- We believe many stock in the information technology sector remain inexpensive and are well-positioned going forward.
- In mixed economic environments, we believe there are many potential investment opportunities – especially in biotechnology, data, mobility and health care – around the world.
We are excited about the innovation and growth taking place across the globe, and believe many stocks in the information technology sector remain relatively inexpensive and are well positioned going forward. Despite our optimistic outlook, we think it is important to understand why and how the Fund underperformed recently.
2015 was a challenging year for the markets. A time period we don’t believe many would characterize as a momentumdriven market, but nevertheless, that’s exactly what it was. The market was driven by a small number of securities, specifically that common acronym that became very popular last year known as FANG (Facebook, Amazon, Netflix and Google). We would also add Microsoft to the mix. All five of these stocks are large constituents in our benchmark index, the S&P North American Technology Sector Index. When you review performance of the index for calendar year 2015, the index was up 9.91%. Meanwhile, the performance of those five stocks contributed 10.45% to performance last year. When you net out those holdings relative to the benchmark, the performance would have been slightly in the red for the year. The result was a very narrow market for outperformance. While the Fund had sizable positions in Facebook and Google, its relative underweight in these positions compared to the benchmark index and its lack of exposure to Amazon and Netflix had a negative impact on Fund performance.
2016 year-to-date is a very different tale; we have largely underperformed because of our exposure to health care — a sector not included in the benchmark. The Fund’s allocation to health care has typically benefitted performance, especially during times of distress in the technology sector. Historically, when the Fund’s allocation to technology has struggled, the defensive nature of the health care sector has often provided a buffer to portfolio performance during those downturns. This has not been the case year-to-date as the industry has been hard hit by headline risks. Continued fears around the U.S. election and potential impact on health
We do not expect this trend to continue, and believe the Fund’s investment philosophy of seeking innovation as a catalyst for change across the market cap spectrum will create growth opportunities over the long run. As such, we maintain our high conviction in portfolio holdings.
We think Universal Display Corp. is good example of our investment philosophy at work. This small cap company specializes in OLED (organic light-emitting diodes) technology, which you may have recently seen in new product rollouts. OLED is a screen technology we have spent a lot of time researching and analyzing. We traveled to South Korea and met with company management and the original developers of the technology to ensure Universal Display’s patents and the trajectory and ability to manufacture the technology was sound.
If you look at OLED technology compared to the current industry standard LED (light-emitting diode) technology, we believe the picture quality and contrast is second to none. And you’re starting to see early adopters of OLED technology. As a result, we think you are going to see a lot more traction and proliferation of the technology over the next couple of years. We think Apple Inc. has recognized the advantage as well, and it is widely speculated the company will have OLED screens across its product line by 2018. The combination of these effects has us excited about the potential growth for Universal Display. The growth has started in mobility, but ultimately we believe the technology will become prevalent across TVs and similar devices.
Another good example would be NXP Semiconductors. NXP is the recognized leader in secure semiconductor solutions for the implementation of EMV (chips in cards) and mobile payments. The company has the largest intellectual property portfolio in secured payment technology and recently licensed this technology to Apple Inc. The company has an emphasis on security of the connected vehicle and the growing Internet of Things. As such, the company’s products are used in a wide range of smart automotive, identification, wired and wireless infrastructure, lighting, industrial, consumer, mobile and computing applications.
Attractive Valuations In Health Care
Despite short-term setbacks in the health care sector, we believe this is one of the sectors with the greatest opportunity for innovation and growth going forward. In our view, current health care holdings are exceedingly undervalued as they have leading science to create novel new therapies to dramatically improve outcomes to address unmet medical needs. As such, the Fund has maintained its approximate 15-20% exposure to the sector.
In terms of specific holdings, take Vertex Pharmaceuticals as an example. The company has seen its fair share of recent controversy, yet we think the outlook for Vertex continues to be bright. The stock was originally purchased in 2009 based on its position as the undisputed leader in addressing hepatitis. More recently, this biotechnology company enjoyed positive results from a late-stage cystic fibrosis treatment shown to significantly improve patient lung function. These results, as well as our view that Vertex continues to maintain a very compelling pipeline of new therapies, is why the stock is in the portfolio today.
We think the stock has substantial upside. It’s that kind of indepth fundamental analysis that over time we believe will make these difficult times pay off.
Looking Across Sectors for Innovative Ideas
We continue to find and be excited about opportunities well beyond the traditional realm of science and technology. As we’ve said in the past, in a difficult economic environment, we believe these kinds of companies are disproportionate beneficiaries. We think Bioamber is a good example of our applied science investment approach at work. The company has developed a methodology for converting feedstocks into succinic acid and other key chemicals that are used in everyday products like paints, food additives and cosmetics. Rather than utilizing fossil fuels as the core input, Bioamber uses sustainable sources, thus preserving natural resources while, in our view, producing a higher quality end product. At scale, we think this process is economical and has meaningful positive environmental implications, which bodes well for the company going forward.
Over the short term, lingering fiscal concerns and other geopolitical risks have resulted in a rather muted growth outlook. That said, in mixed economic environments, we believe there are many potential investment opportunities – especially in biotechnology, data, mobility and health care – around the world. As we look at the securities of such companies, we are focused on what we believe are good growth prospects and sound capital structures. We believe there will be a modest improvement in capital spending trends, and we are looking for a continuation of an active mergers-and-acquisition environment. As always, we will carefully monitor the macroeconomic environment, but our focus remains primarily on security-specific fundamental research. Going forward, we believe this attention to bottom-up research, coupled with the innovation and transformation under way across the globe, will provide investment opportunities for the Fund.
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s portfolio manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through Sept. 30, 2016, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. The information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance, and time horizon.
Top 10 Equity Holdings as a percent of net assets as of 09/30/2016: Micron Technology, Inc. 5.5%, Aspen Technology, Inc. 5.0%, Alliance Data Systems Corp. 4.6%, Euronet Worldwide, Inc. 4.2%, Microsemi Corp. 4.1%, Microsoft Corp. 4.0%, WNS (Holdings) Ltd. ADR 3.6%, Vertex Pharmaceuticals, Inc. 3.6%, Cerner Corp. 3.6%, and NXP Semiconductors N.V. 3.6%.
The S&P North American Technology Index is an unmanaged index comprised of securities that represent the technology sector of the stock market.
Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. Because the Fund invests more than 25% of its total assets in the science and technology industry, the Fund’s performance may be more susceptible to a single economic, regulatory or technological occurrence than a fund that does not concentrate its investments in this industry. Securities of companies within specific industries or sectors of the economy may periodically perform differently than the overall market. In addition, the Fund’s performance may be more volatile than an investment in a portfolio of broad market securities and may underperform the market as a whole, due to the relatively limited number of issuers of science and technology related securities. Investment risks associated with investing in science and technology securities, in addition to other risks, include: operating in rapidly changing fields, abrupt or erratic market movements, limited product lines, markets or financial resources, management that is dependent on a limited number of people, short product cycles, aggressive pricing of products and services, new market entrants and obsolescence of existing technology. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers. Holdings information is not intended to represent any past or future investment recommendations. Holdings and allocations can and do change frequently.
WADDELL & REED INVESTMENTS℠ refers to the investment management and investment advisory services offered by Waddell & Reed Investment Management Company, the investment manager of the WADDELL & REED ADVISORS FUNDS℠ mutual funds, which are distributed by Waddell & Reed, Inc.
Before investing, investors should consider carefully the investment objectives, risks, charges and expenses of a mutual fund. This and other important information is contained in the prospectus and summary prospectus, which may be obtained at waddell.com or from a financial advisor. Read it carefully before investing.