Kyle Caldwell reviews some of the most monumental shifts taking place and outlines how investors can profit.
Identifying tomorrow’s winning investments is ultimately what all fund managers are paid to do for a living. However, the statistics show that many active fund managers fail to add value over the long term, when measured against a backward-looking index that reflects companies’ past success rather than future potential by listing them in order of size.
Most fund managers will claim not to look in the rear-view mirror and describe themselves as being index-agnostic. A sceptic, though, might find this hard to believe when the performance of these managers and their peers is judged in comparison with the relevant index. Simply put, if a UK fund manager benchmarked against the FTSE 100 index completely avoids the five biggest names in the index, which together account for 28 per cent of the total index, the fund’s performance relative to the index will be heavily influenced by the performance of the five giant stocks they do not own.
Therefore, even though many fund managers do look forward and aim to profit from certain trends, the reality is that most of them retain exposure to a selection of the constituents of their benchmark index.
Nonetheless, in many cases a portion of their portfolio will be allocated to companies they think are likely to influence the investment landscape over time. Such firms can be found after identifying the so-called super-trends that are reshaping the world. Here we look at some of the best ideas being followed by leading fund managers.
Tech firms changing the world
Huge advances in technology over the past two decades have transformed the way businesses operate and consumers buy goods. There have been numerous influential innovations, with the internet being the biggest game-changer, and over the next decade, it’s likely that the speed of technological change will increase.
Tech-savvy businesses have been reaping the rewards, which is why it is no surprise to see that Apple, Alphabet, Microsoft and Amazon are the four biggest companies in the world by market capitalisation. Investors who spotted at an early stage that these businesses would become dominant players will have made a mint. But the quandary facing those sizing up these businesses today is whether the valuations attached to the shares will prove sustainable in the long run. Some investors, including Alasdair McKinnon, manager of The Scottish Investment Trust, are steering clear of big technology names on these grounds.
He says: ‘Today, Facebook and Amazon shares cost more than six times as much as they did five years ago. You would need to pay 12 times more for Netflix shares and even Google costs 2.5 times more than it did in 2013. It’s certainly possible that these shares will continue to do well, but we see better opportunities elsewhere: in stocks that are arguably valued to reflect a pessimistic view of their prospects and therefore have much more potential for positive surprises.’
Other investors, however, including James Anderson, manager of Scottish Mortgage investment trust, argue that the competitive advantages of tech-heavy businesses are worth paying more for. Among the stocks backed by Scottish Mortgage at an early stage that have achieved great success are two of China’s biggest tech names, Alibaba and Tencent, which have established both dominance and scale in their respective fields. ‘The basic underpinnings of the technological revolution are getting stronger rather than weaker,’ says Anderson.
Profit from the next industrial revolution
The trouble with a hot trend such as technology is that the ‘stock market tends to get carried away’, notes James Henderson, manager of Lowland investment trust. Indeed, several technology companies that have never turned a profit are on pricey valuations, including Tesla, Spotify and Snapchat. According to Henderson, the key to playing any super-trend is to look under the bonnet and invest in the sub-sectors that look set to dominate in coming years.
In the technology space, the rise of robotics and artificial intelligence (AI) stands out. Sundar Pichai, chief executive officer at Google, recently stated that AI would have a greater impact on the world than the exploitation of fire or electricity. Indeed, advances in AI and robotics are powering what many believe to be the fourth industrial revolution.
Henderson owns Blue Prism, an Aim-listed stock that has seen its share price rocket from £1.11 to £13.22 (as at 6 April 2018), since its stock market listing in April 2016. The firm provides ‘software robots’ that automate back-office clerical tasks. ‘Robotics and AI are viable trends that are real and will change the way many industries operate over time,’ says Henderson.
Walter Price, manager of the Allianz Technology Trust, expects AI to becoming an even more significant trend over the next decade. He says there are various ways to profit. ‘From consumer goods such as the Amazon Echo to autonomous driving, practical applications of AI are emerging. We expect AI to increasingly be used to make our lives more convenient.’ AI is already disrupting a number of other sectors that investors can profit from, adds Price, such as healthcare and financial services.
