A Technology Index With a Difference

Investing in technologies poised for exponential growth possesses inherent appeal. Companies like Intel, Google, and Amazon have changed the way we work and live, delivering massive profits and share price appreciation along the way.

Morningstar created the Exponential Technologies Index to highlight transformational innovation. Launched in 2014, the index redefines technology indexing in several ways.

First, it’s not narrowly confined to companies classified as technology-related on sectoral or industry lines. It recognises that companies benefiting from innovation can be found across the economy, including in sectors like industrials, financial services, healthcare, and energy.

Second, the index identifies technological themes then uses the insights of Morningstar’s equity research team to select the companies best positioned to benefit—as producers, users, or suppliers. And third, the index is unconstrained by geography, including companies across the globe.

In a recent paper examining the index’s performance and portfolio characteristics, we concluded that its diversified collection of innovators has delivered strong performance, driven more by stock selection than by riding a wave in the technology sector.

What are Exponential Technologies?

Morningstar’s equity research team views nine technological themes as poised for exponential growth:

• Big Data & Analytics

• Nanotechnology

• Networks & Computer Systems

• Energy & Environmental Systems

• Medicine & Neuroscience

• Robotics

• 3D Printing

• Bioinformatics

• Financial Services Innovation

Some of the themes encompass a number of trends. For example, Networks & Computer Systems includes the “internet of things,” 5G networks, and virtual reality. Immunotherapy is a powerful field captured within the Medicine & Neuroscience theme. Blockchain and cryptocurrency fall under the broader category of Financial Services Innovation. The themes are subject to change at the index’s annual December reconstitution but have remained constant since 2014.

With the themes selected, Morningstar equity analysts work backward to identify the companies they feel are best positioned to benefit—as producers, users, or suppliers.

Beneficiaries of the nanotechnology theme, for example, include not only chip manufacturers like Qualcomm but also equipment makers like Applied Materials and electronic materials vendors like Entegris. Google parent Alphabet is an obvious innovator in Big Data & Analytics, but Western Digital and Seagate Technology benefit as makers of storage equipment used in data centers. Fanuc is a leading maker of robots, while Rockwell Automation uses robots for discrete manufacturing. Vestas Wind Systems is a leading provider of wind turbines, while Albemarle also earns inclusion under the Energy & Environmental Systems theme because electric-vehicle adoption boosts demand for the lithium it produces. Within Bioinformatics, Illumina makes it into the index as the leader in genomic sequencing, while Nektar Therapeutics uses such data to drive drug discovery and Analog Devices supplies sensors to medical devices and fitness trackers.

Given the range of themes and beneficiaries, the index more closely resembles a diversified global growth than a narrow thematic offering. From a sector perspective, it’s heavy on technology, but the healthcare weight is just as high, and financials, industrials, and communications also feature prominently. Geographically speaking, the index is roughly 60% United States and 40% rest of the world, with above-market weight to European names like Roche and AB and with Chinese tech giants Alibaba and Baidu also included.

The Exponential Technologies Index has delivered through stock selection
The past several years have been favorable to the technology sector. But thanks to its 200-stock equal-weight construction, the index actually holds less of the high-flying FAANG stocks (Facebook, Apple, Amazon.com, Netflix, and Google-parent Alphabet) than the Morningstar Global Markets IndexSM from which it is derived.

Performance attribution conducted in Morningstar Direct shows that the index’s excess returns versus the Global Markets Index since 2014 have been driven not just by being in hot sectors but also by selecting stronger-performing stocks than its benchmark. Top contributors have included not just tech stocks like NVIDIA and Advanced Micro Devices but also those in healthcare (for example, Exelixis), financials (CME Group), and telecom (T-Mobile).

By combining an expansive view of innovation and leveraging Morningstar equity research analysts to select beneficiaries, the Morningstar Exponential Technologies Index has taken a unique and successful approach to technology indexing.

This article originally appeared on the Morningstar Blog