Could there be a role for tech ETFs in your portfolio?
In early 2021, tech stocks were booming, SPACs were spiking, and people were piling in, chasing returns. As the weather warmed and the pandemic waned, the momentum returned to earth.
Is the downturn a needed dose of reality, or does it represent a buying opportunity for those who sat on the sidelines when tech was all the rage? I won’t attempt to answer that question; I’ll defer to an insider who is quite knowledgable on the topic, Sylvia Jablonski, who authored the guest post that follows. We have no financial relationship.
Sylvia Jablonski, Chief Investment Officer of Defiance ETFs, manages Defiance’s retail and institutional investment research, capital markets and thematic ETF model portfolios. Acknowledged as a top expert in the ETF space, Sylvia is frequently featured on CNBC, Bloomberg and the Wall Street Journal.
FIRE Investors are looking for financial independence and early retirement. While their foreseeable income may be fairly fixed, their particular investment decisions could help make the percentage difference that accumulates over time towards an earlier retirement or larger retirement income.
In the current climate of high equity valuations and historically low-interest rates, many turn to the stock market to maximize their investments and grow their wealth. This article will explore how technology ETFs – products such as 5G ETFs, SPAC ETFs, biotech or next-generation quantum computing, and machine learning funds – can play a role in a successful FIRE investment plan.
Starting with the basics, ETFs, in general, tend to be passively managed, meaning that they have lower fees than actively managed funds or plans. Most FIRE adherents seek to maximize their gains by pursuing a low-cost investment strategy built around index funds.
Such funds follow an index, perhaps of the whole S&P, and their constituents change according to those of the index. They are transparent, heavily weighted towards equities, and are self-managed. This means that the investor has access and agency in administering the fund. (S)he avoids paying 1% to an advisor on top of the fund’s management fees, which can divert funds and delay retirement.
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Index-linked ETFs come a long way in meeting a FIRE investor’s priorities. They are passively managed, usually with relatively low associated fees, accessible, liquid, and tradeable for the individual investor to manage themselves. They usually include several stocks, thereby diversifying exposure and mitigating the risk of overinvestment in any single stock.
The question, therefore, becomes, what are the best sorts of ETFs for a FIRE investment portfolio?
Indices that mirror the whole stock market are generally considered a sensible part of a long-term investment strategy. Indeed, a typical FIRE portfolio might balance indices of U.S. equities, international equities, and U.S. bonds. However, adding some exposure to sectors or themes within the market can open the investor to the potential returns of long-term structural trends.
Investment capital has been pouring into technology stocks for a long time. The graph below shows what companies investors and traders believe will grow most over the next five years – the success of four of the top seven are directly linked to their development of new technologies (Tesla, Apple, Microsoft, Google). The other three’s success is intrinsically linked to their effective exploitation of cutting-edge technologies – Video streaming (Netflix), social networking (Facebook), online retail, and cloud computing (Amazon).
We see from this graph that it is actually a little misleading to call technology a theme or sector. Technology pervades all aspects of our lives, from leisure and cooking to fitness, communication, work, industry, health, and travel. Any industry looking to grow must engage with how technology can support and enhance its business.
That’s where technology ETFs can capture the growth in some of the most dynamic sectors of the market. They focus on companies involved in developing or producing the technologies that will define the future.
Take 5G, for example, the tech innovation and infrastructure that will provide faster speeds, more functionality, and lower latency in mobile communications. Five years ago, it still seemed like a far-off dream. Now 5G networks have been launched by 113 mobile operators in 48 countries.
South Korea was the first to launch a national network in 2019 and had 12 million subscribers by 2020. In the US, the government threw its support behind 5G. By the end of January 2021, PwC reported that US mobile operators had collectively covered 75% of the country with 5G service.
The full implications of the 5G rollout are yet to be felt. But its ultra-fast speeds, low latency, and network slicing capacity are expected to support remote mission-critical services, smart cities, and the internet of things, to name just a few.
5G has the potential to transform the way we live, work and pursue leisure. A 5G ETF captures the growth across the whole 5G ecosystem, from the semi-conductors needed for the cell phones to the real estate needed for the required urban networks of receptors to the telecom companies themselves. An investor who sees the future of 5G as the enabling technology for fundamental change and growth can express that vision in a 5G ETF.
Next-Gen Quantum Computing (QC)
Commercial QC is still in its nascent stages, but software developers can already access quantum advantage via the cloud. QC’s unprecedented ability to process and analyze thousands of possibilities simultaneously promises significant breakthroughs for industries relying on simulation, optimization, and sampling. Machine Learning (ML), a branch of artificial intelligence, could be transformed by its alliance with QC. The process of a computer looking at patterns, asserting a hypothesis, testing those conclusions, and then improving its hypothesis could be exponentially improved, paving the way for robotic personal assistants, driverless cars, and business-enhancing big data analysis.
QC is a hotbed of competition for tech giants such as IBM, Honeywell, Google, and Microsoft and smaller quantum pure-plays such IonQ, which recently reverse IPO-ed in a $650m deal.
Again, a quantum computing ETF or machine learning ETF can articulate an investor’s confidence in this sector’s future without overexposure to any one particular company. The ETF could encompass the whole next-generation computing space from hardware to software to big data management solutions. Defiance ETFs’ next-gen quantum computing ETF has risen in value by over 100% over the past year.
A SPAC ETF offers a slightly different approach to the other tech ETFs, but according to the same principle, it still holds the potential to contribute to a FIRE investment strategy. SPACs (Special Purpose Acquisition Companies) are formed to take other (often technology) companies public.
They help the target business IPO more quickly, smoothly, and easily, helping it take advantage of market momentum and access much-needed capital, often before it has made a profit. SPACs have been known to provide a leg-up to highly innovative companies – examples include Virgin Galactic, DraftKings, and OpenDoor – and as such can provide great returns for their early backers.
SPACs have disrupted the monopoly of the traditional, cumbersome IPO process and a spac ETF offers investors exposure to these systemic shifts. The graph below shows how this happened gradually over 2020; this year, a new SPAC is formed every 5 days, and SPACs have already raised over $38 bn, which is more than in the whole of 2019.
Goldman Sachs has suggested that SPACs could generate more than $700 bn in acquisition activity over the next two years.
The SPAC boom is changing how companies do business and raise capital. Market forces push SPACs to identify companies with strong growth potential, but not all will see growth like Tesla or Draftkings. That’s where a SPAC ETF can function to express confidence in the space while mitigating the risk of any individual SPAC deal.
Diversified yet targeted exposure
Tech ETFs can complement a balanced portfolio of investments geared towards financial independence and early retirement. Imagine if you had bought an automobile ETF 120 years ago or an internet ETF thirty years ago. It is not possible to know which specific companies will come out on top, but the sector’s confidence as a whole is clear. As ETFs target the most liquid, promising businesses in the space, they offer diversified yet targeted access to some of the trends and technologies that are likely to define the coming decades.
Tech ETFs can give FIRE investors low-cost, liquid and diversified exposure to the digital trends that could shape our future.
What are your thoughts? Have you diversified your investment plan with tech ETFs? What has been your experience with these investments?