December 19, 2013
|Josh Spencer, manager of the T. Rowe Price Global Technology Fund.|
The pace of change in the technology sector and the rapid diffusion of innovation necessitate a global search for tomorrow's technology leaders. While U.S. firms are dominant in some areas, leaders in other segments can be found in burgeoning technology centers around the globe that may become the Silicon Valleys of tomorrow. T. Rowe Price Global Technology Fund Manager Josh Spencer works with a team of analysts in North America, Europe, and Asia to find attractive investment opportunities.
Technology and change are synonymous, but the pace of innovation can pose challenges for investors. The technology landscape is littered with the remnants of once-dominant firms that did not adapt fast enough to developments. Many promising startups, on the other hand, are never able to leverage a good idea into a profitable product. And the rapid spread of new ideas around the globe can even make it a challenge to know where to invest—today's technological backwater might soon become a center of innovation.
A Shifting Global Landscape
Consider how different the global technology landscape was only a decade or two ago. The U.S. led the world in business software and services and integrated circuitry; Taiwan and South Korea were dominant in lower-end semiconductors and consumer electronics; Europe had the world's leading telecommunications equipment firms; and Japan was the center of high-end consumer goods, such as digital cameras and televisions. China was a modest player in low-end manufacturing, with only a very small domestic market for cellphones, personal computers, and other devices.
Today, China boasts over 1 billion mobile phone users, and it is the world's top market for online commerce. Leadership in consumer electronics has become more dispersed, with South Korean firms dominating the market in flat screens for televisions and computers. Europe has lost much of its market share in cellphones and other telecom equipment, but it has taken the lead in low-power semiconductors used in mobile devices.
Interestingly, the center of gravity in many other technology segments has shifted back to the U.S. in recent years. Spencer notes that U.S. firms have often seized the initiative in the transition to mobile computing through smartphones and other devices. The U.S. has also led the way in the development of what some call Web 2.0, where content on a website can be manipulated and shared by users, as in social media or networking sites. Most recently, U.S. firms have played an important role in the development of "cloud based" computing, in which data and software are stored on Internet servers rather than on site at a business or residence.
Spencer and his team see several areas around the world where firms are challenging the dominance of U.S. competitors or even taking the lead. They are also keeping an eye on what may become the Silicon Valleys of tomorrow—regions where talent, research, and funding are clustered together to nurture the quick exploitation of new ideas and markets.
Taiwan: The World's Semiconductor Leader
Investment analyst Alison Yip, who follows Asian technology firms from the T. Rowe Price office in Hong Kong, travels throughout the region to meet with managements and gain insights about products. One of her frequent destinations is Taiwan, the world's leading producer of semiconductor chips. Much of this production takes place in the Hsinchu Science and Industrial Park. Yip notes that the area has some of the characteristics of Silicon Valley, particularly in the synergies it offers local firms. The park has a complex infrastructure to support the supply chain of wafer design and fabrication, integrated circuit packaging, and downstream hardware assembly. Taiwan's chip companies have secured a particular competitive advantage in foundries, or companies that fabricate chips for others based on the client's designs.
Yip believes that the waning growth of the personal computer industry, one of the primary markets for semiconductor chips, is a key challenge facing Taiwan's technology sector. The maturing smartphone market may also weigh on chip prices. "The commoditization of hardware will gradually lower industry returns over time," Yip says. Nevertheless, some relief might be on the horizon for chipmakers in Taiwan and elsewhere in the region. The industry has seen notable consolidation in recent years, resulting in less cutthroat competition and more rational pricing models, according to Spencer.
Europe: Low-Power Chips Offer Opportunities
Semiconductor leaders with a different focus can be found on the other side of the globe. European firms have taken the lead in a class of low-power semiconductor that is increasingly important in extending the battery life of graphically intense portable devices such as smartphones and tablets. Europe also leads the world in semiconductor lithography, which uses light to etch extremely small circuits onto wafers.
Tobias Mueller, a T. Rowe Price London-based analyst who follows the region's technology firms, says that the "Silicon Fen" region around the University of Cambridge, north of London, has become an important hub for chipmakers and other technology firms. More recently, "Tech City" in East London has become a hub of innovation thanks to both the cheap rents available to young entrepreneurs and a large pool of venture capital financing.
Mueller is currently focused on companies whose business is centered on the ownership of intellectual property in the form of patents and other protections. Firms that own and license the designs for integrated circuits are one important example. "These are very capital-light business models," he explains, "which means the cash generated in the business can either be reinvested in innovation or returned to shareholders as dividends. Investors also benefit from the subscription models these businesses deploy with customers, which provides good visibility on future revenues."
China: Becoming a Leader in E-commerce
Many of the semiconductors and other technology components produced around the world make their way to China, where they are assembled into smartphones and other electronic devices. However, rising wages, increasing competition from developing nations in Southeast Asia, and greater factory automation in developed countries is threatening to undermine China's lead in technology manufacturing.
