The technology sector is filled with names such as Apple, Microsoft, Amazon and Facebook that are readily familiar to consumers. Semiconductor companies, though, don’t enjoy those high profiles, perhaps because they do the grunt work behind the scenes making the chips and other components that serve as the nerve centers for a wide array of glitzy devices.
“People think of semiconductors as less exciting companies in a plodding industry,” says Paul Wick, who has managed the Columbia Seligman Communications and Information fund for nearly 30 years. “But there are really a number of exciting stories in the sector.” Since 2012, the fund has allocated between 28.5% and 50% of its assets to semiconductors, according to Morningstar, well above the 11.4% to 15.9% allocation in the S&P North American Technology Sector Index over the same period.
After a disappointing 2018, semiconductor stocks were among the market’s biggest winners in 2019. By mid-November, the SPDR S&P Semiconductor ETF (XSD) had posted a total return, year to date, of 55%, more than double the return of the S&P 500 over the same period. With the tailwind of a significantly higher allocation to semiconductors and semiconductor equipment stocks than most of its tech peers have, Wick’s fund delivered a 45% return over the same period, beating the category competition by about 15 percentage points.
Despite the surge, he doesn’t think semiconductor stocks are in bubble territory. As a group, they still trade at less lofty valuations than broad market indexes, have better growth prospects than most companies and enjoy an increasingly diverse end user base that helps make them more resistant to recession. In the 1990s, personal computers accounted for 55% to 60% of global semiconductor industry revenue. Since then, semiconductors have found their way into everything from health-care devices to television sets and automobiles.
The companies in Wick’s portfolio also have strong intellectual property value and improving profit margins. They are enjoying firmed up prices and demand for their products, demand that had lagged in 2018 and the beginning of 2019. M&A has become more commonplace in the industry, and several of Wick’s portfolio companies have been acquired in the last couple of years. Still, he acknowledges, the sector could be hurt by the continuing threat of a trade war with China and the lingering uncertainty about U.S. semiconductor companies’ sales to Huawei, the Chinese telecom company.
A Different Path
The fund’s strong resolve about semiconductor strength shows its willingness to chart a course different than its peers. Unlike many tech managers, Wick is wary of what he considers extremely high valuations and investment fads, both of which run rampant in the world of technology. He often invests less than most tech fund managers in some of the indexes’ most popular stocks, or doesn’t invest in them at all. His sector weightings can vary a lot from those of the benchmark.
With his focused portfolio of 50 to 65 stocks and his top 10 holdings representing 40% to 50% of assets, his performance skews toward a relatively narrow group. Mega caps with $100 billion or more in market capitalization account for only 29.32% of fund assets, while they represent 66.84% of the index. Small and mid-cap stocks with public values between $2 billion and $30 billion, on the other hand, are heavily overweight in the fund because they tend to be less risky than small caps but have better growth prospects than mega-cap companies. They are also more likely to be acquired, and they can be undervalued because they are less followed by investors and analysts.
While the fund owns a few popular industry titans, including Apple, Alphabet and Microsoft, these don’t occupy nearly as much space as they do in the index. Wick calls Apple, which has been in the fund since 2006, “a great franchise and best-of-breed company that’s been extremely profitable.” He likes its tendency to buy back stock, which helps profitability.
Price Matters
Wick’s investment philosophy and distaste for overpaying for stocks began to take shape in 1987, when he began his career as a high-yield debt analyst at Seligman. He went on to manage the firm’s high-yield debt fund two years later, and then took over its equity technology fund after its manager left in 1989. “No one else wanted the job,” he recalls when asked why he made the transition from bonds to stocks. “It was a small fund and a big research headache.”
Within a few years, of course, the personal computer revolution would move technology stocks from the background to the forefront. Later, the internet revolution, the popularity of cell phones and widespread computerization would change the way people live and alter the investment landscape.
Through all of it, Wick never forgot that financial stability and price matter, even in the fast-paced world of tech stocks. “As a high-yield bond fund manager I had to pay attention to cash flow statements, balance sheets and profitability. That carried over when I went to the equity side,” he says.