Encouraging perseverance: the key to successful investing in technology stocks

It’s just about a year now since the FAANG stocks – Facebook (Meta), Amazon, Apple, Netflix and Google (Alphabet) – were trading at record highs. However, this has already faded into a distant memory within the collective consciousness of investors. It is not the first time that overvalued technology stocks have experienced a hard landing. Between 2000 and 2002, following tremendous gains in previous years, the Nasdaq index collapsed by 83%. At the time, most investors headed for the exits with massive losses. Nonetheless, over the long term, technology-driven growth stocks have been the most profitable type of investment. Despite the enormous fluctuations, since 1985 the Nasdaq has achieved an average annual total return of more than 13%. This is significantly more than any of the other major indices.

Innovation and technology are the engine of growth for the economy, and thus also for financial markets. The reason for this is simple: increased efficiency. We are all familiar with Moore’s Law, which essentially states that the computing power of a microchip will double approximately every two years. Similar general laws concerning efficiency increases apply for instance to electric lighting, DNA sequencing or the price efficiency of solar cells. These efficiency gains mean that nascent companies win market shares from competitors, build up new markets, become more organisationally efficient and can enhance growth by employing their capital. As such, and with the benefit of hindsight, a ‘buy and hold’ allocation to household-name technology stocks has, and should, prove very lucrative for investors.

However, there are two particular problems with such a view. First, one has to consider survivorship bias, as not all investible companies, by any means, have survived until today. This is particularly true of the small and mid-cap area. Second, today’s end point in terms of the return conceals a myriad of disappointments. For instance, between 1999 and 2001 an Amazon investor would have had to take on the chin a temporary loss of more than -94%, and even Apple lost around 80% of its value between 1992 and 1997. This year, Netflix has lost around three quarters of its share value. Although an investor in this stock would still have received annualised returns of more than 34% over the last 20 years, hardly any investors have stayed the course during these fluctuations.

The issue of perseverance was considered in another form as early as the 18th century by mathematician and physicist Daniel Bernoulli. Simply put, the value of an asset is not determined exclusively by its price, but rather by its utility. This is based on the circumstances of the person making the judgment, and thus also incorporates subjective risk aversion and a mostly asymmetrical perception of losses. As a consequence, this reduction in perceived utility caused by the volatility of technology stocks erodes the conviction that one should stay the course, even though from a purely financial perspective “perseverance” would seem to be the optimal choice over the long term. This is confirmed by current market dynamics.

It is therefore interesting to be able to address two particularly salient investment-related issues: First, there is the increased risk associated with small and mid-cap stocks: although these provide good returns if the company is successful, not all market participants enjoy success. Second, it is difficult to persevere with investments in technology stocks. While they generate strong returns in the right environment, they are also vulnerable to drops in value during periods of economic contraction. In our view, a sensible solution is to combine innovation-focused small and mid-caps with equities of both major technology companies as well as dividend-paying blue chips. When allocating between the different segments, efficient management of the global liquidity and economic cycle is crucial in achieving success.

When it comes to the implementation, convertible bonds are a great option for allocating investments into small and mid-caps. Thanks to their inbuilt airbag in the form of the associated option and the resulting convexity, they make investing in smaller, more volatile companies more feasible by limiting the risk of loss.

The second part of the implementation involves large-cap stocks. Here, it is important to take the liquidity and economic cycle into account when managing the equity component, as centrally created liquidity in particular leads to rising prices of financial assets. By astutely incorporating statistics, it is possible to adopt a focused position either in growth stocks or in defensive quality-dividend stocks respectively – to encourage perseverance and maximise long-term performance.