However, much of the most exciting development in the Chinese technology sector in recent years has had nothing to do with hardware or other manufactured goods. Most notably, Chinese firms have enthusiastically embraced the potential of the Internet for marketing to the nation's huge but underdeveloped consumer market. China now boasts the world's biggest e-commerce site by transaction volume, as well as homegrown (and government-monitored) firms that dominate Internet search and marketing within the country.
Consulting firm Bain & Co. recently reported that, as of 2012, nearly two-thirds of Chinese mobile users had smartphones versus slightly over half of U.S. subscribers. Not surprisingly, Chinese firms are aggressively pursuing mobile search, video, and gaming. Bain has estimated that China will become the world's largest digital market in 2013.
Intellectual Property: Key to a Strong Tech Sector
One fundamental challenge China is facing as it diversifies from traditional manufacturing into software, services, and media is the need for improved governance of intellectual property protections. Spencer and Yip believe that this is a problem shared by other major emerging markets, where it is stifling foreign investment and domestic entrepreneurship.
The lack of intellectual property protection is vexing India, as the country has struggled to develop its prowess in science and engineering education into a vibrant technology sector. After its immense investments, the nation is now wrestling with a glut of engineers, which has depressed wages. Spencer believes the nation's technology sector has also suffered from a lack of targeted investment, which has left its vast potential untapped.
Focus on the Profitable
Spencer notes that many companies, particularly those in Japan, have tried to compete in too many markets and have failed to focus on areas with the most potential for future growth. Indeed, once-dominant consumer electronics makers have struggled with remaining relevant. For example, camera makers have seen sales shrink dramatically as consumers increasingly rely on smartphones for photography.
However, Japanese firms are showing signs of change. Companies have adopted more shareholder-friendly policies, such as considering breaking up into smaller firms in order to unlock shareholder value. T. Rowe Price's technology analyst in Tokyo, Hiroaki Owaki, and his team are also keeping a close eye on firms that are poised to benefit from recent economic reforms aimed in part at boosting the competitiveness of Japanese firms.
In some cases, managers trained in Silicon Valley have helped to bring a focus on profits and shareholder value to foreign firms. Yip points to important leadership roles in the Taiwanese chip industry that have been filled by alumni of U.S. competitors, and Spencer says that some of the leading executives in Chinese Internet firms have been trained in the U.S. as well. Nevertheless, the idea of a "reverse brain drain" of foreign-born, U.S.-trained engineers and managers moving back to their home countries may be overblown. Much of this talent remains in the U.S., where career paths are clearer and free from government entanglement and other issues.
Spencer observes that one factor that sets the technology sector apart is that its products are easily—and often instantly—shipped around the globe, making it easier for the best-placed firms to dominate global markets. However, firms that rely on detailed knowledge of local consumer markets or operate within controlled markets can maintain advantages over global competitors.
Consider the media segment. Some of the world's largest Internet media firms operate in the vast Chinese market, and Spencer and Yip think they have some of the best potential for future growth. Because China is partially closed to direct foreign investment, investing in affiliated companies is sometimes necessary to access its immense consumer market. Spencer and his team have also invested in the Internet segment in Brazil, which boasts a large and growing middle class.
Despite some regional differences, the basic factors driving technology development are global. Smartphones and mobile devices are making mobile computing ubiquitous and necessitating crucial investments in network infrastructure. The vast creation of data on the Internet has created new markets for the tools to analyze it. Electronic content is proliferating into new areas, creating demand for industrial electronics and software, even as growing threats to corporate and personal data increase the need for cyber security. Finally, "cloud computing" is lowering the cost and complexity of manipulating and storing data.
Where these advances will take place is far from certain. Indeed, technology has played the key role in creating the global economy, so it is fitting that investors should search globally for the best technology investment opportunities.
The T. Rowe Price Global Technology Fund Investment Process
T. Rowe Price has been investing globally in technology for decades, and the T. Rowe Price Global Technology Fund began operations in late 2000. While Spencer manages the fund from Baltimore, he works with a team of analysts based in the firm's offices in London, Tokyo, Singapore, and Hong Kong. Members converse on a daily basis, but the team also convenes as a whole every third week by telephone—a task that requires some participants to be just out of bed in the morning while others are staying up late.
The research team approaches investment opportunities from two angles. Several analysts cover specific industries, such as semiconductors or software, while others employ a regional approach and cover a range of firms within a given area. Visiting companies and getting to know management teams is an important part of the research process, so the team's analysts travel extensively. Spencer also has a healthy frequent flyer account—he tries to visit Europe, China, Taiwan, South Korea, and Japan at least once each year, often more.
Technology stocks, historically, have experienced unusually large price swings, both up and down. The stocks in which this fund invests face special risks, such as their products or services not proving commercially successful or becoming obsolete quickly. Any foreign holdings could be affected by declining local currencies or adverse political or economic events.