SCHRODERS SEES YEAR-END RALLY FOR TECH SECTOR

Simon Webber, a fund manager for the Schroder Global Technology Fund, shared his views on the tech sector in a recent interview with finatiQ. The underlying fund has a five-star rating from S&P.

Vasu: Do you expect analysts to downgrade the earnings of tech companies for 2003?

Simon: Yes I expect it to happen when tech companies in the US and Europe report their third quarter earnings in October. Given the industry's overcapacity, pricing power is weak and that will impact profit margins. Expectations in some sub-sectors are still too high and will have to be revised downwards for next year.

Vasu: So are there any good reasons to be positive about the tech sector?

Simon: In the near term we are not expecting many companies to exceed expectations. However, it is important not to underestimate the number of companies in the sector that will lose competitiveness and go out of business. Over a 1-2 year period, it will result in strengthening the competitive positions of companies that remain in business. That in turn, will mean better profitability for existing players. For the Schroder Global Technology Fund, we try and buy the market share leaders and winners in each sub-sector that have a good chance of benefiting from the ongoing consolidation.

Vasu: What are the chances of a year-end rally?

Simon: There is a good chance of better performance in the fourth quarter. Seasonally, the sector has done better in the fourth quarter as demand picks up in the run-up to Christmas and companies generally clear out their budgets. This year however, the boost from company budgets may be limited. But, it may still be too early to write-off the US consumer who have seen a boost in disposable income to the tune of US$200 to US$300 billion due to mortgage refinancing. That has not filtered into the economy yet and it could surprise on the upside as we go into the Christmas holiday season.

Vasu: Will the prospects of a war in Iraq spook investors and cap a year-end rally?

Simon: The Middle East situation is an over-hang but the concerns are largely discounted. I don't think it is a key determinant in how tech stocks will perform. The critical factor is still the US consumer and how much he will spend into the fourth quarter.

Vasu: What's needed for a sustained rally in the tech sector?

Simon: Business spending accounts for 70% of information technology spending. It will take business confidence to improve before companies spend more on PCs and software. So far, it hasn't happened yet. But as companies have held back on spending in the last 12 to 18 months, there is some pent-up demand which could come through quickly if there is a pick-up in business confidence.

Vasu: Are the cash levels of the Schroder Global Technology Fund high enough to capitalise on buying opportunities?

Simon: Our cash level currently stands at about 10% and this is likely to be reduced in October as we try position the fund for a seasonally better fourth quarter performance from the tech sector. We may not see a strong rally like we did last year, but even a 10% to 20% upside from current levels will be a good return for investors.

Vasu: Semiconductors are the biggest sector in the fund. But many analysts are negative about semiconductors? What's your investment rationale?

Simon: No doubt, semiconductor price are weak. But as unit shipment improves and capacity utilisation increases, pricing pressure will ease and average selling prices should go up. In terms of sentiment towards the semiconductors, it is always darkest before the dawn at the bottom of the cycle. Sell side analysts are notorious for capitulating at the wrong time. For long term investors, they are getting much better valuations at this juncture and they are buying at close of the bottom of the semiconductor industry. In our view, long term growth for the industry should be better than the technology sector as a whole. More intelligence and functionality are being written into semiconductors and it stands to reason that more value should be attributed to the industry.

Vasu: You also have a significant exposure of about 21% to the software sector. What's the rationale for this?

Simon: We have just over 6% in Microsoft, which is a key component of our benchmark. We also have two holdings in gaming software stocks, which have done well. The gaming console story has been good for this year and it looks like it could run well into next year as well. We also have a number of holdings in the enterprise software space, which has faced some difficulties this year. But some of the stocks in the space are trading at attractive valuations. If you take a long term view that some of these stocks have sound business models and good products that are not going away, than it makes sense to buy selectively. An example is Siebel System which has a 40% market share of customer relationship management software. In my view, companies are not going to stop analysing their customers because it enhances their competitive advantage. Siebel trades at its lowest ever valuation of only 1x sales compared to its peak years of 10-15x sales and the company still has a 10% operating margin. We want to capitalise on opportunities like this and with a two year investment horizon, we think that stocks like Siebel should do well.