SCHRODERS: TECH SECTOR TO DO VERY WELL IN SECOND HALF

An interview with Grant Cowley of the Schroder Global Technology Fund on prospects for the tech sector in the second half:

Q: One of the worst hit sectors over the last year has been the technology. How would you assess the outlook for the technology sector going into the second half of this year?

After a tremendously volatile and unpredictable 18 months for technology, the second half of 2002 is likely to be a much more stable and improving environment for technology companies. Characterised by stabilisation in demand across most sub-sectors, combined with a modest level of inventory rebuilding, the aggressive cost cuts of 2001 will show through in improved earnings growth as the year progresses. 2001 taught us how cyclical technology is, and in late 2002 that fact should be a positive.

As 2002 progresses we will also witness the anniversary of the poor earnings reports of 2001, making growth comparisons in the second half particularly easy. In fact, technology is likely to post the highest earnings growth of any economic sector in the second half of this year. In the absence of a revolutionary new technology to drive growth, such as the Internet provided in the late 1990s, we believe that this agreement of a cyclical rebound in earnings is a key for investing this year.

Q: What would you cite as some possible contributing factors to the downturn of the technology sector over the past year? What in your view, will lead to a pick up in this sector?

Technology products generally have much shorter life cycles than other types of capital equipment. It has been 3 years since the huge IT upgrades ahead of Y2K, and over 8 months since the height of excess investment in Internet infrastructure. Many companies, fearful of global recession and the 11 September attacks, also became overly cautious with budgets in the second half of 2001 and were spending at an unsustainable rate. Products such as desktop PCs and enterprise networks are therefore likely to see simple replacement and maintenance demand drive an improvement in sales in 2002.

With the exception of wire line communication equipment, inventories are now quite lean right across the technology food chain, indicating that re-stocking will be a significant driver of production in 2002 even in the absence of strong end-demand. The extremely low utilisation rates in many parts of the technology food chain would see a sharp rebound under this scenario, and history has taught us that investors often underestimate the speed with which margins and earnings can recover. Despite the rebound, the current low utilisation rates mean that it will be late in 2003 before many companies can achieve a "normalised" operating margin.

Q: So how has your strategy changed? Specifically, what are some of the successful stock picks currently included in your portfolio?

Semiconductor stocks were generally the first sub-sector of technology to weaken going into the downturn, and have proven to be the best performing sub-sector so far as we begin to focus on recovery. Our strategy has been to maintain an overweight exposure to this group, and this has been of benefit to the extent that recent profit taking has been warranted, and we have been trimming positions in companies such as ASM Lithography and Xilinx, which had performed very well this year.

Q: How will you position the Fund to benefit from this upcoming growth?

We aim to invest in those companies who are demonstrating an ability to manage their cost base through the downturn. Within companies, we are looking at those with more variable cost bases. This can reduce the inevitable hit to profits in the short term, and holding the prospects that when final demand improves the operating leverage will be seen in a level of profit recovery not currently fully discounted in the market. Some hardware and equipment manufacturers, including the Hewlett-Packard/Compaq combination, stand to benefit from this.

With higher fixed cost industries the lowest cost manufacturer on a global basis have the ability to take market share whilst their competitors struggle. Companies such as Taiwan Semiconductor and Micron continue to invest in leading edge technology to maintain this competitive advantage. In order for us to gain, we therefore plan on positioning the portfolio towards companies such as these.