Capitalising on the return potential of tech stocks

Technology stocks: Highly profitable in principle, but nerve-wracking

Technology stocks have proven their long-term success. For example, an investment in the Nasdaq 100 index back in 1990 would have yielded a total return of approximately 8,500% to date, which is triple the performance of the broader S&P 500.

However, this sector is not without its challenges, as seen by the over 35% drop experienced in 2022 and when the dot-com bubble burst at the turn of the millennium. Such downturns test investor patience, and often investors lack the endurance to withstand these tough periods. This leads them to make pro-cyclical decisions that can undermine their expected returns.

Given these significant fluctuations, a key question arises: How can investors avoid the substantial interim losses that come with a long-term lucrative technology portfolio? The answer lies in dynamic asset allocation, which involves actively adjusting the tech stock weightings to suit the investment environment.

Technology companies are known for their desirable qualities, such as innovative power, disruption potential, and rapid growth. To optimally complement these, an investment style is needed that embodies the exact opposite. This includes companies with a solid financial foundation, consistent earnings, and reliable dividend payouts – known as dividend aristocrats. These firms have consistently increased their dividend payouts per share for 25 years or longer. Focusing on substance reduces risk and results in less fluctuation in the portfolio's value.

The maximum drawdown in these stocks is only about 50%, in stark contrast to the approximately 90% in technology companies.

The key to success: Shifting investment styles

Since dividend aristocrats have also achieved long-term outperformance compared to the broader market, a simple buy-and-hold investment strategy would already work. However, a combination of both investment styles is far more advantageous.

Their differing attributes result in a high negative correlation (after deducting market beta), which can be capitalised on. The key to success is a mechanism that enables switching between investment styles at the right time.

Adjusting investment strategies according to changes in liquidity and economic cycles is a promising strategy. Rising liquidity stimulates the economy, benefiting growth and technology stocks. Conversely, when liquidity decreases, investors’ need for safety increases, shifting their focus to value and quality companies.

Enhanced portfolio stabilisation through an allocation in convertible bonds

 The past has frequently demonstrated the unstoppable nature of innovation. It is therefore prudent to supplement the two primary large-capitalisation investment styles with a fixed portion of innovative, ideally disruptive, companies. This trait is predominantly associated with small-cap companies, which offer significant opportunities but usually come with higher risks. Often, early stages see inflated expectations reflected in the valuations of these companies, leading to potential disappointments that drastically affect prices over time. Consequently, Fisch Asset Management strongly believes that investing in convertible bonds is particularly advantageous in this segment, offering protection against falling stock prices due to their convexity.

Combining convertible bonds and stocks

The outcome is a strategy that capitalises on the synergies between convertible bonds (approximately 40% of the portfolio) and stocks (about 60%). Model calculations indicate that this investment strategy has historically worked very well. The historical back-test results show technology-like returns with significantly reduced drawdowns.