In The News

Can tech stocks save the TSX?

Written on June 13th, 2013

Financial Post – 13/06/14 – Neil Johnson wants to help resurrect investment in Canada’s technology industry. If it comes to fruition, the chief executive of Difference Capital Funding Inc., a publicly-listed merchant bank in Toronto, and his colleagues will be a happy bunch because of the increased business they will have received from companies looking for funding.

But Canadian investors, who are suffering from the lack of diversification on the country’s equity markets, will benefit as well. They have already started plowing into the technology sector in an attempt to escape moribund resource stocks, pushing the S&P/TSX Capped Information Technology Index to a 27% gain so far this year.

“You just have to look at the recent capital flows and the sector rotation into technology,” Johnson said of the renewed interest in I.T. “We may not get back to previous levels and it may not be healthy to, but we’re seeing a reversion to the mean and tech will eventually have a rightful share of the capital markets, just as it does of the economy.”

Nevertheless, the frothy dot-com days of the late 1990s seem a long way off and Canadian tech will likely remain a bit player on equity markets for some time still to come. At the height of the technology bull market that flamed out 12 years ago, I.T. and other “new economy” stocks represented roughly 28% of the Canadian market. Today, their share is less than 3%, reflecting the almost complete collapse of the play over the past decade as investors rushed for the exits to put their money into the country’s mining and energy sector.

Mr. Johnson, whose company provides financing for promising technology, media and health-care companies, said most people did well by this move, benefiting from a tremendous rise in commodity prices. But the pendulum has swung too far, he added, leaving investors overexposed now that resource stocks have fallen on hard times.

As a result, he believes investors are desperate to find an alternative play and are slowly recognizing the opportunity that tech offers, which has helped make it one of the best performing sectors in Canada so far this year.

Leading the charge is CGI Group Inc., up 34% year to date, followed by Open Text Corp. up 33%, and BlackBerry with a gain of 24%. Celestica Inc., Constellation Software Inc., and Macdonald Dettwiler & Associates Ltd. have also all returned greater than 20%.

“It’s a reflection of what is happening in the real economy,” Mr. Johnson said, noting a recent Forbes article that said Ontario is home to the second-largest cluster of technology companies in North America behind only California. “It’s important to everyone’s portfolios and having too little exposure is dangerous.”

Mr. Johnson anticipates investment demand for technology will grow in Canada, just as it has south of the border, where talk of a new secular bull market in the sector has been ramping up over the past couple of years.

Tobias Levkovich, U.S. equity strategist at Citigroup Global Markets, noted recently that information technology is the most widely-held sector among the top mutual fund managers down south and the third most-liked among hedge funds.

Even so, Mr. Johnson doesn’t expect a mad rush into Canada’s tech sector. For one thing, there just aren’t many tech companies to invest in on the TSX as yet. For another, many of the investment teams in the space have considerably shrunk since the dot-com era, forcing the industry to rebuild its “muscle memory” to teach the market what makes a good technology company and how to value them.

“I recently counted something like 14 Canadian public technology companies being sold at double their market price and sometimes more to U.S. companies,” he said. “They get it, but we don’t have that ecosystem of brokers, analysts and fund managers anymore. That is the reality right now, but as investors get more exposure to the sector, the real value will be recognized in our public companies and we will have more IPOs to satiate the demand for this asset class.”

Of course, it won’t take much to do that. Initial public offerings in the tech space have been almost non-existent in Canada over the past 11 years. While more than 400 IPOs took place on the TSX venture exchange since February 2002, only 10 were related to technology.

George Fleming, CEO of SoMedia Network Inc. has first-hand experience of how Canada’s investment climate has lagged when it comes to technology, particularly regarding growth capital for businesses looking to expand operations

I recently counted something like 14 Canadian public technology companies being sold at double their market price

“There is a very large number of interested investors across Canada, but the angel community is more advanced than the brokerage community with regard to what’s going on in technology in this country and they’re typically only able to fund early-stage tech,” he said.

But he thinks the gap is narrowing as demand grows on public markets. For example, his company, which provides corporate online video production services, is expected to list on the TSX Venture Exchange later in June, making it the first Canadian Internet technology IPO since 2001.

“Our timing is good. We started on this path a very long time ago, but public markets were very much focused on resources and weren’t open to us,” he said. “You have to remember that tech jumped off a cliff. Is it going back to 30%? Let’s hope not; we don’t need another bubble. But a normal weighting of 10% or more seems more than possible.”

A weighting of tech stocks in that magnitude would be welcome news for the TSX, which is often criticized for its lack of breadth relative to other global exchanges. The S&P/TSX Composite, the country’s broadest benchmark index, is heavily skewed towards financials, which makes up almost 34% of the benchmark, and energy and materials, which that have weightings of 14.4% and 23.5%, respectively.

The biggest sectors after the big three are industrials with just a 7.6% share of the composite, followed by consumer services at 6.5%. Technology is a paltry 2.2%.

The S&P 500, by comparison, is far more evenly distributed, with seven of 10 sectors individually representing between 11% and 17% of the index.

Based on these statistics, the Canadian equity market could clearly benefit from greater sector diversification, but even if tech — or some other sector — helps balance the load in the next few years, the TSX is likely to remain a poor vehicle for building a diversified portfolio.

Canadians invested 65% of their equity holdings in homegrown companies during 2010, according to a recent Vanguard report, but the country’s equity market is a drop in the bucket when compared to other countries, representing just 4% of market capitalization globally.

For that reason, Susanne Alexandor, managing director and head of wealth management at Cougar Global Investments Ltd. in Toronto, said it remains imperative for Canadian investors to diversify outside of Canada to the U.S., Europe and elsewhere.

“Investors didn’t pay attention to diversification during the bull run for commodities, which benefited the Canadian market,” she said. “With investors questioning or calling for the end of the commodity supercycle, investors need to look abroad for diversification and away from the lagging Canadian equity market.”

Back to News