SINGAPORE (July 1): On May 16, trade tensions between the US and China escalated to a new high when the former announced that Huawei Technologies was placed on the Entity List. Essentially, this means the Chinese company is subject to licence requirements for exports, effectively barring it from doing business with US companies. To soften the blow on US companies and smartphone owners, the prohibition is only set to take effect after a 90-day grace period. Yet, the conflict could worsen.
Interestingly, though, all of the technology funds available to Singapore investors have done remarkably well so far this year, despite the rising tensions between the US and China. All of the funds recorded double-digit returns above 20%, according to Morningstar data, outperforming the technology-heavy Nasdaq Composite Index’s 18.8% and, for most, the MSCI All Countries World Information Technology Index’s 22.4%. In fact, technology funds are among the top year-to-date performers in the Singapore fund universe.
One reason for the outperformance is the low base from which the returns are measured, says Richard Clode, co-portfolio manager of the Janus Henderson Horizon Global Technology fund. “After a very tough market in 4Q2018, the starting point was low, and the big relief has been the US Federal Reserve’s [decision to keep interest rates unchanged and possibly cut them],” he says. “The trade war just hasn’t affected the fundamentals of most of the tech sector.”
The right stock picks have also contributed to the outperformance. Clode says his fund’s thematic plays in process automation and foldable displays, as well as avoiding “certain large-cap names”, have paid off. Contrarian positions in social -media and networking companies have also worked well, he adds.
By using thematic overlay, Clode says he is able to identify technology trends that provide superior growth, followed by finding high-quality companies that can generate higher-than-expected earnings. “We do that across the spectrum, so we do not ignore stocks that are not as exciting or [reflect] high growth, but can also exhibit unexpected earnings growth and deliver strong stock returns as a result,” he says.
At Franklin Technology Fund, stock selection in system software has borne fruit, says portfolio manager Jonathan Curtis. This includes ServiceNow, which helps businesses manage digital workflows; Twilio, which helps businesses connect to customers via digital channels; and zScaler, which helps enterprises secure their assets as workloads transition to the cloud and employees become more mobile.
“We believe the big opportunity in technology is digital transformation. Digital transformation is about enterprises employing data and software to better understand their customers and business processes,” says Curtis. “While we are confident in our thesis, a slowing macro environment will negatively affect all portions of the market. That said, we believe that investment in themes we have identified will remain robust, regardless of the macro environment.”
Portfolio rebalancing
Nevertheless, the ban on Huawei is a massive concern for technology fund managers. Although Huawei is not a publicly traded company, the restriction imposed on the world’s largest supplier of telecommunications equipment and second-largest mobile phone manufacturer by volume is expected to have repercussions elsewhere.
About 60% of Huawei’s devices — many of which use chips from Intel and Broadcom and glass from Corning — are sold outside China. These companies have suspended shipments to Huawei, and other US suppliers such as Qualcomm and Texas Instruments, as well as software developers such as Oracle and Microsoft have also suspended shipments, pending guidance from the US Commerce Department’s Bureau of Industry and Security. Companies outside the US are considering how to respond.
“The US-China trade [tensions] create near-term demand challenges for certain semiconductor companies with high exposure to Huawei. In addition, there are risks for semiconductor capital equipment vendors as China seeks to build its own semiconductor industry. [This includes] risks for US hardware companies [that] build their products in China and need to import them into the US,” says Curtis.
Against this backdrop, many technology funds have rebalanced their holdings to minimise risks. For instance, Aberdeen Standard Global Technology Fund has reduced its exposure to Taiwan Semiconductor Manufacturing Co (TSMC). Holdings in the company were reduced to 3% at end-May from 4% at end-April this year, according to the fund’s monthly factsheets. As a result, TSMC, which was previously the fund’s top fifth holding, has fallen to top 10 holdings. The fund also sold Texas Instruments, which is not among its top 10 holdings.
According to Andy Brown, investment director of global equities at Aberdeen Standard Investments, the fund cashed out from both companies as their near-term outlook has become “less appealing”. “With the cash, we topped up Manhattan Associates, Mastercard, NICE Systems, Microsoft and Experian, which are all relatively insulated from the trade war and where the outlook is relatively more appealing,” he tells The Edge Singapore. The fund also added Nvidia Corp, China-headquartered Autohome, FANUC and Altium. Overall, the fund’s exposure to US companies has increased to 51.3% from 50.5%, while holdings of Chinese companies have been reduced to 8.2% from 9.1%.
Deal or no deal?
The risk now, of course, is retaliation from China. On May 20, Chinese President Xi Jinping visited a rare earth plant in Jiangxi province, fuelling speculation that China’s dominance of global rare earth production could be used against the US. Rare earth minerals are used in products ranging from Apple’s iPhones to Lockheed Martin’s F-35 stealth fighter.
All eyes will be on the G20 meeting, which will take place in Osaka on June 28 and 29. US President Donald Trump and Xi have confirmed that they will be meeting on the sidelines of the summit. Trump has said that a trade deal with -China could include Huawei, but he did not say how. While market observers are not expecting an agreement to be reached at the summit, neither are they expecting an escalation.
In any case, fund managers who spoke to The Edge Singapore say they will be on their toes. “We are monitoring the situation and the broader US-China trade war very closely. China may retaliate with its own list, which could result in potential shifts in market dynamics,” says Pam Hegarty, portfolio manager of the Parvest Disruptive Technology fund and senior equity analyst at BNP Paribas Asset Management.
“On the other hand, any thawing of the trade tensions could lead to a broader resolution of intellectual property concerns. The fact that implementation of the ban was delayed by 90 days may be a sign that it is a negotiation tactic,” she adds. Moreover, Hegarty notes that US companies are pressuring Trump to reach a deal. An open letter addressed to Trump, dated May 20, was signed by 173 companies, including Nike and Adidas.
Still, could the US blacklist more Chinese technology companies? After all, the US had added “a few small Chinese supercomputing companies” to the Entity List as at June 21, according to Hegarty. If more companies were put on the list to the point that both the US and China are banning each other’s technology companies, end-demand would be affected, she warns. “In this situation, we may adjust the portfolio to be more defensive, but not necessarily reducing exposure to China,” she says.
As at May 31, the Parvest Disruptive Technology fund’s China exposure, which is the third highest, stood at only 4.82% of its portfolio. This compares with its US exposure, which is the highest, at 77.55%. Of the top 10 holdings, most comprised US companies and none are Chinese companies.
