How can investors mitigate volatility while investing in tech?

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Technology stocks hold the promise of exposure to paradigm-changing areas of innovation such as AI, VR and AR, and the metaverse. However, the sector can also be volatile, and it has faced the same headwinds as the rest of the equity market in the past year. As a result, many investors are steering clear of it.

Depending on their risk tolerance, investors may want to reconsider, says James Learmonth, senior portfolio manager at Harvest ETFs. He’s part of the team that manages the Harvest Tech Achievers Growth and Income ETF (HTA:TSX), which invests in 20 equally weighted tech companies with a minimum market capitalization of US$10 billion that trade on a North American exchange. Holdings in HTA must be traded in an active options market, because what sets the HTA ETF apart from a core tech portfolios is that its complemented by an active covered call strategy.

“Writing call options on the portfolio gives investors a way to monetize some of that volatility and generate cash flow to meet their investment objectives from an income perspective—while still remaining invested in large-cap technology companies and exposed to any potential upside in the future,” Learmonth explains. “This kind of environment is where a covered call strategy like ours can provide additional value for investors.”

A challenging year for all stocks

“As all equities came to terms with rising interest rates this year, growth stocks experienced multiple compressions, and investors started to put a higher discount rate on future earnings for growth companies, including those in the tech sector”. says Learmonth.

“As we moved through the year, we started to see pretty dramatic slowing of global economic growth from the general hangover of the pandemic-era monetary and fiscal stimulus. That has started to impact the growth outlook for companies in general,” he adds.

The pandemic initially boosted tech sales as people upgraded for remote work. However, the return to in-person work led to decreased demand for home office setups, causing a shift in tech company strategies. They adapted by focusing on hybrid work solutions and innovations to suit evolving needs.

Of course, not all companies have experienced the pullback equally. “A dichotomy exists between established tech companies and earlier-stage technology companies,” says Learmonth. “More of [the latter’s] valuations are dependent on future prospects that, in many cases, they haven’t realized yet.…Established companies with strong operating models are revenue-, earnings-, and cash flow-positive, [and so] you’ve seen more established companies holding up relatively better.”

Established companies well positioned for future growth.

Learmonth adds that established companies, with their strong balance sheets, have been able to invest through the downturn, so they’re well positioned for an upswing. That’s in contrast to earlier-stage companies that are often more dependent on external funding and can’t invest—or can’t invest as much—all the way through the economic cycle.

Looking to the future, Learmonth says a number of macroeconomic trends make tech an attractive place for investors to be. Several themes—digitization of the consumer, the shift to cloud-based infrastructure, AI, VR and AR, and the ubiquitous need for cybersecurity—stand to drive continued investment in technology into the future. Investors who are comfortable with a few ups and downs have an opportunity to participate in significant potential growth.

“We’re looking for companies that have grown to the point where they’re the dominant players or leaders in the end markets they serve,” Learmonth emphasizes. “We want to build a diversified portfolio within the technology sector. Then, from there, we overlay our active covered call strategy to enhance the underlying dividend yield of the portfolio and offer a higher yield to investors.”