is worth less than before due to the higher borrowing costs today.

This period is also marked by risks of a business slowdown, which hurt earnings that anchor how stock prices are valued. In November 2022, we saw headlines dominated by layoffs in the tech sector as earnings slowed. Twitter’s new leader, Elon Musk, slashed headcount by a brutal 50%. Meta — which owns Facebook, Instagram, and WhatsApp — has cut 13% of its staff. 

Equity markets have declined 17.2% this year, but the technology sector had a much tougher ride with a decline of about 26.8% as of 31 Oct 2022. The Endowus Investment Office believes that the technology sector as a whole would benefit when interest rates start to peak and central banks stop their rate hikes. The sentiment towards growth-oriented tech stocks should also start to become more positive.

Minutes from the US Federal Reserve’s November meeting suggested that most officials thought they should dial down the pace of interest-rate hikes. This may mean a shift to a smaller rate hike of 0.5 percentage point at the Fed’s final meeting of the year, in December. It comes after the Fed went ahead with a jumbo rate hike of 0.75 percentage point at the November meeting to cool inflation from a 40-year high. 

2022 has seen the first sizeable challenge for the growth investing style in over a decade, says a recent report by BlackRock. While some Covid-inflated earnings required some repricing, there was also indiscriminate selling, even as the broader challenges that companies face today will only motivate more innovation. With a tight labour market and rising input costs, companies will be more incentivised to hunt down innovative solutions. 

Indeed, Franklin Templeton pointed out too that in time, artificial intelligence and machine learning could create new worker capacity and change the way work gets done. “Ultimately, technological advancement in other areas such as quantum computing and cloud computing could drive productivity and be deflationary,” it adds in this report.

BlackRock says the key is to be selective and risk aware, particularly in this highly uncertain macroeconomic environment. It sees particular areas of interest such as e-commerce, software,  and communication services. The fund manager is also targeting companies that didn’t reach peak earnings post-Covid and those that are expected to be resilient in a recession. It is avoiding businesses that have high expectations priced into their valuations but present murky competitive advantages, as well as companies with weaker balance sheets or that appear to be walking tenuous paths to profitability. 

As with all investments, predicting the timing of the entry and exit points is incredibly difficult. For long-term investors, consider a dollar-cost averaging approach if it suits your needs.

How we constructed the Endowus Technology Portfolio: a recap

The Endowus Technology Portfolio gives investors access to the most innovative companies globally that benefit from technology advancements. 

When designing the portfolio, the Endowus Investment Office worked to maximise the diverse sources of potential returns. For example, we included not only a concentrated bet on the core technology sectors of software and hardware, but also exposure to the non-traditional tech sectors. We also brought in funds with exposure to private (unlisted) tech companies in the growth stage, translating to more diversified opportunities to generate returns.

The portfolio is globally diversified. The high allocation to US companies merely reflects the heavy dominance of US tech companies in the global technology index. Exposure to Asian markets include China, Korea, Japan, and Taiwan; that to European markets includes Netherlands, Germany, and France.

Underlying funds of the Endowus Technology Portfolio

Portfolio allocation of the Endowus Technology Portfolio

2022 performance

The Technology Portfolio outperformed the MSCI ACWI Information Technology (IT) Index by about 1.3 percentage points in the third quarter of 2022. Most of the outperformance was driven by the brief rebound in July, when all of the funds registered positive returns. The portfolio rallied harder than the index due to its greater exposure to growth and small cap stocks, which enjoyed stronger performance.

On a nine-month basis, the Endowus Technology Portfolio has returned -39.7%, versus the benchmark’s -30.6%. This may be attributed to the fact that the portfolio, compared to the benchmark, tends to hold more that are smaller-sized and positioned to be future leaders in the industry. Such companies, compared to the established mega-cap names, often face more headwinds and challenges in a rising rate environment. The portfolio is also more globally diversified — with significantly higher exposures, as compared to the benchmark, to markets such as Asia and Europe that are thought to be less established than the US.

While the portfolio’s performance has been disappointing, we continue to believe that the portfolio is well-positioned to capture the upside during market rebounds, as we have observed during the short rebound in July 2022 when the portfolio managed to do better than the benchmark. Additionally, the underlying holdings are high-quality companies positioned for long-term growth; we believe the portfolio will perform attractively in the long run.

Endowus Technology Portfolio returns

A core-satellite approach

Launched in November 2021, Endowus Satellite Portfolios are used to supplement the core portfolios and are meant to express an active decision by the investor to provide further diversification opportunities to try to generate alpha (above market returns), or to express a specific investment view or strategy. This can be done through a single fund or a portfolio of funds. 

Here’s how satellite strategies differ from that of core portfolios:

• They tend to be more concentrated in nature and narrow in exposure, targeting a certain sector or country or theme, as compared to the passive broad market exposure of core portfolios.
• While they may follow an index and can be passive, most satellite portfolios and funds tend to be active in the way they invest and seek to generate alpha.
• The investments tend to be shorter term in nature and reflect tactical or opportunistic investment strategies, as opposed to the strategic nature of core investments. 

Find out how our other Satellite solutions have performed in 2022 — click here to read about the Endowus Global Real Estate Portfolio and the outlook on property stocks, or follow this link for an update on the Endowus China Equities Portfolio.

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