Corporate technology spending has always been cyclical and recently reached a low point, but history suggests the downturn won't last forever, according to Fidelity Portfolio Manager Marc Grow, who expects a meaningful bounce back among tech services firms.
“The reduction in IT investment is happening across various end markets but should ultimately be short-lived,” says Grow, who leads Fidelity® Small Cap Stock Fund (FSLCX). “As a result, I’ve been looking to capitalize on this by investing the fund in attractively valued, small-cap tech services firms poised to benefit once customers eventually ramp up spending.”
In managing the diversified domestic small-cap core strategy, Grow favors businesses with an honest and capable management team, superior return metrics, and strong free-cash-flow generation. His investment framework tends to be value-oriented and biased toward high-quality businesses.
The decline in technology spending, explains Grow, has been several years in the making, affecting companies of all sizes. In fact, he notes that at the peak of the COVID pandemic, even the most formidable tech giants scaled back expenditures by laying off workers and reducing capital investments.
Meanwhile, among small-caps, the regional bank industry, which represents about 10% of the Russell 2000® Index, is one area that has seen a decline in tech spending, says Grow.
The higher interest-rate environment has been extraordinarily difficult for regional banks to navigate, even resulting in a few high-profile bank failures in early 2023.
As a result, says Grow, these lending institutions have either paused or delayed some IT projects to focus on navigating an environment plagued by lower profit margins and a shifting deposit mix.
“I believe smaller regional banks need to modernize their IT infrastructure to keep up with larger players, creating meaningful opportunities for tech services providers, consultants and business process outsourcers,” Grow contends.
Another area ripe for more technology spending, in his view, is businesses catering to the needs of the consumer retail and e-commerce industries.
“With consumers keeping a closer eye on their wallets as it relates to spending on electronics, PCs, smartphones and other durable goods, the resulting decline in revenue has forced many companies to defer their IT projects,” says Grow. “However, as business clarity improves, I expect these firms to resume their technology investments, potentially providing a tailwind to the fund's holdings.”
More specifically, he cites several stocks within the portfolio as of July 31 that are well-positioned for a revival in tech spending, including WNS (WNS), Kforce (KFRC), Genpact (G) and U.K.-based Endava (DAVA).
“These companies vary in terms of their expertise, service offerings and geographic mix,” Grow concludes. “But I see them all as beneficiaries of a broader uptick in IT spending. More importantly, I want to own these stocks now, so that the fund can capture the upside opportunities that I believe should arise as the market rebounds.”
For specific fund information, including full holdings, please click on the fund trading symbol above.
Marc Grow is a research analyst in the Equity division at Fidelity Investments.
In this role, Mr. Grow is responsible for the coverage of U.S. small-cap industrials stocks. He also manages Fidelity Small Cap Stock Fund and Fidelity Small Cap Stock K6 Fund. Previously, Mr. Grow was on the equity research team covering small-cap consumer stocks and auto dealerships.
Prior to joining Fidelity, Mr. Grow was the chief financial officer of Lakeside Capital Group and was also an equity analyst at the value- focused hedge fund V. I. Capital Management. He has been in the financial industry since 2010.
Mr. Grow earned his bachelor of arts in accounting from Whitworth University and his master of business administration degree with a focus on value investing from Columbia University. He is also a CFA® charterholder.