Innovation. It’s not just technology

Investors who associate innovation solely with the technology sector may do well to take a broader view.

15 Oct 2019

A promising strategy should interplay the latest developments at solid players across diverse sectors, and capture performance that is sustainable – both in financial and ESG1 terms.

  • ‘Disruptive technologies’ do not all fall within the tech sector.
  • Real innovations exceed sector barriers, providing investment opportunities that purely sector-based strategies may miss.
  • Targeting companies that are sustainable in the both ESG[1] and the financial sense, i.e. with high ESG standards as well as robust business models that ensure competitiveness and growth.

 

Just the technology sector? No

Our disruptive technology strategy looks for stock ideas throughout the economy, and is not limited to the technology sector. For example, we own Amazon because of its strong position in cloud computing, even though the stock is classified in the consumer discretionary sector like other retail companies. The stocks we would pick can be found in sectors as diverse as industrials, communications services, healthcare, financials, consumption and energy.

Disruptive players can be linked to one or more of four main themes that match our view of disruptive tech. These reflect profound changes in the way companies operate and in consumption patterns.

  • Cloud computing
  • Artificial intelligence and advanced data analytics
  • Automation and robotics
  • Internet of Things

In addition, we monitor emerging technologies, such as 3D printing, blockchain, and renewable energy. We can take exposure through stocks in related fields rather than directly targeting niches. So, crypto currencies can be represented by providers of powerful semiconductors that enable rapid calculations.

In cloud computing, we invest in both the large companies that provide cloud infrastructure services, as well as companies that provide software applications as a cloud service.

One can invest in artificial intelligence and data analysis via the financial services and healthcare sectors. Finally, the Internet of Things can involve sometimes unforeseen applications. Stories are proliferating of people saved by their internet-connected watch allowing for a rapid medical diagnosis.

 

A better world or the best of worlds?

We believe that the use of machine learning algorithms will create economic value by making long and complex processes more efficient and by providing enhanced decision-making tools. However, there are pitfalls. The effectiveness of any algorithm depends on the quality of the data used to train the artificial intelligence. For example, genetic data has historically been biased because it was primarily sourced from non-diverse populations of European descent. In addition, AI for facial recognition can be misused by governments and other actors to negatively impact privacy or to create fraudulent videos. This illustrates the need for regulation to ensure proper use of these powerful tools.

Beyond moral and technical considerations, the question of abuse of dominance arises when one looks at (the giants of) technology. It has given rise to debate about the need to regulate or even dismantle companies. We are actively monitoring stocks that are exposed to the threat of tighter regulation.

We believe it is important for investment managers to take an active, fundamental approach to investing in disruptive technology trends. We meet companies, suppliers, customers, competitors, industry experts, academics, and others to enhance our knowledge of the changing technology landscape.

 

A conviction-based approach

We apply fundamental stock research to identify sustainable companies with enduring competitive advantages trading at attractive valuations. We look for companies with resilient business models that do no harm from an environmental, social and governance (ESG) perspective. Companies that have a lasting competitive edge based on innovation, the number of patents, its market share, its reputation and other barriers to entry. Financially, we examine the valuation relative to peers, the stock’s own history, using discounted cash flow models.

Our view of the disruptive technology universe is broad, including emerging markets and small and mid-caps. These segments are particularly active in disruptive technologies and can be a continuous source of innovation.

 

The right time to invest?

Looking at valuations, technology stocks are currently trading at a 10% premium to the broader market based on a forward-looking 12-month P/E ratio. This is in line with the historical median since 1995.  We believe this premium is justified by the superior growth prospects of the technology sector.

The current macroeconomic and geopolitical environment is highly uncertain. Most of the sectors we invest in, including technology, industrial, and consumer discretionary, are cyclical. However, we believe investing in companies with strong secular growth drivers makes sense across cycles. Even in the event of a sharp slowdown, we expect companies not to freeze all of their technological investments, but focus on the more innovative parts of the industry.

Accordingly, we view disruptive tech investing as a long-term (three to five-year) strategy, which involves keeping a close eye on the changes that can arise rapidly in this field.


[1] ESG = Environmental, social and governance