More change on the way: future trends for 2015 and beyond
Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.
The 30-second summary: Thematic investing is a core part of our investment process at Heptagon. This is our fourth annual review of the long-term secular trends that we expect only to grow in importance over time. The digitisation of the world and the associated data deluge underpin almost every other current development. Ramifications will be felt everywhere, across most conventional industries as well as within the healthcare and banking sectors. Well-placed businesses that offer exposure to various future trends include Amazon, ARM, Duerr, Illumina, Google, McKesson, MasterCard, Novo Nordisk and Western Digital. Investors can access a range of these ideas via our Helicon UCITS equity fund, or via our Helicon Future Trends product.
Technological narratives tend towards extremes, typically either utopian or dystopian. In reality, however, technological development is a much steadier and more predictable march – things get smaller, quicker and better. It is important to remember that almost no technology remains fixed. The analogy with a human being (or any other living organism) seems a good one: technologies start, develop, persist, mutate and then decline, only to be replaced by others. From the mechanisation of the Industrial Revolution through to the computer-driven upheaval during which we are currently living, innovation has always underpinned economic change and disrupted the way we do things.
From our perspective, at Heptagon, we simply try to identify trends that will likely grow in importance regardless of developments either in the broader economy or interventions on the part of governments. Our thirty theme pieces written since the start of 2011 have discussed topics as diverse as nanotechnology and molecular diagnostics while also considering themes such as food innovation and cybercrime. It remains important to remember that innovative ideas often can develop into consensus views and hence also missed investment opportunities, particularly in a world awash with information. The commentary below focuses on our core themes where we currently have the highest conviction.
Digitisation and data underlie almost everything
During the last thirty years there has been a seismic shift. Computing is no longer thought of as the preserve of enterprise mainframes; rather, the Internet has been consumerised. Back in 1990, less than 1% of the world’s population was connected to the Internet and just 3% owned mobile phones. Today, more than one-third can communicate via the Internet and two-thirds are in possession of mobile devices (according to McKinsey). Moreover, if the Chairman of Google (Eric Schmidt) is correct, everyone will be online by the end of this decade. The US is 87% of the way there, but the comparable figures for China and India are 46% and 19% respectively.
Even if this target is not reached, it remains the case that the amount of data being created is staggering. According to Intel, it will have trebled between 2012 and 2015. Furthermore, forecasts from Western Digital and Seagate, the world’s two largest data storage businesses, suggest that worldwide data creation should run at a rate of 30-40% on an average annualised basis through to the end of this decade at least. The related growths in connectivity and creation are being driven by greater processing power, cheaper memory and storage facilities, faster and wider networks, and smaller devices with greater mobility.
Skype, online retail, music streaming, the application of IT to the healthcare sector, digital payments and MOOCs (massive open online classes) are becoming increasingly commonplace. As more and more people, businesses and devices become interconnected, data usage and the range of applications to which data can be applied will become even more advanced. Expect developments such as crypto-currencies, 3D holograms, intelligent implants, smart materials and augmented reality among others only to grow in significance. Nanotechnology and the Internet of Things will only likely exacerbate this shift. Combined, these are very powerful forces.
Nano means very small. Even today a device the size of a grain of salt (equivalent to one millimetre cubed) can now include a solar cell, a thin-film battery, a memory chip, a pressure sensor, a wireless radio and an antenna. The range of ‘things’ to which such a device can be applied is almost limitless. Moreover, these dimensions will only likely get smaller. Sensors could, therefore, theoretically be attached to entities as diverse as a horse in a field, a container on a freight train, a smoke alarm in your home, or a lamppost in a street. These could all be thought of as nodes in the Internet of Everything. Currently just 0.6% of all objects in the world are connected to the Internet, according to Cisco. With a forecast compound annual growth of 20% through to the end of this decade, Cisco expects the number of connected people and things to expand from 12.5bn to 50.0bn. Even at this point, connected penetration would be only 3%; just the tip of the iceberg.
While we all still enjoy the comfort of knowing there are coins in our pocket and banknotes in our wallet, banking and how we spend our money look poised to benefit from the digital revolution. The annual value of online, mobile and contactless payments globally will have reached $2.5trillion by the end of 2014 (according to Juniper Research). While this sounds an impressively large figure, cash still accounts for over 80% of worldwide personal consumption expenditure and fewer than 8% of all retail purchases globally occur online at present.
