Have we hit a point where the dominance of tech firms ceases to be an opportunity for investors and instead becomes a threat, asks Jeff Salway. And how could this impact fund portfolios?
They have billions of users, are collectively worth more than $3.5 trillion, and play a role in the daily lives of people all over the world. They are also in the sights of lawyers, regulators and politicians on both sides of the Atlantic – a challenge that could leave a dent in millions of investment portfolios.
The dominance of the four US technology giants – Apple, Amazon, Facebook and Google – was one of the most enduring stories of the last decade. Their combined market value, with Netflix and Microsoft added, now exceeds that of all the companies in France, Germany, Spain, the Netherlands and Italy put together, and they feature heavily in the portfolios of funds held by investors and pension savers.
In early 2020 Google’s parent Alphabet became the latest tech behemoth to hit $1 trillion (£760 billion) market capitalisation, following in the footsteps of Microsoft, Amazon and Apple.
Gathering storm clouds
But that milestone arrived amid gathering storm clouds. Concerns over data and privacy have prompted regulators and politicians belatedly to get to grips with the ethical and moral implications of the data revolution. Big tech now faces a range of legal and political challenges, including antitrust probes in the US and Europe, investigations by dozens of US states, tighter data privacy laws and growing consumer awareness of the value of their data.
“Just like other life-transforming technologies of the past, today’s tech giants are reaching maturity – that transformation from fresh, innovative company to overgrown, sometimes mistrusted hulk,” says Sanjiv Tumkur, head of equity research at Rathbone Investment Management.
Which begs the question: at what point does the dominance of Big Tech cease to be an opportunity for investors and start to become a threat?
Facebook has been in the headlines more for bad reasons than good over the past couple of years. Most notably, the Cambridge Analytica disclosures in 2018 landed the company with a $5 billion (£3.8 billion) US Federal Trade Commission (FTC) fine. Yet Facebook’s share price still reached an all-time high in early January 2020, taking the stock valuation up to $622 billion.
It’s a similar story with Google. The search engine giant has already incurred three European Union fines related to antitrust and competition rules, including a record €4.34 billion (£3.67 billion) in 2018 for using the Android mobile operating system to block rivals. It was also fined $170 million (£139 million) in autumn 2019 by the FTC, for allowing YouTube – which it has owned since 2006 – to collect data on children under 13 without parental consent.
Meanwhile, Amazon is among the defendants in wide-ranging FTC and US Congress probes, and in a formal EU investigation against potentially anti-competitive practices, among other ongoing inquiries.
For all their power, none of these companies is immune to scrutiny or to the fall-out that could follow. Spencer Adair is joint deputy manager of Monks investment trust, which includes Alphabet among its biggest holdings and so gives him access to Google’s management. “Fines make a difference, but companies like Google have also realised just how open to manipulation any open platform can be,” he says.
Recent changes to practice include allowing phone manufacturers to install any apps of their choosing alongside Google apps, and making Android users aware of other browsers they can use. Some of these developments also reflect artificial intelligence advances that allow them to screen out dubious content.
Business models across the sector are also changing, with a greater emphasis on transparency. “The next generation – the likes of Netflix and Spotify – are much more about fee-for-service: pay to subscribe and we won’t advertise to you,” Adair explains.
“The economics is upfront and central. You then saw Google, Facebook and Amazon realise that on some issues people want more privacy of data. They have matured and been influenced by the blunter business model of the next generation.”
Legal changes have played a role too, with the EU’s General Data Protection Regulation (GDPR) helping to ‘raise the bar’ in terms of how people think about their data and who owns it.
Political scrutiny of tech company practices is expected to intensify ahead of the US presidential elections in late 2020. “The risk has risen, not diminished, and with the US election this year big tech will become a target of political rhetoric, particularly when you consider the impact of a company like Amazon on ordinary US businesses and consumers,” says Thomas Becket, chief investment officer at Punter Southall Wealth.
Increased political attention is unsurprising – governments now spend vast amounts on extending internet access to their citizens, and so have a much greater interest in how these networks are used and who profits from them than even a decade ago.
So is there any real threat to the big tech giants and to the case for investing in them? Remember, of course, that these companies aren’t simply held by dedicated technology funds. If you hold some form of global growth fund or investment trust in your Isa or through a pension, chances are that you have at least some exposure to them.
The threats posed by antitrust investigations include that of a company being broken up. While President Trump has at times been vocal about wanting to rein in tech companies, the attorney general in charge of preparing the order to investigate antitrust violations, Jeff Sessions, has since resigned.
Antitrust debate not going away
But Tumkur doesn’t see the antitrust debate going away any time soon. “We think the ubiquity and necessity of the internet to society means those companies that dominate in the digital sphere will inevitably come in for greater scrutiny,” he adds, pointing to Facebook’s move to beef up its antitrust law expertise by hiring the chief of the Department of Justice’s San Francisco antitrust division.
The biggest risk to a company is something that affects its culture and how it operates – anything that impacts on long-term profitability. “So you need to look at the drivers behind that profitability,” says Adair. Google has historically behaved like a private company, he explains, reflecting its ownership by the founders, which meant they didn’t need capital and so didn’t have to listen to the concerns of minority shareholders.
Investors who don’t believe these companies are vulnerable to far-reaching regulation or that they could be forced to change their business models might be too complacent, according to Becket. “In this environment, with questions around certain companies’ actions during the last US elections, it could become very political, and the risk of actions impacting on profitability is probably higher than most investors expect,” he says.
He can also see a scenario where the investment case for the likes of Apple, Google and Facebook weakens because of the pricing fundamentals. “They have benefited from passive investment flows and you can make the case that some of these stocks are starting to look expensive. Apple’s share price has doubled year after year, even when earnings have fallen. If we see reduced passive investment flows to tech companies, US growth starts to lag, and at the same time people are questioning these firms from an ESG perspective, we could see strong headwinds for them.”
Tumkur is less convinced. “Clearly if regulation were to significantly hurt that future growth, then this could cause some wobbles, but we suspect such regulation would reduce the advantageousness of their positions and growth potential, rather than destroying it completely.”
In other words, investors can expect evolution rather than overhaul, as tech companies respond to the demands of politicians and regulators desperately play catch-up. It would still pay to be vigilant though, says Becket. “I’m not saying that investors shouldn’t hold positions in these companies, but try to find managers that take a very selective approach to them – the ones that are willing to pick stocks on their merits and not just because they are a big part of the benchmark.”
US big tech firms are not resting on their laurels
The world’s five most powerful technology companies are exploring uncharted territory.
Facebook and augmented reality
Facebook’s AR platform will turn an ordinary building into a virtual street art installation and everyday objects into “otherworldly experiences”. It will deliver accessibility to experiences normally too expensive in the real world.
Google and artificial intelligence
Google’s AI efforts are driven by the realisation that computers should adapt to how people live their lives. Google’s automated Gmail responses have seen usage reach beyond 12% of its email user base.
Amazon banking and finance
Amazon is partnering with Bank of America in its merchant lending programme. The e-commerce giant already offers a range of financial services including Amazon Pay, Amazon Lending and Amazon Cash.
Apple and the experience economy
Apple is inviting customers to visit retail locations to partake in ‘Today at Apple’ sessions, which not only teach customers to use its tech but also encourage art, music, photography and design exploration.
Microsoft and Blockchain
In May 2018, Microsoft announced the Azure Blockchain Workbench, a suite of tools for developers to create blockchain products in days instead of months, all hosted on its cloud computing platform.