Other tech winners
Another tech sub-sector that many tech-minded investors are focusing on is the so-called ‘internet of things’, a world in which everyday objects contain technology that connects them online. Mark Sherlock, head of US equities at Hermes, owns the US-listed stock Silicon Labs, a semiconductor company that makes products that enable wireless activity for thermostats and security cameras. ‘Super-trends are long-term in nature, but the danger is that any theme could end up being a shortterm fad. The internet of things concept will only become more prominent over time,’ says Sherlock.
Cyber security is another sub-sector that looks set to grow over the next decade as businesses are driven to spend more and more money on protecting their data from increasingly innovative hackers. Looking further into the future, quantum computing is an area to watch, according to Mike Fox, manager of the Royal London Sustainable Leaders Trust.
Plug into the battery revolution
The field of technological solutions to environmental problems also offers plenty of rich pickings. According to Fox, one of the main ways to profit is to target businesses that support clean technology, such as renewable energy. An alternative route is to plug into the battery revolution. ‘The challenges facing electric car manufacturers are much less difficult than those faced in the switch from horses to cars 100 years ago,’ says Fox. ‘Take-up of electric cars so far is extremely low, but we think there’s a high chance electric cars will become widely adopted in the future.’
There are various problems, not least the lack of charging points here in the UK. In addition, charging times, ranging from 30 minutes to a couple of hours, will surely need to fall for electric cars to become credible replacements for petrol and diesel vehicles.
However, Jon Forster, co-manager of Impax Environmental Markets investment trust, argues that growth in the electric vehicle market will accelerate in coming decades. ‘The combination of swiftly improving technology, initiatives from developing economies, public health concerns pressuring governments to tighten air quality regulations and changes in consumer preferences is driving significant growth in the electric vehicle market. The investment opportunity is global in scope and decades long in outlook,’ says Forster.
Picks and shovels
Investors looking to take advantage of this trend should steer clear of the big car businesses such as Tesla, according to Fox, as valuations have gone through the roof. Tesla, co-founded by Elon Musk, who earlier this year launched a car towards Mars, is another tech firm that has never turned a profit.
‘The way I see it, the situation is comparable to the [California] gold rush: we don’t want to be buying miners; we prefer to look for the providers of the picks and shovels,’ says Fox. He owns Germany-listed Infineon, which provides semiconductor solutions for electric vehicles. He also owns France-listed Valeo, which makes products ranging from sensors to engine parts.
Another investor who has taken a different direction to play the battery revolution is Stephen Bailey, who manages the Liontrust Macro Equity Income fund. He is targeting electric vehicle battery commodities such as lithium, cobalt, nickel and copper.
He says: ‘We believe this is best achieved via the diversified miners. We view these stocks as a disruption-proof way of investing in the electric vehicle trend without having to predict which automotive manufacturer or battery technology will become the market leader.’ Bailey owns Glencore, Rio Tinto and Anglo Pacific within the theme.
The silver economy and millennials’ values
The developed world’s ageing population poses numerous economic challenges that politicians will have to stand up and address at some point. But as investment bank Credit Suisse points out, the so-called ‘silver economy’ throws up plenty of opportunities for investors. ‘The number of senior citizens in the world is expected to grow to more than two billion by 2050. Investors positioned to service the continuum of senior citizens’ wants and needs – such as senior-centric consumer goods, healthcare services, housing, wealth management and pension solutions – are likely to achieve attractive returns.’
Another separate super-trend, according to Credit Suisse, focuses on millennials’ values. This generation is one of the largest in history, and millennials will soon be reaching maturity as investors. The bank says: ‘Their values – particularly caring about the environment and climate change – are most likely to become ever-more influential and fuel growth in areas such as sustainable investment and clean energy.’
Other more established trends relate to infrastructure and water. In short, there’s a great need for infrastructure spending in both developed and emerging market economies, to improve health and transport systems. The same is true with water infrastructure, in the face of ever-increasing demand for effective water management schemes.
Further super-trends will doubtless emerge in coming decades, as technological innovation continues to evolve to meet the increasingly sophisticated needs of the world’s growing population.
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