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Murdo MacLean. Client investment manager at Walter Scott in Edinburgh.
We have historically been somewhat more favourable towards technology stocks. And at the same time, with inflation and the outlook for Fed actions, how’s that affecting the tech stocks as well as how we are maybe reallocating our portfolios in light of the recent sell off?
And just to give you an idea, I suppose, of how our exposure has evolved in terms of technology, back in 2008, obviously the world was rather a different place. And at that point we had approximately 15% of a global portfolio exposed to technology companies versus the benchmark, MSCI World Benchmark, of around 11%. So we were still overweight. Less overweight than we are today, and obviously in absolute terms, a lower number. Now, today, as of the end of December, Walter Scott global portfolios are on average around about 33% exposed to technology businesses versus 24% to the benchmark. So you can see those numbers have both gone up quite significantly.
People are using technology in far greater variety of ways today than ever before. And this has been made possible by innovation, by huge growth in computational power, the shift to cloud based solutions, the evolution and capabilities of wireless connectivity. And of course, that thing that we all have in our hands now that mobile phone, what it’s capable of doing today versus the past. How much of that has had to do with interest rate level to me is somewhat questionable. And at the very least, it’s a very difficult thing to calculate. Economies evolve due to innovation, I think due to the way that people want to behave in life and so on. And monetary policy I think is in the background, but I wouldn’t necessarily say that it’s at the vanguard of driving those things. I think it’s the other way around if I give you my honest opinion.
The general accepted view to your question is that if rates go up, the value of future cash flow has come down. And hence valuations and then share prices will fall. I suggest that this is certainly not exclusively the case. If it is true for tech companies, it must surely apply to all businesses who you would calculate a future cash flow on. I think further some make the argument that tech stocks, because they’ve done best or very well, they will be penalized most. And I think there is maybe some grain of truth to that. However, I think that we need to, as we at Walter Scott do, we need to disaggregate the companies for whom the optimism in the market is sky high, but may or may not deliver on those expectations. And those companies who are far more reliable in terms of the growth that they can deliver and maybe that’s based upon the fact that they have done it before. They have a long track record of success, of consistency, of growth, and that they have a real clear, well established business model that feels tangible today.
So I think you need to separate those two types of businesses in tech, or frankly, in any sector around the world, before you can make a general comment about the impact that inflation and therefore interest rates can have. I think the recent role is that we’ve seen in the well-storied ARK Innovation fund is a case in point here. The fund has been heavily exposed to technology and it’s down 50% over the last 12 months. Now, if you take closer look at that fund, eight out of the 10 of their top 10 holdings, so eight out of the top 10 holdings, do not generate any profit whatsoever.
In fact, they actually lose a lot of money. And I think, at the same time, many of those companies in the last 12 to 18 months have reached exorbitant valuation levels. So what we’re seeing here is, as money becomes less freely available, and that’s a natural consequence of interest rates perhaps rising, that the degree of comfort in taking excessive risk falls, naturally. It’s like going to a casino I suppose. If someone gives you a hundred dollars and you have to pay them back, you don’t feel nearly as bad losing that as if it’s your own hundred dollars. So I think there’s definitely that dynamic playing out. And I think this is what we’re seeing in the collapse of a lot of share prices in the first two, three weeks of the year. And obviously that trend to some extent started last year in share prices are some of the more speculative companies out there, or spec-tech as they’re becoming known as.
And it just makes me wonder, how many of those investors that bought those companies last year or two years ago knew that they were effectively called spec tech. I fear very, very few of them actually believe that when they bought into those companies. So I think that it’s important when we think about interest rate increases and it’s very hard to know to what extent they will rise, say they rise any [inaudible 00:05:01] from now, they will still impact different companies in different ways. And I think that’s very much how we look at it. And with a firm focus on investing in tangible, proven, long term successful businesses that really do operate with immensely strong structural tailwinds, we feel that they are more than capable of operating and being successful in an environment where interest rates are somewhat higher than they are today.
The other part of that question was how are we thinking about inflation, but also how are we relocating portfolios? I think the simple question comes back to inflationary pressures. Where are we seeing inflation?
Generally, we’re seeing it at the moment in input cost and labour costs, which is obviously another input cost there. And again, we fall back on choosing to invest in businesses that have, first of all, beaten through periods of inflation, that know how to cope with it, that have management teams that have taken precautions in their businesses to give them flexibility when we do see short, sharp bouts of cost push inflation as we may or may not be seeing right now. And whether that transitions into long term inflation again, the businesses that are more capable of weathering that in our experience will do so. And those companies that, whether it’s because they have excessive levels of debt, and therefore find it difficult when interest rates rise as a consequence of inflation, or whether they simply just don’t have the broad shoulders and the well mapped out supply chains, they are the ones that will typically suffer.