It is well known that public market investors have embraced the technology sector with open arms since the financial crisis. However, it is important to recognize that this focus has manifest itself across private markets as well. So what is it that investors of all types find so attractive about these companies? And should their enthusiasm be curtailed by current valuations?

To start, technology is becoming a larger and larger share of investment spending across the U.S. economy - put differently, this enthusiasm is not limited to the capital markets. As we show on page 39 of the Guide to Alternatives, as well as in the chart below, the steady increase in the share of private equity deals being done in the software sector has tracked a similar increase in investment in software across the economy more broadly. Furthermore, it is interesting to note that while private equity investors have always embraced technology, their focus within the sector has shifted over time. A decade ago, investors were focused on opportunities in hardware; today they are increasingly focused on software.

Most investors seem to agree that technological adoption looks set to continue, but more and more we see people questioning the price they are paying for this exposure. However, it is important to recognize that technology is one of the few sectors that still has pricing power, which should allow these companies to defend both profits and profit margins against a backdrop of rising input prices. Furthermore, these companies have demonstrated an ability to generate consistent streams of earnings regardless of the macroeconomic environment; given at some point global economic growth will return to trend, this will be particularly important over time.

Valuation matters when investing in the long-run, but so do corporate profits. Given the “all-weather” nature of earnings in the technology sector, it makes sense that these companies have become darlings of both public and private market investors. Furthermore, as populations around the world increasingly rely on technology for both work and pleasure, the idea of maintaining secular exposure to these companies - both public and private - makes a great deal of sense within the context of a diversified portfolio.

Software investment and private equity

% U.S. PE deals targeting software companies, software inv. % GDP

Source: BEA, Pitchbook, FactSet, J.P. Morgan Asset Management. Software investment is represented by nonresidential fixed investment in software. Deal, exit and investment data are as of June 30, 2021. Data is based on availability as of August 31, 2021.

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