Polar Capital Technology: AI means we’ll outperform the index

Polar Capital's Ben Rogoff sits down with ii's Sam Benstead to discuss how his £4.6 billion technology fund invests.

The discussion includes the future of the Magnificent Seven shares, whether technology stocks are too expensive, and the value that an active manager can deliver during periods of rapid technological change.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Ben Rogoff, who is the manager of Polar Capital Technology Ord (LSE:PCT) Trust. Ben, it's great to have you in the studio.

Ben Rogoff, manager of Polar Capital Technology Trust: Thanks for having me.

Sam Benstead: The Magnificent Seven is the big theme in tech investing, but where do you stand on these giant American technology shares?

Ben Rogoff: About a third of the portfolio is still invested in the Mag 7. You only have to get a few things right in life and investing, as someone much smarter than me once said, and I think we made a very key decision probably nearly 20 years ago to move away from a multi-cap investment approach to really looking more at the index. Again that's very uncool to talk to the index but actually the index has been a phenomenal thing to be tethered to ever since the great financial crisis.

One of the reasons for that within tech has been that the large got larger, the Mag 7 are really a manifestation of the fact that some very large companies have ended up dominating the profit pools associated with technology, be it Microsoft Corp (NASDAQ:MSFT) in software or obviously Google [Alphabet Inc Class A (NASDAQ:GOOGL)] in search and so on. So, we've been delighted with the Mag 7 exposure that we've had and it's probably been higher than most.

How do we feel about it today? I think the answer is that it's more nuanced. By the way, you've got to be slightly careful what you wish for.

These companies have been the engine room of PCT's performance, haven't they, over a sustained period of time, but they've also been very difficult to outperform.

So, we'd love to see the market broaden, just like others. In the end, though, you have to operate with the market that you've got, not the one that you want.

But what are we doing at the margin? The answer is we're reducing Mag 7. We're doing that not because anything has gone wrong with those businesses, in fact we've got lots of NVIDIA Corp (NASDAQ:NVDA) at 12% of the portfolio, we're still overweight on Amazon.com Inc (NASDAQ:AMZN) relative to an index that albeit is at zero, and we feel that they've been incredible conduits for AI for the last two years.

But, we're beginning to feel that some of them are looking less good conduits for AI over the next few years and so we've reduced our Alphabet/Google exposure. They've got, obviously, an incredible model. They've got a cloud business that's on fire, they've got Waymo. There's lots of great things about this company. We've owned it continuously since it became public. So, we're huge fans, but they also have lots to lose from a world where 800 million people are now using OpenAI ChatGPT. So, that one we've been reducing.

Apple Inc (NASDAQ:AAPL) I've also owned continuously since 2003. It's probably the best investment decision I've ever made. Everything I've done subsequently with that stock has been wrong. Because I bought 1% of the trust in 2003 and I should have just left it there. But, joking aside, it's one of the most phenomenal businesses on earth, but smartphone penetration has been full for a sustained period of time.

The company isn't struggling, but certainly replacement cycles have extended. The hope is that AI will revitalise iPhone sales and they tried to launch Apple Intelligence as a way to do that. Our sense is that Apple Intelligence hasn't been great. But, more importantly, we feel that AI is something you're going to do in the largest model, the most complex, sophisticated, not a winner takes all, but a winner takes most, which is why the OpenAI's and others are spending so aggressively to have the very best model.

Apple doesn't have a model, and so in a sense it's a bit of a spectator to what happens next, and that's given us a good opportunity to reduce our exposure there. So, at the margin we expect to keep reducing the Mag 7 names. I think we can find better conduits for AI elsewhere.

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Sam Benstead: Just how expensive are technology stocks? It's often a very pricey sector, but where are we now versus history?

Ben Rogoff: Markets are at the higher end of where they've tended to trade, that's not just true for tech or even for the US, but it's true to say that things are not cheap. However, I think the forward price-to-earnings (p/e) of the US tech sector is in the high 20s, which is a level that I think some people will find uncomfortable. The relative PE, so when you think about what PE do you pay relative to the PE for the broader market, is around 1.4 times the market multiple. 

