Is bigger always better?

CR: Hello and welcome to Silicon Valley Byte Size, an update on the tech sector from the Allianz Technology Trust. I'm Cherry Reynard, and with me today is Mike Seidenberg, manager on the Trust. So welcome, Mike.

MS: Nice to see you. It's great to be in London.

CR: Today, we're going to be talking about large and mid-cap stocks versus the so-called mega-caps. The Trust has long believed that the sweet spot for long-term growth is often found in the mid and large-cap companies, even though it's the mega-caps that have been dominant more recently. So, Mike, can you start by explaining why you've traditionally held more in the mega-caps.

MS: The primary reason we've held more mid and large-caps is really a function of our process. And it's a mosaic where we look at a variety of inputs. I mean, those inputs run the gamut from obviously the usual - talking to the companies, quarterly reports, but it's also talking to the users of technology. It's talking to chief security officers, chief information officers, consultants and the net of that is what we're really looking for are emerging areas of spend. And many of those tend to proliferate in the mid and large-cap sector, where companies tend to grow a little bit faster. And that's been a really rich area for us across all the sub-sectors in technology over time.

CR: And are there any sectors that you can only find in the mid and large-cap? So, I'm thinking areas possibly like cybersecurity or something, where you haven't got the mega-cap stocks yet?

MS: Yeah. I mean, cyber obviously bounces to the top. You still don't have a mega-cap company there. You know, I think we're very close to having what I would consider a large-cap company in that sector. And I'm not sure if we'll ever see a mega-cap cybersecurity company. One of the challenges is just that your adversaries are constantly, changing attack modalities, and therefore there isn't necessarily this, learning curve on a core technology, decade after decade. For example, we’ve seen that with a database right, where they've been able to innovate over, a very similar technology over multiple decades. But cyber comes to mind. You know, within the internet space, you tend to have a variety of really large companies and then the bulk of the space. It really consists of, mid-cap to large-cap companies. Here again, some really interesting companies in that space. And then if I think about, the semiconductor equipment space here again, specialized semiconductors, tend to be in that mid large-cap neighbourhood.

CR: I mean, obviously mega-caps have done enormously well in recent years and have been very dominant. But what about the longer term? You know, I'm thinking, maybe 10 years or more. How do sort of mega-caps compare with large and mid?

MS: Yeah, I mean, we're really living in unprecedented times with respect to the domination that's being afforded to some of these mega-cap companies, and you have to go back. I mean, I don't know if there has been a period where they've outperformed as much as they have, and they've really driven contribution to indexes is as strongly as they have. Traditionally, if you take a look at technology, the mid-cap space has really been a driver of performance. But, as I pointed out, you just haven't seen that as of late. One of the things I'm proud about what the Trust is, we are keeping up with the index, but we're really getting there by not owning benchmark positions in the mega-cap. We're getting there elsewhere. I mean, I'm proud of the team and the way we're getting our performance.

CR: Is there anything that might flip it?

MS: I mean, I feel like a broken record player given that you tend to have these regulatory headwinds that still persist and let me be really clear, the mega-caps are wonderful companies. It's just that, a lot of them appear really fully valued, and therefore, I'd like to think we can deploy capital elsewhere and drive performance. So, one would think that, regulatory remains somewhat of a challenge for them. You know, growth overall, as you get to that scale is not particularly easy. But, in fairness to the group, broadly speaking, they’ve just done a great job. And in a variety of cases, whether it's expansion and in new markets, whether it's changing the businesses more towards services, the net result is you just have more predictable businesses and investors will pay you higher multiple for that.

CR: Yeah. Are there any additional considerations when investing in mid-caps? I'm kind of assuming that a US mid-cap doesn't look quite the same as a UK mid-cap. But, do you have to consider liquidity, for example?

MS: I mean, we look at a variety of factors. And we do look at liquidity, making sure that should we need to exit or when we do exit, we're able to do that with the least amount of friction, on the sell and the buy side. You know, I think the thing you really want to think about with mid- cap is, as you're meeting with the teams and really understanding how they think about their business, if I met a smaller company, and they told me they were going to do four things really well, that would probably scare me because I just think that there's, the bandwidth is constrained. And you really want companies that can focus on doing two or three things really, really well. And so, I think that sometimes you run the risk of some of these younger companies of trying to have such ambitious plans. I would really prefer, and the team really prefers, just being able to focus on a few things, and then doing that really well, and then, basically earning the right to buy something else from the company.

