Technology Mutual Funds and ETFs alike are becoming increasingly prevalent across multiple industries in the rapidly-changing investing landscape. When it’s time to make investment decisions in your 401k, IRA or brokerage account, these funds are inching their way into view and are generally associated with high growth and above average volatility. But, after all, so many companies identify as “technology companies” now, so what companies are these funds actually comprised of, and how do you choose the right one?
The ultra-wide umbrella of “Technology”
When prospecting tech funds, the first thing you should do is familiarize yourself with the various sub-industries that all fall within the “technology” umbrella. Computer hardware manufacturers have a much different cost and revenue model from a cybersecurity company, for example, and can be subject to entirely different risks.
A small subset of the common categories are listed below. Note that some of these have blurred lines and could share commonalities with other categories. See if you can name to yourself a company that would fall under each of these.
- Technology Services
- Computer Hardware Manufacturing
- Cloud Computing
- Consumer Electronics
- Software as a Service (SaaS)
- Platform / Marketplace
- IT Services
- Enterprise Software
As you can see, there is a vast array of categories, all with their own cost structures, macroeconomic factors, revenue models, risks, etc that ultimately fall under the tech umbrella. When you are evaluating a mutual fund’s holdings, take note of which categories the majority of the holdings would fall under. This will help you establish an initial understanding of the fund structure from a perspective of risk and correlation between companies.
The difference between growth and value still applies
Tech companies have historically been labeled as growth opportunities, generally due to perceived scalability and the fact that a significant number have been founded just within the last 20 years, but it’s important to take a step back here and make an additional effort to read between the lines. While the difference between growth and value investing still applies for technology companies, the industry can be extremely volatile and fast-changing.
What this means is that young “growth” companies can see their technology become outdated almost overnight. On the same token, some companies that have been around for 100 years can continuously expand into newer niches with fresh market potential. What may have been considered as a “value” play by traditional standards can quickly become a growth opportunity. This means that when evaluating funds from this perspective you will want to first double check the prospectus and holdings, and then try to familiarize yourself with some of the key revenue drivers for the companies to form a general idea of what some of the companies are investing their resources in.
Know your benchmark
A benchmark is a standard that you can measure performance against. When evaluating the performance for general mutual funds (say a large-cap value or small-cap growth), typical benchmarks are the S&P 500 for funds with larger companies, Russell 2000 for funds with small-cap companies, and the Wilshire 5000 for a better benchmark of “the entire market”. For bonds, the Barclays Capital U.S. Aggregate Bond Index is typically the benchmark.
What about technology? Since these funds will often have a mixture of small-cap and large-cap companies in industries across the board, what is an appropriate benchmark? You’ll find that the benchmarks these funds track against vary considerably. One common index you’ll see funds benchmarked against is the Morgan Stanley Capital International All Country World Index (MSCI AWCI). This is a diversified index that tracks companies from approximately 23 developed countries and 23 emerging market countries and is widely considered as the broadest global equities index. Other indexes may be industry specific, like the MSCI Telecommunication Services and MSCI Software and Services indexes.
No benchmark is necessarily “wrong” or “right”, but when allocating your hard-earned capital it’s important to know what companies, industries and countries it is being measured against. This will give you a better idea of what performance the fund managers are aiming for.
Don’t forget the mutual fund fundamentals
This part is crucial. Regardless of the benchmark or specific industry, you are still investing in a mutual fund – don’t forget to review the important pieces.
As we have discussed, there are no one-size-fits-all “technology” benchmarks, so passively-managed technology funds are typically hard to come by. As a matter of fact, at the time of writing in May 2020, googling “passively managed technology mutual fund” does not even return a single direct match. This means that virtually all of the tech mutual funds are actively managed, so what does that mean?
Fees. While the average expense ratio for a passively managed index fund is currently hovering between 0.1% – 0.3%, the average expense ratio for technology mutual funds typically falls between 0.5% – 1.3%. This is a significant difference that can start to chip away at your returns, making it even more important to know where your money is going. There are also the other fees such as 12(b)-1 and load fees to watch out for.
We get it – the point of a mutual fund is to achieve diversification while eliminating the need for heavy research into each separate holding. But with a few hours of effort spent conducting your normal mutual fund due diligence in addition to dissecting these funds to learn more about the specific industries these companies operate in, you can hopefully become more comfortable in where exactly your money is going. And you may learn something cool along the way