2023-04-14 13:27:26 ET
Summary
- Despite the 2022 bear market in technology, the Fidelity MSCI Information Technology ETF has a five-year average annual return of 18%-plus.
- The FTEC ETF carries a 5-star Morningstar rating and has a relatively cost-efficient expense ratio of 0.08%. The fund is up ~10% since my BUY rating in January.
- Top holdings include Microsoft, Apple, Nvidia, Visa, and Broadcom. Earnings reports since my last update on FTEC show how resilient these companies are.
- The declining U.S. dollar makes FTEC an excellent choice for investors who are underweight technology stocks and want to add exposure to the sector.
As many of you know, and despite the narrative painted by many investment professionals over the past year, the technology sector has significantly outperformed YTD. Indeed, as measured by the State Street Sector SPDR ETFs (see graphic below, courtesy of Seeking Alpha ), the Technology and Communication Services Sectors are tops so far this year - and by a wide margin. In my opinion, the technology sector is the sector for the 21st Century and all investors should have a healthy exposure to the sector - which includes a heavier weight than that of a standard S&P 500 ETF. That being the case, investors should consider the Fidelity MSCI Information Technology ETF (FTEC), which is +20.6% YTD and up ~10% since my last Seeking Alpha update in January (see FTEC: Fidelity's Tech ETF Is Solid & Defensively Positioned ). The two major factors for the out-performance is continued earnings and free cash flow resilience and the tailwind of a falling U.S. dollar (see "Risks" section).
Seeking Alpha
Investment Thesis
The fundamental drivers supporting the technology sector are both well-known and powerful: 5G smartphones and infrastructure, high-speed networking, migration to the cloud, the EV and clean-energy transition, the internet-of-things ("IoT"), data centers, semiconductors, and hardware accelerators to run AI/ML algos on mega-data sets - to name just a few.
All of these technology sub-sectors help to boost productivity and make companies in all other sectors more efficient and profitable. That being the case, and as mentioned earlier, investors - who want to build a well-diversified portfolio and hold it for the long-term and through the market's ups-n-downs - should consider having an over-weight position in the Technology Sector. There are obviously various ways to do this: owning individual tech stocks, owing well-diversified tech ETFs, or owning both (as I recommend).
With that as background, let's take a look at the FTEC ETF to see how it has positioned investors for success going forward.
Top-10 Holdings
The top-10 holdings in the FTEC ETF are shown below and were taken directly from the Fidelity FTEC ETF webpage where you can find more detailed information on the fund.
Fidelity
As can be seen in the graphic, the FTEC ETF is a relatively concentrated fund: The top-10 holdings equate to 62% of the entire portfolio with a whopping 40.7% of assets allocated to just two companies - Apple ( AAPL ) and Microsoft ( MSFT ). The point here is that if you already have large positions in either of these two stocks, you might want to look elsewhere for technology ETF for diversification reasons. On the other hand, if you are relatively under-weight these two companies, or simply want to increase your exposure to them, the FTEC ETF deserves your consideration.
Both Apple and Microsoft are well covered on Seeking Alpha so I won't go deeper into either company other than to highlight some financial aspects that show how cash rich these two companies are:
- Microsoft ended its Q2 FY23 (calendar Q4) with $99.5 billion in cash and cash equivalents. That's an estimated $13.32/share in cash based on the company's 7.47 billion shares outstanding. During Q2, Microsoft Cloud revenue gained 22% yoy (26% on a constant currency basis).
- Apple ended Q1 FY23 with $30 billion in cash. And it's important to note that cash balance was after returning a whopping $25 billion to shareholders via dividend payments and share buybacks during the quarter.
Nvidia ( NVDA ) is the #3 holding with a 6.1% weight. Nvidia stock has been on a tear this year after an arguably over-done sell-off last year. Much of the run has likely been fueled the market's recognition that the company has emerged as a leader in AI. Indeed, Nvidia has left the rest of the tech-sector in its dust this year:
While many investors are well aware of Nvidia's high-performance compute solutions, the company also has arguably become a leader across multiple AI disciplines as well: From generative AI, to training on large language models ("LLMs") to data analytics, inference, and cybersecurity solutions to make sure AI pipelines are protected against threats:
The FTEC ETF has ~6% allocated to the top-two credit card processors Visa ( V ) and Mastercard ( MA ). Despite fears of a recession, these two companies have held up relatively well (+9.1% and +4.1%, respectively) over the past year.