Digitisation, data, mobility and cash alternatives go hand-in-hand. Electronic money – in contrast to its cash peer – is instantaneous, weightless and exact. It offers speed and flexibility. If customers do not need either to queue to get cash out of banks and also spend less time waiting at the point of sale, they are less likely to abandon their purchases and more likely to spend ever-increasing amounts. Against this background, the online retail market is set to expand at a growth rate of at least 15% based on most forecasts, while PayPal (a payment processor for online vendors, owned by eBay), forecasts that before the end of this decade, most people will not take their traditional wallet with them when they go shopping. These trends could see the overall market for non-cash payments almost doubling by 2020.
Looking further ahead, the potential for further changes in how we spend and bank our money is significant. An industry which is dominated by information and where many products/ services are already ‘virtual’ in nature has already made a partial step in the right direction. The emergence of alternative currencies (such as Bitcoin) and peer-to-peer lending schemes (such as Funding Circle) highlight the potential for emerging services to displace more traditional ones. Expect these only to grow in importance.
The robots are coming
The idea of automation has had long-held appeal. Machines do not just save labour, but can also improve quality, accuracy and precision. Automated processes are commonplace in areas such as switching in telephone networks and the steering of aeroplanes, but looking ahead, there will also be a growing ubiquity of robots. Robots already help to build cars and assemble electrical goods. Around 60% of the manufacturing process within the car industry is now automated, for example, with robots involved in the welding, gluing, painting and final assembly processes. Correspondingly, some car manufacturers now produce twice as many cars as they did a decade ago.
Close to 200,000 robots will have been sold during the last year, implying annual growth of over 10% and an industry size of more than 1.2m robots in service (according to the International Federation of Robotics). This is equivalent to one for every 6,000 people. The ratio should only grow over time. It is possible to envisage scenarios where robots will be employed in areas as diverse as performing surgery, spraying crops, guarding property or doing household chores.
Being able to communicate with other devices (via the Internet of Things) and/or share the results of their actions (via data transmission through the cloud) only increasing the power of robotics. The robotics market is already estimated to be worth at least $25bn in size (according to research by Citi), but could expand by 20% through to 2016. Indicative of the potential, Japan – the country in which robotic penetration is highest – has committed to growing its robotic population 20-fold before the end of the decade. If other countries were to head down a similar path, current expectations for market size could be comfortably surpassed.
We all want to live longer. Technological change and data can help drive this process, but only so far. While the prospect offered by molecular diagnostics has the potential to be revolutionary, part of the impulse for extending life ultimately remains behavioural, namely wanting to (if not needing too) eat more healthily.
Beginning with the basics, healthcare expenditure accounts for around 10-15% of a typical OECD nation’s GDP, a significant figure. Yet the industry is remarkably inefficient. Very few areas of healthcare have been digitised even if electronic healthcare records and prescriptions have the potential to improve matters markedly. Wide-ranging estimates have put the benefits from introducing electronic health records and other similar projects at between $80bn and $450bn annually for the US (depending on what is included within the definition of healthcare IT; most, conservatively, average at about $300bn). Lives could be saved too. It is a sobering statistic to note that in-hospital medical errors result in more fatalities than traffic accidents, homicides and suicides combined in America (according to data from McKean Associates).
While digitising healthcare records and patient prescriptions is undeniably a logical step in the right direction, it should be seen as part of a broader revolution sweeping through healthcare. Put simply, current medical practice is predominantly reactive, with treatment/ medication commencing after the concerning signs and symptoms appear. In the future, medical practice may become substantially more proactive. Although less than 1% of the human genome differs between individuals, understanding these differences holds the prospect for great advances in disease prevention and treatment.
Just a decade ago it cost around $80m to sequence a human genome, based on data from the US body, the National Human Genome Research Institute. It was hence the preserve of specialised academic and government research centres. Even five years ago, the cost remained exorbitantly high, at close to $9m. By contrast, today the cost is only $1,000. Data throughput and the cost of DNA sequencing are currently improving by a factor of 10 every 18 months. As a result, a sequencing machine today would cost a surgery or hospital as little as $50,000, fit comfortably onto a desk, and be able to read 10m letters of genetic code with a high degree of accuracy in only two hours.
While medical innovation can save both lives and money, so can what we eat. Put another way, almost a third of the world’s population is currently overweight or obese. This levies an overall annual cost of $2trillion (in terms of treatment and lost productivity), corresponding to 2.8% of world economic output. Such a sum is equivalent to the cost of armed conflict or smoking, according to McKinsey. It will also only grow over time, and by 2030, close to half of the global adult population will fall into either the overweight or obese category. Food innovation is responding to this impulse with many manufacturers launching low sugar, salt and fat products, for example. However, these comprise only a small percentage of the 180,000 annual new product launches (a figure set to rise to 300,000 by the end of this decade). Other growth categories include products catering for people with food intolerances, changing needs as they age and also those that emphasise natural provenance. All look set to experience growth.
