Investing in digital transformation

The world runs on software and portfolio manager Ali Khan is tracking the trends.

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Key takeaways

  • Digital transformation is likely to drive results for the tech sector for the foreseeable future as businesses work to stay competitive and relevant among nimble, tech-savvy start-ups.
  • Cloud computing is an agent of digital transformation—enabling businesses and individuals to use the internet to access software, making technology available on-demand, anywhere, anytime.
  • COVID-19 may have sped up the process of digital transformation for many businesses.

Technology is at the forefront of everything and software is the engine that makes everything work—from the apps on your phone to the software that helps the stock market run smoothly and safely. That may be one reason for the technology sector's relative resilience through the steep market downturn in the first quarter of 2020.

To find out what may be in store for the sector for the rest of the year and beyond, Viewpoints talked to Ali Khan, portfolio manager of Fidelity® Select Software and IT Services Portfolio (FSCSX ).

What are your thoughts on the technology sector right now?

Technology helps drive businesses but it's also become critical to our personal lives. Video calls are a good example of this. A couple of weeks ago, I attended a video wedding—I was sitting on my couch, in a tuxedo. And it made me think about what the current situation would have been without some of the technologies we use day-to-day.

Obviously, a global pandemic is a very grave situation, but this environment highlighted the importance of technology for companies and people around the world. We've been able to stay connected, stay informed, buy things for the home, live our lives—and, in many cases, do our jobs. Crises usually accelerate trends that are already in place.

The CEO of Microsoft put it best on the recent earnings call when he said, "2 years of digital transformation happened in 2 months."

Digital transformation refers to the movement toward reimagining businesses in the modern digital world. What does that mean for the fund you manage?

I think software is potentially an underappreciated beneficiary of this process.

There are companies working to build up ecommerce systems, to enable digital payments, to enable collaboration virtually, or on supply chain optimization—all the systems that help companies and people manage their businesses and their lives.

And this digital transformation is enabled by software.

There's this phrase that companies don't want to be "Uberized." In every industry, there's someone like Uber that's coming in and trying to disrupt the way things are done. Trying to be nimble is the only way that companies—even larger companies, including Fidelity—are trying to stay ahead of the curve and invest in technology.

What are the major technological trends reshaping the business world?

The core trends that I've been spending most of my time on are digital transformation and cloud computing—those are the 2 main trends that Select Software is exposed to.

Digital transformation essentially means that every company is trying to use technology to differentiate itself, to operate their businesses better, to compete more effectively, to engage more with their customers.

Cloud is an enabler of that digital transformation. It used to be that technology would be sitting at each company. But now technology can be delivered over the internet and consumed as you go. So think about video calls, for example. None of us have anything installed anywhere. It's all done over the internet—and that's just one example.

It's extremely valuable, important technology that gets the job done for people and companies around the world—and that's why software companies tend to have very strong economic and business models.

What challenges is the technology industry facing now?

Technology is obviously economically sensitive and it's tied to business confidence and consumer confidence. When people aren't employed, they're not necessarily thinking about buying a new phone or a new car. When businesses in challenged industries like travel, hospitality, or energy are struggling, they're obviously not thinking first about digital transformation.

In a crisis, companies are laser-focused on technologies that give them an immediate return on investment. Technologies that require a much heavier implementation or take more time to pay back usually get shelved in those environments. So we're trying to have a clear framework for what companies in technology are positioned better or worse, to make sure we position ourselves in the best companies.

What do you look for when you're trying to find investments?

When I'm looking at technology stocks I try to answer 3 questions.

One, is the company addressing a very large market opportunity?

Two, does the company have a sustainable competitive advantage? To find out, one would spend a lot of time trying to dig into the company's differentiation and how sustainable it is.

And 3, is the stock available at a reasonable price?

In technology, we tend to have a lot of examples of companies that check boxes 1 and 2. But I think it's also very important time to be disciplined around owning stocks at reasonable prices.

One of the silver linings of market volatility is that it provides more opportunities to step in on companies that were always well-positioned for the long term, addressing very large market opportunities with sustainable differentiation, but were not at a reasonable price. So volatility opens up the aperture in terms of the number of companies and the types of companies that the firm can own.

In the fund, one of the things I've tried to do, with both digital transformation and cloud, is find companies that are seen as trusted partners to large companies that are embarking on digital transformation. And so the likes of Microsoft (MSFT) and Salesforce (CRM), which have been top 10 holdings in the fund for some time, are examples of companies where, if you're a CEO or a CTO of a company and you're embarking on a really important technology project, those are the companies that come to mind.

They're seen as reliable, trusted partners that not only have an opinion on how digital transformation should be done, but also have the technologies, products, and services to enable companies to do that.

Fidelity® Select Software and IT Services Portfolio: Top 10 holdings

  • MICROSOFT CORP (MSFT)
  • ADOBE INC (ADBE)
  • VISA INC (V)
  • SALESFORCE.COM INC (CRM)
  • PAYPAL HLDGS INC - (PYPL)
  • MASTERCARD INC (MA)
  • ALPHABET INC (GOOGL)
  • COGNIZANT TECH SOLUTIONS (CTSH)
  • AUTODESK INC (ADSK)
  • ORACLE CORP (ORCL)

As of March 31, 2020. Any holdings, asset allocation, diversification breakdowns or other composition data shown are as of the date indicated and are subject to change at any time. They may not be representative of the fund's current or future investments. The Top 10 holdings do not include money market instruments or futures contracts, if any. Depository receipts are normally combined with the underlying security. Some breakdowns may be intentionally limited to a particular asset class or other subset of the fund's entire portfolio, particularly in multi-asset class funds where the attributes of the equity and fixed income portions are different.

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