Mastercard made Morgan Stanley's list of " top-30 picks for 2025 " with the rationale:
MasterCard is likely to be a key player in the evolution of B2B payments over the next 3-10 years.
Morgan Stanley has an Overweight rating and a $438 price target. Mastercard closed yesterday at $369.65.
One of my favorite tech stocks, Broadcom ( AVGO ), is the #6 holding with a 2.3% weight. As my followers know, the heart-and-soul of Broadcom is its high-speed networking development platform (both hardware and software) that always keeps the company's products on the very leading edge in that sub-sector (which, of course, is where the high-margin is). As I pointed out in a Seeking Alpha article in February (see Datadog And 2 Other Sure-Fire Winners In The AI Arms Race ):
The company has sold out its entire capacity at the beginning of FY23 - something the company also did in FY21 and FY22. And, unlike most companies in the technology sector, AVGO's strong FCF profile has enabled it to become one of the best dividend growth stocks in the entire S&P 500. AVGO currently pays an $18.40/share annual dividend.
Indeed, in Q4 AVGO raised the quarterly dividend by 12% to $4.60/share. It was able to do so because for full-year FY22, Broadcom generated $16.3 billion in free cash flow (a very impressive 49% of revenue). With a forward P/E of only 15.1x, a 2.9% yield, and a very strong backlog, AVGO is a steal here.
The top-10 holdings are rounded out by Adobe ( ADBE ). Adobe is incorporating "Firefly AI" - which it advertises as a new family of generative AI models - into its products in order to allow customers to more easily edit images. Adobe stock is down from a high of near $690 back in November of 2021 to the current $378 (-45%) yet still trades with a relatively rich forward P/E of 24.6x. However, last month Adobe announced its Q1FY23 earnings and it was a beat on both the top and bottom lines . Revenue of $4.7 billion (a record) was up 9.4% yoy and the company bought-back 5 million shares of its stock during the quarter.
Performance
As mentioned earlier, the FTEC ETF has an impressive long-term performance track record, delivering a life-of-fund (since inception in October 2013) average annual return of 18.7%:
Fidelity
The following graphic compares the five-year total returns of FTEC with some of its technology peers: the SPDR Technology Sector ETF ( XLK ), the Nasdaq-100 Trust ( QQQ ), and the Vanguard IT ETF ( VGT ):
As you can see, the FTEC ETF has delivered a 126% gain over the past five years, trailing the XLK ETF by ~12.5% but beating the QQQ's by nearly 21%.
Risks
Most of the companies in the FTEC portfolio have global brands and therefore generate significant revenue from overseas. That being the case, the fund has above average foreign currency exchange risks. Indeed, the YTD rally in FTEC is due, in part, to the weakness of the U.S. dollar as investors consider that the Federal Reserve is likely close to the end of its interest rate increases:
MarketWatch
As noted earlier, revenue at Microsoft's cloud business was +22% yoy, but up a more impressive 26% on a constant currency basis. That is, MSFT had a 4% FX headwind for one of its primary growth drivers. With the falling U.S. dollar this year, that headwind is not near as severe going forward.
In addition, the companies in the FTEC ETF are not immune to a slowing global economy and the impact that high inflation is having on consumers. That said, most of these tech companies are cash rich and continue to generate strong free-cash-flow - the combination of which means that they are in a strong position to weather a mild recession.
FTEC has a 30-day SEC yield of only 0.81%. So, for all the investors out there whose primary (or only ...) investment consideration is yield, let me be clear: The main investment thesis in the FTEC ETF is capital appreciation, not income.
Summary and Conclusion
The FTEC ETF is a 5-star rated fund with a relatively cost-efficient expense fee (0.08%). The fund has an excellent performance track record since its inception in October of 2013: An average annual of 18%+. While the fund is arguably over-weight in Apple and Microsoft, given the current environment, it's probably not a bad bet to allocate ~40.7% of the fund into the two tech heavyweights that are cash-rich, continue to generate strong free cash flow, and continue to reward shareholders with dividend growth and stock buybacks. FTEC is a BUY and should be considered as a core technology holding for investors that want to build a well-diversified portfolio for the long term.
For further details see:
FTEC: Fidelity's Tech ETF Is Going Higher On Lower U.S. Dollar