It doesn’t matter if you look at the last three years or the last 30, U.S. technology has consistently been one of the best performing sectors in the world. Indeed, since January 1992, the S&P 500 Information Technology Index has climbed by 3,764% compared to 954% for the S&P 500 Index, while the former has outpaced the latter by 74% since January 2019, according to S&P Capital IQ.
Canadians may have, unfortunately, missed out on those gains as domestic investors may tend to own companies headquartered closer to home. Canada’s tech sector, which accounts for 11% of the S&P/TSX Composite Index, also usually has one big name at a time (Nortel, Research in Motion and now Shopify), while U.S. tech, which makes up 28% of the S&P 500 Index, has names like Apple, Amazon and Alphabet, all companies that have done well over the long run.
Over the last few years, Canadian investors and advisors have increased their exposure to U.S. tech. While many are buying individual stocks, a lot are also adding tech-focused exchange-traded funds (ETFs) to their portfolios. “At TD Asset Management Inc. (TDAM), our largest ETF is TD Global Technology Leaders Index ETF, and it's grown to approximately $1.6B in under three years," says Trevor Cummings, Vice President, ETF Distribution at TDAM.
Many people believe they are getting exposure to technology by investing in ETFs that track the NASDAQ Composite Index, the index commonly used as a proxy for technology exposure. Several low-cost passive ETFs, including the popular Invesco QQQ Trust Series 1 (NASDAQ:QQQ), offer investors exposure to a cap-weighted basket of non-financial stocks representing the NASDAQ-100 Index.
While having exposure to the NASDAQ-100 Index has served investors well so far, imperfection may exist, particularly if you are using it as a proxy for technology exposure. One issue is that it holds many non-tech stocks, such as PepsiCo, Starbucks, CSX Railway, Mondelez and AT&T.
A little context: 50 years ago this February, the NASDAQ stock market opened as a scrappy competitor to the New York Stock Exchange (NYSE), offering multiple market makers, lower listing fees and other advantages for new listees. That attracted a lot of technology startups over the years, including from what are some of the world’s largest market-capitalization equities, which now comprise roughly half of the exchange’s listings. But the other half includes companies in the consumer services, consumer goods and health-care sectors, among others.
“They might be great investments,” says Cummings, “But they don’t have anything to do with technology.”
The NASDAQ also doesn’t cover the entire tech universe. Major companies, such as Block (formerly Square), Alibaba, Taiwan Semiconductor and Twitter all trade on the NYSE. There are also several more global technology leaders domiciled outside the U.S. that trade primarily in their home markets.
Investors can buy ETFs that only hold stocks classified under the technology sector, either on the NASDAQ or multiple exchanges, but that presents other challenges. The Global Industry Classification Standard, a widely used method for assigning companies to different sectors, places Amazon and eBay in the consumer discretionary sector alongside dollar stores and fast food chains. Alphabet and Meta sit under communications, next to Disney and Comcast.
“People who use the NASDAQ (and others) as a proxy for technology exposure are accepting a bit of compromise,” says Cummings.
Pure play tech ETFs
To remedy this potential issue, TDAM launched the TD Global Technology Leaders Index ETF (TSX:TEC) in May 2019. “We wanted to offer pure technology exposure,” explains David Roode, Vice President & Director, ETF Product Strategy at TDAM.
In the months leading up to the launch, TDAM worked with index provider Solactive to create an index of over 250 global technology leaders. Using a different classification system, the Solactive Global Technology Leaders Index includes stocks in smaller tech-related sub-sectors trading on exchanges around the world.
That makes TEC a sector-specific, cap-weighted index fund that tracks the unique Solactive Global Technology Leaders Index. Investors can gain exposure to concentration in the Big Tech complex, such as FAANG1 as well as participate in the emerging themes of tomorrow.
Canadian investors have embraced TEC. Since its inception, it’s grown into one of the country’s largest technology ETFs with more than $1.5 billion in assets under management.
Exposure to innovation
As TEC was gaining in popularity, TDAM discovered that investors were also seeking a solution that provided less exposure to the mega cap companies and “more exposure to the innovative companies of tomorrow,” says Roode. What did TDAM do? They worked with Solactive to develop an index of technology innovators.
The creators of the Solactive Global Technology Innovators Index wanted to ensure that each stock had room to grow, so it placed some parameters on what could be included. Companies had to have a minimum market capitalization of $750 million and a maximum of $500 billion, revenues had to fall between $50 million and $25 billion and there had to have been a high rate of revenue growth, return on invested capital and operating margin growth. Eligible stocks were ranked on these criteria, and the top 100 names were chosen to form the Solactive Global Technology Innovators Index.
The ETF tracking this index, TD Global Technology Innovators Index ETF (TSX:TECI), made its debut last November. It too is cap-weighted, with the exception that no one constituent can exceed 10% of the fund. Though its constituents are smaller than those of TEC, its guidelines ensure that they are still substantial businesses with proven markets and histories of revenue growth.
With TEC and TECI, Canadian investors can now get undiluted exposure to the global technology sector – and for a competitive management expense ratio of 35 and 45 basis points, respectively. If you feel your portfolio is not effectively capturing the potential long-term growth opportunity of these life-shaping businesses, Cummings says, “these are two potential ways to remedy that.”
1The five prominent technology stocks that make up the "FAANG" acronym used extensively within the investment industry: Meta Platforms (Facebook Inc. Ticker: FB), Apple Inc. (AAPL), Amazon.com Inc. (AMZN), Netflix Inc. (NFLX) and Alphabet Inc. (GOOG).
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