Where to invest
Many of the trends described above naturally overlap and intersect and hence we believe that should investors seek to consider gaining exposure to them, then opting for a basket or range of businesses may be most appropriate strategy. The below list is far from exclusive, but simply comprises a selection of ‘best ideas’ or well-exposed companies. Moreover, it should not be forgotten that given the nascent nature of many of these developments, several of the potentially best exposed businesses may still be privately owned rather than publicly listed.
Among the mega-cap tech behemoths, Amazon and Google have both developed attractive positions. Beyond being well-known as the world’s largest online retailer (with last reported revenues of ~$75bn), Amazon has developed a significant position within cloud computing via its AWS service, which accounts for over 25% of the cloud services market. Amazon has also been an early adopter of robotics, having acquired privately-held Kiva Systems in 2012. Kiva’s robots are self-propelled wirelessly connected machines that receive orders (from the point when the customer hits the ‘place your order’ icon), move around warehouses to retrieve items and then take them to the appropriate shipping point. With regard to Google, not only does the company dominate the global search engine query market (ex-China), but has spent $30bn over the last five years in order to leverage its core competencies into new areas. Longer-term opportunities could include wearable devices (Google Glass) and the connected car (Android Auto) among others.
These businesses (and Apple, Microsoft too) have also begun to make inroads into the payments/ cash alternatives market. However, the approach has tended to be collaborative rather than confrontational, recognising the fact that MasterCard and Visa are heavily interconnected within the financial system as the dominant payment processors. These businesses are benefiting from the ongoing shift from cash to card-based payments and both companies are continuing to innovate actively in their own right (MasterCard seems to be ahead of Visa in this respect). In a recent meeting with MasterCard management, the company’s Chief Financial Officer described to us in detail the opportunity comprised by the Internet of Things and how many machines, for example, could make direct payments (via a processor) without the presence of a human.
Businesses across a variety of industries have already begun to embrace the Internet of Things including large organisations such as GE, Siemens, ABB and also a range of mining companies and auto manufacturers. Many have also started deploying robots. Duerr looks well-placed within the robotics space, having developed an early lead in partnering with car manufacturers and, as a result, typically has a leading market share in the segments where it is present. More broadly, in order for devices to function autonomously, there is a requirement both for effective software and hardware. ARM Holdings looks well-positioned in the former category, being the world’s leading semi-conductor intellectual property company with c30% market share. Over 2bn ARM-licensed chips alone were shipped last year. Meanwhile, Rockwell Automation has established a strong position in designing and manufacturing electronic and electrical equipment, systems and services for both commercial and consumer markets.
Within the healthcare space, McKesson has established a strong position as a world leader in medical management systems and pharmacy distribution. Some 20% of all US physicians use McKesson systems, connecting and automating 37m patient records. In addition, over 50,000 pharmacies and 44,000 healthcare providers use McKesson IT, processing more than $14bn transactions annually. The company is also establishing an international presence. With regard to molecular diagnostics, Illumina has been in the vanguard. The company raised guidance three times during the past year and sees its addressable market as worth up to $20bn, against last-reported revenues of $1.4bn. Elsewhere, Novo Nordisk is positioned as the world’s leading provider of diabetes care (one of the inevitable consequences of rising obesity), operating in a market with more than 10% annual growth potential.
Finally, it should not be forgotten that whether it be DNA sequencing, the management of diabetes treatment and the broader organisation of healthcare records, or the processing of cash and the planning of robotic fleets, all of these processes are data-dependent. Data needs to be collected, stored, analysed, retrieved and secured. Some 90% of data is currently stored on hard-disk drives and most industry experts expect this mechanism to remain the default storage standard for the foreseeable future. Western Digital and Seagate dominate the market, with over 80% share between them. Both companies have benefited from industry consolidation and a more stable market has allowed the businesses to invest further for future growth.
The above businesses highlighted in bold have averaged 31% annualised returns in absolute terms on an equally weighted local currency basis over the last five years (versus 11% for the MSCI World). During the course of 2014 they gained an average of 14%, relative to 5% for the global market using a similar methodology.
Other topics on which we have written – and in which we continue to have high conviction – include the US freight rail renaissance, the potential for both liquefied natural gas and fracking to revolutionise the energy industry, global power and water shortages, and what the home of the future may look like in terms of smart materials as well as LED lighting. All of our previously published pieces may be found on Heptagon Capital’s website. Over 2015, we will look to add selectively to this list of topics.
Alexander Gunz, Fund Manager, Heptagon Capital
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