Preparing portfolios for the next wave of disruption

Disruptive technologies, which are either innovations which create a new market or those which change the way an established industry functions and in the process displace the incumbents, have had a huge impact on the global economy in recent years. Retailing and newspapers, for example, are two industries which have been transformed by the rise of the internet, and there are many others undergoing such drastic change. But how can investors take advantage of these changes, or should they concentrate on protecting themselves from those companies likely to be adversely affected?

Disruption and innovation is a core theme in Sarasin’s global thematic equity process, looking to marry analysis of long-term trends with more traditional equity analysis. Iain McNaught, global equity analyst at Sarasin, explains how hard it is for incumbent businesses to stay at the top of their game. “If you look at the S&P, the average tenure of a company has gone from 61 years in 1958 to 18 years today. This has got a lot shorter because there is a lot more disruption coming through.”

It is clear to see how some business models have crumbled recently, he explains, highlighting how supermarkets and high streets have been hit by online retailers, while established airlines unable to compete with leaner, low-cost upstarts. And any investor looking to play this theme should be aware of both those on the way up and those who may be on the way down.

“I think it is more important to avoid the torpedoes than to catch the shooting stars,” says Mr McNaught. Established companies faced with changes to their industry may try to change their business models, or to buy and incorporate their new completion, but this is often easier said than done.

Picking the winners, even if you have correctly identified the new trends, can be difficult. These companies are often funded by private equity and are hard to access, while those listed on public markets tend to have very high valuations.

And there is no way of telling which companies will succeed. The rise of a new technology often brings a number of players into a particular market, but not all are likely to thrive. With hindsight it is easy to pick Google as one of the big winners in the digital age, but a decade ago many were touting Yahoo as the one to watch.

The internet of things

Lombard Odier highlights the ‘internet of things’ as one of the major themes driving the technology sector over the next decade or more as the web goes through its next evolution. Globally there are currently around seven billion devices connected to the internet, a number that will rise to 50bn or more by 2020, according to Cisco. And this could transform a range of industries, from ecommerce to farming, with Cisco predicting the ‘internet of things’ market will be bigger than current US GDP in 10 years’ time.

“These days even cattle can be connected,” says Bolko Hohaus, head of the technology investment team at Lombard Odier Investment Managers. “Cows can swallow a bolus which in turn sends a wireless signal to its collar giving information about the temperature of the cow and sending alerts, allowing, for example, illnesses such as pneumonia to be picked up earlier.”

Amazon, which has had a huge impact on traditional retailing, continues to be an innovator. Mr Hohous highlights its purchase of Dutch company Kiva Systems for $775m (€560m) and how this has improved the efficiency in their warehouses by 400 per cent through the use of modern robotics. “Now the products come to the workers, rather than the other way around. This now means that same day delivery is possible, which will enable Amazon to increase their revenues.”

The opportunity for investors in these sectors is still early, he claims, but it is hard to know who all the winners will be and volatility in the technology sector is relatively high. Lombar Odier’s LOF Technology Fund, which has $450m in assets, has a turnover of around 150 per cent a year, with Mr Hohaus explaining how companies who may appear to be on a successful path getting derailed, while those who have done very well tend to get challenged more than in other industries.

However he highlights how technology stocks have outgrown global equities over the last 20 years, a trend which he expects to continue. But some parts of the market are too expensive. “Twitter assumes too much good news up front in their stock price,” warns Mr Hohaus. “And some 3D printing names have risen too far. But there are plenty of attractively priced options with great cash flows and balance sheets.”

The internet of things will require stronger networks, Wifi, near-field communications and lots of sensors to ensure machines can talk to each other, explains Tim Jaksland, innovation sector analyst at Carmignac Gestion, and he believes Google is well positioned to benefit.

“Google is one of our biggest tech holdings at the moment and is extraordinarily well positioned for this trend,” he explains. “It isn’t easy investing in this as there are a lot of products in the early stages and it is difficult to say which will succeed. Google acts as a gateway for new technologies, so if you invest in the stock you get a cut no matter who wins.”

In emerging markets, South Korea’s Samsung is also worth a look, according to Carmignac. “Samsung is not a super innovator like Google, but they are a fast follower,” says Mr Jaksland. The company has a strong position in semiconductors, which are vital for the internet of things trend, while they also provide the devices that consumers will use, such as TVs and smartphones.

But with little more than a decade having passed since the collapse of the dotcom bubble, are investors’ ready to listen to predictions labelling technology companies as the next big thing? The dotcom question does come up in more or less every meeting, admits Lombard Odier’s Mr Hohaus, and clearly remains at the back of peoples’ minds. But he believes that even if some sectors of the market are overvalued, these are very different times to the dotcom era.

“Back then just adding dotcom to your name would see your stock open the next day 30 per cent higher. But many of the companies didn’t have sustainable business models and were trading at totally ridiculous valuation levels,” says Mr Hohaus.

“Disruptive technology companies are affecting all sectors, and technology is the key driver of US growth – more than half has been driven by the sector over the last 20 years. Technology is how you pick between winners and losers. This is not a fad, it is a key enabler.”  

Case study: 3D printing

The manufacturing process known as ‘3D printing’, whereby objects of virtually any shape are created by building layers from a digital model, has been around since the 1980s, used mostly for prototype parts. However technology has advanced to the point that it is now coming into the mainstream.

The process “is great for low volume, high precision goods,” says Frederique Carrier, director of the Portfolio Advisory Group at RBC Wealth Management. “We are seeing it in the luxury car industry, for airplane engine parts and so forth.”

There are two main advantages, she says. Because 3D printing can do things in a very complex manner, it is well suited to personalisation. And there can be cost benefits, for example with dental implants. “Traditionally a dental implant might cost you 50 cents in materials, but you then have a lot of manual labour. The systems and materials in 3D printing might be €25, but there is no manual labour, which makes it much cheaper as an end product.”

The revenues of the entire 3D printing industry is about $2.4bn (€1.7bn), explains Ms Carrier, while global manufacturing is about $10tn. “So 3D printing is only 0.02 per cent of that. It is tiny, and it is not going to take over global manufacturing. But a rise to just 1 per cent would mean huge growth for the industry.”

There are plenty of companies using 3D printing and many others who are considering it, and investors can follow this indirect route to access the growth. Or they can invest in the companies providing the printers or the software, but these stocks can come with “eye watering valuations”.

“We would tell clients to really pick your entry point,” says Ms Carrier. “Because this is a new technology and we don’t know who will be the winners or the losers it is perhaps best to have a diversified approach.”