Going back to a post-credit financial crisis range, that is towards the high end. Having said that, we're three years into a new AI cycle and there are some incredible opportunities for technology to redistribute profit pools, both within the tech sector, but also beyond it. The earnings profile of our portfolio is very much at the higher end.

We're hopeful that our portfolio can grow earnings 20%-plus. We're still trying to build a portfolio that's diversified, because there will be challenges along the way to some of those companies.

But the profile of tech is strong. It's meaningfully better than the broader market, and let's not forget that, at least in our view, we're going to see more AI disruption. We're going see companies that fall foul of AI as some of their core propositions are challenged by ever better models. If that's true, the premium that you pay for a tech company that's delivering that disruption, all things being equal, should be relatively high.

One last thing, if I may. I think the conversation about valuations is obviously relevant but often people bring it up as a way to, I suppose, denigrate the technology story. But we're all the sum total of our cumulative experience, and for people that were around in the 90s like myself, the dot-com period was a tricky one. Obviously you're very excited on the way up and then learn an awful lot on the way down. I think that some people want to liken the current period to that 90s experience.

But if one does, then you sort of come away empty-handed because here we are today trading on 29 times or 1.4 times [the market multiple]. So, yes, at the high end of life. But in the late 90s, when people were super-excited about dot-com and it was at the heady end of that, the tech sector traded in the 50s and 60s on a forward p/e and we traded on more than two times the market multiple. So, look, things may be a bit extended, but with good reason. And we look nothing like we did at the end of the late 90s.

Sam Benstead: Volatility is another big theme with technology shares. Your trust has been known to fall 20-30% in value over certain periods, so how do you manage that as an active portfolio manager?

Ben Rogoff: There aren't that many drawdowns of that magnitude, but there were plenty of double-digit setbacks, and obviously this year we had the DeepSeek moment in January, where for a window of time at least, there were some question marks around the sustainability of AI capex, and with a cheap Chinese model, why would anybody build another AI cluster again?

Thankfully, that's just not been borne out at all. We've seen all the hyperscalers raise their capex throughout the year and that almost contained the episode, but it didn't stop stocks falling very hard.

What I would like to say, if I may, is that, yes, first, I can't give investment advice obviously, but I think the most important takeaway from the volatility that is inherent with technology investing, but also any single-sector investing, is to have an appropriate amount of risk, but also to have the right investment time frame. I've been a PCT holder since the day I joined Polar Capital in 2003. You can ride the volatility and those setbacks better, if you've got the right investment time frame.

But it's worth pointing out that the DeepSeek episode is unlikely to be the last time that the AI story is challenged. We're three years into a new cycle, we're all still learning on the job. That Chinese model introduced some innovations around how you build a large language model that were new news to almost everybody. Maybe not to Jensen Huang at Nvidia, but to nearly everybody else they were pretty scary. The headline-sticker shock of being able to build a model for $6 million (£4.4 million) when everybody else is spending billions was pretty uncomfortable, and, of course, it turned out that those numbers weren't quite right.

The point I'm trying to make is that when you're really in this steep part of an innovation curve, and where investor understanding is still quite limited, you're going to get setbacks.

I think of 95 to 98, which feels to us broadly analogous with where we are today, and was a really good period for markets [even though] history is only an imperfect guide, of course. We had seven setbacks of 15%-plus in the Nasdaq 100 during that time. So, I think it's not a question of buckling up, it's just a question of expecting volatility, it is inherent to new technology cycles.

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Sam Benstead: With investment trusts, it can be even more volatile because of the premium and discount mechanism. What is the discount on the trust at the moment? And do you see that narrowing?

Ben Rogoff: The discount has sadly become a feature of an investment trust, it seems, and in an industry-wide challenge discounts have stayed stubbornly high. I think ours today is more like eight, nine, but nonetheless we're not comfortable with that number.

This is an incredibly liquid portfolio, and we're delighted with the return profile it's delivered. I think it's a very well-loved trust, it's probably not for me to say, it's probably for others to say, but we're a FTSE 100 [company] and we've got a long track record. I am hopeful that discounts can close. The company continues to buy back stock. It's a very creative thing to do. It's great for long-term holders because you pick up the accretion associated with buying something that's trading at 90p in the pound.

