Ivy Sector Insights – Information Technology
Commentary as of April 16, 2020
In the current scenario, what are the factors impacting technology stocks?
As bottom-up investors, our job is to seek out companies that have risk-reward in our favor through a market cycle. This has become especially important in the current environment. Until January of this year, financial markets were at an all-time high and the pundits were battling about what would cause the next slowdown and market correction. And something completely unexpected did – the spread of COVID-19.
In our view, there are companies in every sector that have resilient business models – no matter the environment. Through bottom-up research, we seek to find and invest in these types of companies. In terms of technology, we believe the following three factors are most important in the current environment:
- Global supply chains: We expect to see global supply chains becoming less concentrated and less reliant on a few countries. Balkanization – companies bringing supply chains closer to their customers – has been underway for a while. This was a center point during the U.S.-China trade dispute and, considering the recent COVID-19 pandemic and the disruptions it caused, global supply chains will likely remain an important factor for companies.
As supply chains move away from lower-wage countries and closer to the customers, we expect automation to be a major factor supporting this transition. We are leveraging this trend and are investing in companies that are in the value chain of enabling and supporting automation.
- Evolution in demand: The spread of COVID-19 has shaken the global economy. Currently, a record number of people are filing for unemployment. In such an environment, consumer and corporate demand will probably face headwinds in the near term and the demand profile for the second half of this calendar year remains uncertain.
At the same time, a new trend has emerged – a large proportion of people are working from home. This has increased demand for cloud computing, endpoint security equipment, an upgrade of the work-from-home IT environment (new PCs, new screens) and many other areas. As such, we believe technology companies exposed to this trend will clearly see tailwinds and we are opportunistically looking to gain or increase exposure in such secular growth companies.
- Changing consumer behavior: With the increasing adoption of the internet and online activities, consumer behavior has been changing. This change has been accelerated by COVID-19 in which many activities including education, health care and conferences have become remote. We hope to take advantage and invest in companies that are in the value chain of supporting this transition.
Which are some companies that you are investing in?
We want to invest in companies that smartly allocate capital and act as shock absorbers in our portfolios, and are backed by secular trends, rebounding when financial markets recover. We believe that analog semiconductor companies, foundry stocks and infrastructure providers have a favorable risk-reward profile with limited downside risk in the event of an extended down-cycle and a rebound from secular tailwinds when the macro picture begins to improve.
- Foundries: Companies such as Taiwan Semiconductor Manufacturing Company (TSMC) that manufacture semiconductor chips are a key part of the global supply chain and it remains a stock with steady compounder characteristics in the technology ecosystem. TSMC acts as the foundry of the world and it enables most devices that have silicon inside of them including smartphones, servers, automotive electronics, industrial automation, PCs and tablets, and many more. As silicon intensity rises, TSMC benefits with its diversified manufacturing strategy, its dominant market share advantages (>60%), its execution in node transitions (7nm/5nm/3nm and beyond), and its sustainable capital allocation.
- Semiconductor analog companies: Companies such as Texas Instruments and Analog Devices design semiconductor chips that act as the bridge between the physical world and the digital world. These companies remain resilient through semiconductor cycles for a whole host of reasons. They have long product life cycles, numerous market segments, difficult to replicate technology intellectual property, complexity of design and process technology, a deep bench of experienced design engineers, low capital expenditure requirements and enviable margin and free cash flow profiles. For example, the average product life for Analog Devices (ADI) in its industrial end markets is 20 years with almost no price erosion. This creates formidable barriers to entry and makes them attractive long-term investments.
- Infrastructure providers: Companies such as Amazon, Alphabet (Google) and Microsoft that provide the infrastructure enabling the adoption of remote activities are part of another segment we believe may see demand through COVID-19 and on the other side of the crisis as well. Most of these cloud infrastructure providers extensively use semiconductors such as memory chips (dynamic random-access memory (DRAM) and NAND), graphics processing units (GPUs), and central processing units (CPUs) and other chips, which benefit the semiconductor supply chain.
At Ivy, we have the institutional wisdom of portfolio managers and research analysts who have covered the technology sector for multiple decades. And through active debate and regular conversations in our daily morning investment meeting, we aim to identify long-term investments that benefit our shareholders.
Past performance is not a guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through April 16, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.