CR: Does that make the skill of the management team more important? That sort of execution piece.

MS: I mean, yes and no. Yes, to the extent that you know, no one's going to get fired today, from, buying a Microsoft product, right? So, there's a certain amount of dedicated spin that goes to these mega-cap companies on an annual basis, just because they are such an important part of the IT infrastructure, for many businesses. I think on the mid-cap side, the thing that we really think about is how do you gain traction? How do you become part of that budget? And once you're part of it, how do you make sure that you're giving them enough product to continue to kind of satisfy your growth that you need to achieve? So, I do think, from a management perspective, it tends to be a little bit different time type of manager. And I'd say that, when companies are early days, that a lot of times, you kind of liken the management team there to almost, launching a rocket ship, right? And then anyone who knows anything about launching rockets are able to tell you that's a really hard thing to do. I think getting a company from a start-up to a public company is a really difficult process. And I have the utmost respect for entrepreneurs and for teams that are part of that, process and sometimes you meet people that do it have done it, four or five times and that's just one of the things that's great about my job, is meeting these super talented managers.

CR: Yeah. Yes, it takes a lot of energy, doesn't it? What about, you mentioned evaluations there. Do mid-caps tend to receive less analyst coverage, and is there therefore more, kind of, mispricing for active managers to exploit?

MS: I mean, I think it is a space where if you have a differentiated view on a company by doing the work and going out, and with your process and really understanding what the competitive landscape looks like, and what the opportunity is for that company, I would say this - you probably have models that are much more divergent in a mid-cap section scenario, then you may have, in a large and mega-cap scenario. Just because, you may be catching that company right as they're really starting to accelerate and grow their business and that, mind share and market share.

CR: If we could just sort of turn to markets at the moment. Do you think it's more important to look at mid-caps now, given this extreme sort of concentration in a handful of stocks that we've seen?

MS: Well, a couple of things. I really think about risk control and the portfolio and I've often said, we have a great board who really wants to think about single stock positioning - single stock positions - and what those weights look like. You know, as we sit here today, some of the more mid-cap-oriented sectors have really struggled. And you'd like to think that, 12 months from now we see a better valuation environment, potentially for those names. But I'm not in the business of predicting the future. So, what I'm really focused on is identifying companies that solve difficult problems and then figuring out, if they solve that problem, what else can they potentially, solve or sell to that customer base?

CR: And are you seeing any M&A in this part of the market, or are they a bit big for that? Are they more likely to be acquirers, for example?

MS: Well, I think that it's a little bit of both. I think at the margin, you see as valuations come in on some of these, really interesting companies, you see a very active private equity market who has, who have the ability because of the fund sizes that they've raised to go in and to take a company private. And then, obviously with the prospects of doing something with it over time, So, we've seen some of that. In general, I think a lot of companies are very aware of their cast situations on the mid, in the mid-cap space. And, we're probably not seeing as many acquisitions being done by the companies themselves, because I think that they can still be pretty patient. You know, this start up environment is different today than it was a few years ago. So, yeah, I think many companies are, in a situation where they are dwindling cash on the start-up side and those become, probably companies that some of our investments would like to acquire. They're just going to be pretty patient because they know how difficult it is for that particular target to go out and raise cash.

CR: Yeah. And just finally, I wonder if you could give a couple of examples of mid-caps you're holding in the portfolio today?

MS: Yeah, and so I'll start with a company called Monolithic power. Really interesting power management semiconductor company, founder-led, really innovative with respect to not only design but also running that manufacturing process. They've taken share. We really like the spaces they play in and their markets. That comes to mind on the semiconductor side. On the software side, I would probably point you in the direction of something like a HubSpot, where they are competing around, they initially started in marketing applications, but now they've moved into, kind of what I call ‘lightweight sales force’, sales force automation product, moving into services. You know, very strong management team. They really understand their in markets. They’re actually getting pulled up into accounts. I think it's an interesting business. I’ve thought that for a number of years, and we continue to like what they're doing.

CR: Brilliant. OK, thank you so much, Mike, for all those insights today. For any information, please do go to the website, Allianz Technology Trust.com. Thanks so much for tuning in.