Technological innovation should not be considered to be the exclusive preserve of sectoral technological funds. For a start, the sector identified as ‘technology’ by index providers does not actually include all the companies in the tech sector.
Dominant players such as Amazon1 (actually part of the ‘consumer cyclicals’ sector) are not even part of the S&P 500’s technology sector.
That’s one good reason for looking at the theme of technological innovation in other sectors. There’s no escaping the fact that technology is profoundly affecting everyone’s daily life. It’s not just the new technologies fanatics who are being rebooted.
Our investment philosophy
Our disruptive technology strategy is implemented within a global equity team of 19 managers located in Paris, Boston and London. They manage assets of EUR 8 billion and draw on the expertise of a team of financial analysts.2
The strategy underpins a portfolio that is highly concentrated, containing between 30 and 50 stocks. It is significantly different from the benchmark’s stock allocation, underlining the fact that this is a high-conviction, judgemental strategy.2 Our process is based on discretionary stock selection, not on positioning relative to an index.
The investment universe comprises about 2 000 companies. Our portfolio includes an allocation of 20% to 25% of securities whose market capitalisation is less than EUR 10 billion. At just over EUR 700 million,2 total assets under management are still relatively small for a strategy in this category.
Our investment process is based on fundamental analysis of the companies’ balance sheets. We look closely at the price earnings growth (PEG), that is companies’ price-to-earnings growth divided by the estimated earnings growth rate. This metric gives us a perspective on the dynamic of the business model in question.
We consider this strategy to be appropriate for investors with an investment horizon of five to 10 years.2 We insist on the fact that our strategy covers a broad range of sectors, not just the tech sector. A look at the diversified breakdown of our strategy demonstrates this point.
Exhibit 1: Sector and geographical breakdown of the disruptive technology strategy
The breakdown of the benchmark is mentioned for illustrative purposes. The overweight of our disruptive technology strategy in US equities reflects the relatively large number of innovative companies in the US. Indeed, US companies enjoy tax advantages on research & development focused on innovation. They benefit the close links between academic research and the corporate world.
Understanding how innovative technologies work and develop helps to explain how some of them broke the barriers between sectors by disrupting the status quo.
The development, for example, of dematerialised means of payment, made possible by the technology embedded in mobile phones, has dealt a blow to incumbents and offered an entry point to newcomers who until now were not credible as challengers in the retail banking business.
In the agri-food sector, Amazon’s takeover of Whole Foods Market in 2017, shook up the organic and quality food distribution sector for affluent urban citizens.
Technology is now omnipresent. This explains the extraordinary increase in market capitalisation for some tech stocks and their impressive revenue growth. Such results can only be achieved by seeking income from a broad range of business activities.
Four themes to consider for a technology that moves the goalposts
We do not look solely at companies in the technology sector. We seek companies whose principal business activity may vary across industries, be they in communication services, healthcare, finance, consumption or energy. For us, what matters is their efforts to implement at least one of the following four innovations:
- Cloud computing – Calculation, storage, cybersecurity
- Artificial intelligence – Data analysis
- Automation – Robotics, management of physical goods warehouses, robots used in medicine
- Internet of things – Domotics, connected objects
To our mind, ‘disruption’ is today essentially associated with these innovative technologies.
Nevertheless, let us remember that there is not necessarily a link between these two characteristics. Technology can be employed without profoundly changing the economic environment and, in the same way, a major, permanent impact can be made in a human activity without it necessarily being achieved by a technological enterprise.
Harvard researcher Clayton Christensen, who introduced the term ‘disruptive technology’ or ‘technology of rupture’, popularised this concept in a book published in 1997. One of his examples is the disruption in the US car market caused by the arrival of the compact Toyota. This new model, more energy efficient, captured a public that did not want to buy the big sedan, the main model sold at that time by US carmakers.
Some observers are not convinced that new players, whose strategy is to increase supply by facilitating access to a service, can be ranked as disruptive companies.
From a financial point of view, valuations are not the main risk for our strategy. This observation remains valid despite the surge in valuations of some well-known stocks in 2017 and 2018.
The changes to the business environment that have taken place in recent times justify our view that this strategy requires a medium-term investment horizon.
The main risk is more difficult to manage as it involves goverment policy decisions that would stiffen or introduce new regulation of the business for some of the flagship companies.
Under this perspective, the integration of ESG (environmental, social and governance) criteria across our full range of investment strategies potentially enables us to better identify those companies who may be at risk from a change in the regulatory environment.
1 This security is mentioned for illustrative purpose only, it is not intended as a solicitation of the purchase of such securities, and this does not constitute any investment advice or recommendation.
2 Source for all data: BNP Paribas Asset Management; for information on the strategy, please refer to the latest KIID and prospectus; these are available from www.bnpparibas-am.com