If we continue to deliver good numbers, if we can do what it says on the tin, and if we can do that in a way that's cost-effective, I think this is a very competitively priced trust in my opinion.

We removed our performance fee not long ago and I think that if we can deliver, if AI can deliver, if the portfolio stays liquid, and if people begin to really embrace the tech sector, there's no reason why this discount can't close.

Sam Benstead: One of the best ways to own tech shares over the past 10, 20 years has been to own an index fund tracking the Nasdaq or a global technology index. So, why should investors pay up for an active manager like yourself?

Ben Rogoff: It's a fair question. PCT has been one of the very best ways to access the tech sector over a sustained period of time.

I'm kind of reticent to talk to the long-term annual return profile because I don't want people to think that necessarily is something that we can sustain, but they've been phenomenal returns.

But, you're right in that, particularly during the last few years where things have become very narrow, it's been difficult for active managers, ourselves included.

If you look at, say, small cap, large cap, just over that two-year time frame that hadn't been here, I think small caps are up 20 and large caps are at 70. That's a pretty formidable headwind for active managers looking for slightly off-the-beaten track ideas.

How do I feel about it today? I'm sure that everyone that comes on to talk to you will tell you that today's a great time for active managers, but I do genuinely feel that. And you can see that. We're now meaningfully ahead of the index over one year and two years, we're back in line with the index over three years, and that's, of course, after costs.

So, that reflects a portfolio where active share is already now into the high 40s. This is a portfolio where we build the book or the trust around the index, but we're unafraid to take very big negative bets. So, we have a very small position in Apple relative to an index. We have a relatively small position in Google today relative to the index, and so active share is already into the high 40%s.

But, more importantly, if Mag 7 becomes a slightly less-good conduit for AI, and I think there's an interesting two-way debate now that's becoming more established, and if AI becomes much more disruptive, which we believe very strongly that it will, then indices that are market cap weighted are, of course, dominated by companies that have done well, not necessarily companies that are going to do well.

So, that's a really interesting set-up for us as an active manager, that we can take some really big negative bets where we feel appropriate. And again, move carefully because I've been doing this a long time and you have to move carefully because the Mag 7 are phenomenal businesses, and they deserve to be where they are.

But one last point, if I may, which is to say that the technology universe is in flux and where value is being added is changing and exchange-traded funds (ETFs) aren't going to help you with that. They're not going to help you identify companies at the margin of technology where they may be embracing AI that allows them to, for example, capture a profit pool that didn't exist before.

Take a company like Axon Enterprise Inc (NASDAQ:AXON), which has become a very popular name. We've owned that stock in the trust for more than 10 years. Axon, for those who don't know, make the body cams, the Taser non-lethal weapons, and now software that allows really modern police, and modern law enforcement. That's been an absolute humdinger for us, candidly.

The company's not in the tech index. Now, if we're right, we're going to find more Axons. We're going to find companies that are at the periphery of tech that will get dragged into the technology story as AI proliferates.

I just think the combination of a market-cap cloud, smartphone-heavy index, and the opportunity set that comes from AI disruptions set us up very well.

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Sam Benstead: Finally, the question we ask all our guests, do you personally invest in your funds?

Ben Rogoff: It's a good question, it's a very fair one and the answer is unequivocally, yes.

In fact I bought shares in the trust on the very day that I joined Polar Capital. I've held them ever since. I've added, and I've taken some away over time. I actually bought some not that long ago. So, I am a holder of PCT, but more than that I've been at Polar Capital for a very long time.

PCT is synonymous with the business that I have been at now for more than 20 years. We love everything about this trust. The same is true for my deputy, Alastair Unwin. I know he owns PCT, we live and breathe this trust.

So, yes, of course I'm an investor in it. I'm excited about the medium-term prospects for returns, but also I obviously have to have skin in the game and something that I believe in, but also something that we've got lots of external investors into.

Sam Benstead: Ben, thank you very much for coming into the studio.

Ben Rogoff: Thank you.

Sam Benstead: And that's all we've got time for today. You can watch more Insider Interviews on our YouTube channel, where you can like, comment, and subscribe. See you next time.