The rate at which technology has been adopted in business and society has grown out of necessity, building up naturally yet aggressively as a result of the pandemic.
These technologies are meant to make our lives more efficient by supporting virtual work, growing e-commerce businesses, offering cybersecurity protection, optimizing through automation and much more.
The outcome: high tech asset valuations. Market adoption in this space, which is normally expected to take years, is happening much quicker. This has investors piling into Big Tech, namely Amazon.com (ticker: AMZN), Apple ( AAPL), Alphabet ( GOOG, GOOGL), Facebook ( FB) and Microsoft Corp. ( MSFT), because they want to get in on something with growth opportunities. A tech stock of this size can come with a hefty price tag. Amazon saw explosive growth over the last year and now costs around $3,100 per share.
Adam Coons, portfolio manager at Winthrop Capital Management in Indianapolis, says investors can expect “continued higher returns probably this year, but then you’ll see muted returns going forward.” As he explains, “that’s what needs to happen for valuations to normalize.”
Keeping this in mind, here’s what retail investors need to know to profitably navigate the tech sector this year:
— Finding tech winners in 2021.
— Tech opportunities in private markets.
— Risks in tech investments.
— Should you still be invested in tech?
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Identifying Tech Winners
This past year, the tech sector got a huge boost from the new working environment. This year, certain factors will help differentiate innovative companies that will surpass the rest.
Anthony Denier, CEO of Webull Financial, a commission-free online stock trading platform in New York City says “2020 was the staging point for technology companies that have been emerging over the last 10 years or so.” He continues, “2021 is the time when you start weeding out tech companies that are leading the pack versus the ones that were along for the ride.”
For tech companies to continue generating business growth, they’ll need to adapt to changing consumer behaviors and innovate. Denier says sustainable tech companies will continue to outperform by demonstrating their ability to adapt and scale with strong management and brand recognition.
“When companies are truly filling a need, they will continue to outperform, and the companies that were just getting inflated due to the association of their peers will start to get left behind,” Denier says.
It’s not enough for investors to look for companies that can generate consistent revenues. Denier adds that tech companies still need to find ways to innovate and “move into the next generation of business.”
“(Apple) does this very well. Not only do they have the recurring revenue stream but they’re also moving into new products like self-driving cars,” he says.
People look to the leaders, Denier says: “Our No. 1 traded technology stock is AAPL every day.”
Looking for sustainable business models that have proven revenue track records is a helpful guide when making investment decisions. Investors who study tech companies should identify how they fare among their competitors if they’re in a large market rather than a niche market, and that the company has strong profit margins. These are some fundamental elements used to analyze long-term buying opportunities.
[See: 7 Undervalued Tech Stocks With ‘Buy’ Ratings]
Tech Opportunities in Private Markets
Private markets have been growing at a significant level over the past decades but have chosen to stay private for longer. According to World Bank data, the number of publicly listed U.S. companies dropped from 8,090 in 1996 to 4,397 in 2018.
Christian Munafo, chief investment officer at Liberty Street Advisors in New York City, says a surge in private companies are deferring going public because of regulatory burdens, they’re optimizing their business models outside of the public eye and there’s already so much capital that’s been available to them in the private markets.
“Companies going public today are much more mature, with revenue growth and vetted business models. There’s been significant growth that’s been happening in the private markets that the average retail investor is not historically able to access because they’re not accredited to go into the venture funds,” Munafo explains.
Munafo says it’s important for retail investors to participate in private tech market growth. “If you’re not able to access this market growth you’re at a massive disadvantage,” he says, because much of a business’ growth is captured in the private market.
A way to solve that is for retail investors to invest in funds, such as the SharesPost 100 Fund (PRIVX). Created in 2014, PRIVX focuses on technology securities and offers retail investors access to venture capital-backed, growth-oriented private companies, typically limited to institutional investors. The fund is priced around $36 per share, with a net expense ratio of 2.5%. While its fees are considerable, PRIVX returned 22% over the past year.
There are several areas of private tech that are attracting a lot of capital. Munafo says massive capital is being invested to better optimize cloud-based applications, fintech, education, cybersecurity and health care.
Risks in Tech Investments
You may not even realize it, but you’re probably already invested in technology. Investors who own a broad-based exchange-traded fund that tracks the S&P 500 like the SPDR S&P 500 ETF Trust ( SPY) or the Vanguard S&P 500 ETF ( VOO) are invested in the sector because the funds’ largest sector weighting is in information technology, at 24%.
Tech ETFs offer a balanced way to stay invested while having exposure to the technology sector. If one company in the index were to fall precipitously, the other assets would help offset that downside risk.
But Coons warns that the problem with ETFs heavily weighted in technology such as the Technology Select Sector SPDR Fund ( XLK) is that the tech sector weighting is nearly 87%, with more than 40% of its weight in Apple and Microsoft. He says concentration risk comes into play with ETFs that have heavy weightings on tech stocks with the largest market capitalizations.
He says the way to reduce concentration risk while having exposure to tech is to find other vehicles that give you exposure to the broader tech market. He suggests looking at sector ETFs to “diversify away from the concentration that comes from FAANG stocks.” FAANG is an acronym for tech companies Facebook, Amazon, Apple, Netflix ( NFLX) and Google, which have some of the largest market caps in the stock market.
For tech investments with growth opportunities outside of the U.S., investors can consider the Emerging Markets Internet & Ecommerce ETF ( EMQQ). This ETF offers investors exposure to the growth of publicly traded internet companies in developing international markets. EMQQ holds a mix of companies among different country weightings and could be a part of a strategy to diversify away from FAANG stocks.
Coons also offers the iShares Expanded Tech Software ETF ( IGV) as a recommendation. IGV holds large-cap tech names but with lower weightings. For example, IGV holds Microsoft and Adobe ( ADBE) at about 8% each and Zoom Video Communications ( ZM) at 3%.
The SPDR S&P Software & Services ETF ( XSW), which focuses on application software and data processing, also helps to diversify investments within tech by including lower-market-cap names.
[See: 7 Best Value Stocks to Buy for 2021]
Should You Still Be Invested in Tech?
Investors may be concerned that the tech market has topped out and their opportunity to invest in the sector has passed. But given the sector’s indisputable value, experts say market participants can anticipate further momentum.
“We don’t see any reason why the continued growth of this type of innovation should not proliferate,” Munafo says in regard to the growth of tech companies.
Companies that can continue advancing will be the ones that can innovate and adapt to consumer behavioral changes. Retail companies in e-commerce, restaurants with an online presence and financial institutions that offer automated digital services will fare better in this competitive, innovative environment than companies that don’t take these measures, experts say.
Denier says every portfolio should have some sort of exposure to the technology sector because it has become an integral part of everything we do.
Now that we are living in a tech-centric world and have grown reliant on technology, people are becoming more comfortable looking at tech as a tool that provides the answers. For that reason, the tech evolution will continue.
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How to Invest in the Tech Sector in 2021 originally appeared on usnews.com
