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 fifth annual review of the long-term secular trends that we expect 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 financial and healthcare sectors. Investors can access a range of leading businesses exposed to these trends via two of our UCITS funds, the Heptagon Future Trends Equity Fund and the Helicon Global Equity Fund.
The most important thing to remember about technology is its inevitability. Once out, the genie can never be put back in the bottle. As we continue to observe in almost every sphere of life, what can be digitised, automated or disintermediated simply will be. Take several examples and it becomes abundantly clear that software is taking over. Consider that the world’s largest taxi company (Uber) owns no taxies, the world’s largest provider of accommodation (Airbnb) owns no real estate, or that the world’s largest phone companies (Skype, WeChat and WhatsApp) own no telecoms infrastructure.
Furthermore, when disruptive technologies converge, their impact in driving change is even more significant, becoming mutually overlapping and therefore reinforcing. Against this background, we should neither be surprised that the pace of innovation is accelerating nor that adoption cycles are shrinking. The number of new patents filed in the US has tripled in the last 25 years and continues to grow well in excess of GDP. Moreover, whereas it took around 35 years for a quarter of the American population to own a fixed line phone, this figure had shrunk to just 13 years for mobile handsets. The adoption of the Internet by a similar percentage of the population took roughly half this time (7 years) and Facebook almost half again (4 years).
Two key questions arise. First, what gives us confidence that this pace of change can continue; and next, why should investors care? In terms of the former, the answer is simple – because it is increasingly easy to do so. Software and the Internet have radicalised the ease of doing business. Today’s greatest disruptors are those that derive their power from consumers in an era where distribution and transaction costs no longer constitute the barriers they did previously. New trends provide new ways of doing things more efficiently, thereby challenging established business models.
This matters also because such developments offer investors growth opportunities in a low-growth world. Thought of from a different perspective, what we seek to identify in our thematic research at Heptagon Capital are trends that are likely to grow in importance regardless of what is happening to global GDP and ideally irrespective of what governments and regulators are doing. Economics relates to the efficient allocation of scarce resource and technology allows us to improve this conundrum in almost every walk of life, from food and energy consumption to retail and transport experiences.
Since March 2011, we have published over thirty notes on topics as seemingly disparate as robotics, personalised medicine, food innovation and nanotechnology. During the past year, we published new research on topics including digital currencies, the car of the future, peer-to-peer lending and energy storage. The commentary below focuses on our core themes where we currently have the highest conviction.
The power of mobile broadband
Mobile broadband is the fastest-growing information and communications technology service in the history of the world. Within the last five years over 1bn people globally have purchased such handsets and the Broadband Commission, an industry body, estimates that this figure can double by 2020. The computational power contained within a current smartphone is equivalent to that of the world’s largest super-computer of 45 years ago. The mix of power and portability is a potent combination. Little wonder then that iOS (Apple-powered) and Android (Google-powered) handsets alone now out-sell conventional PCs by a ratio of 5-to-1.
With this amount of computational power literally in one’s hands, the uses to which it can be deployed are growing exponentially. For the first time ever more people shopped online during America’s Black Friday/ Thanksgiving weekend than they did in bricks and mortar retail stores, according to the National Retail Federation. Amazon reported a 35% year-on-year increase in items sold on Black Friday. Meanwhile, data analysis provided by IBM highlights that of all purchases made during this weekend, transactions initiated on mobile devices accounted for some 36% of total online purchase value.
And, if we’re not buying goods via our handsets, then it is services. Airbnb, for example, now accounts for around 8% of all overnight stays in New York City (compared to less than 1% five years’ ago according to Magid Consulting). Overall, PWC estimates that the sharing economy – comprising travel, transportation, finance, staffing and video/ music content is worth $15bn globally today. The consultancy forecasts compound annual growth for the sharing economy of over 25% between now and 2025, implying a growth in its potential size to more than $35bn.
Three corollaries arise from these developments. First, the amount of data that is being created within the digital universe is growing at an unprecedented rate. Data volumes are currently expanding at 40% a year (according to Gartner), a rate which is set to continue at least through until the end of this decade. Next, all of the data that gets created needs to be stored. Some 60% of it currently resides in the cloud (based on analysis by McKinsey) given the flexibility and cost benefits this affords. Finally, all data that is created and stored needs to be secured. Cybercrime is estimated to cost the global economy as much as $575bn annually, with the number of annual cyber-attacks rising currently by over 50% (according to McAfee and Raytheon respectively).
New technologies are also driving a new era of innovation in financial services. Beyond technology, the enduring legacy of the financial crisis and heightened regulation have created an opportunity for dynamic disruptors. For companies, network effects and technology are changing the way risk is perceived, lowering the cost of customer acquisition and altering the competitive landscape. For consumers, technology is a democratising force, giving them broader-than-ever access to a range of new products and services at lower costs than previously. Clear examples of such innovation comprise crowdfunding and peer-to-peer lending.
The size of the opportunity is immense, particularly when considering that over 85% of transactions by volume globally are still conducted using notes and coins, according to MasterCard. Even in the developed world, the figure is still higher than one might expect, at 59%. However, the shift to non-cash payments is beginning, with the industry having witnessed 36% compound annual growth over the last five years, based on calculations by Capgemini. The increasing ubiquity of mobile broadband is only likely to drive growth further. Some 800m people globally used their mobile handsets for banking purposes in 2014 according to consultants Juniper Research, yet this figure could reach 1.8bn by the end of the decade. Against this background, the number of mobile transactions should grow at a compound annual rate of 22% over the next five years.
Looking further ahead, even conventional cash (whether physical or electronic) may end being superseded. Digital currencies dispense with all this. Buyers and sellers interact directly on a peer-to-peer basis in the digital world. In a fully digital world, not only are there no notes and coins, but also no banks. The system exists in the cloud and is maintained by a network of computers that anyone can join. Central Banks also, theoretically become redundant, at least in their role as arbiters of the amount of money in circulation. Many barriers (regulatory, reputational, social) need to be overcome before the likes of Bitcoin can be considered mainstream, but it will be important to monitor developments here carefully.
It is clear that technology is making our lives easier, but can it also help us live longer? This question matters since demographics and health are two of the most important drivers for long-term economic growth. Moreover, while there are currently around 840m people aged over 60 in the world, by 2050 this figure could reach 2bn, or more than 25% of the world’s population, according to Bank of America.
We believe the answer to the above question is potentially yes, at least when thought about from the following perspective: medicine is increasingly becoming a data issue. The human body is estimated to contain nearly 150 trillion gigabytes of information. This is equivalent to some 75bn fully-loaded 16-gigabyte Apple iPads that would fill London’s Wembley Stadium some 40 times over. Each human genome alone consists roughly 3.2bn base pairs of DNA, equivalent to a text file of around 300 gigabytes. Understand this data and, scientists may understand how to save more lives.
The good news is that the cost and time required to sequence DNA has come down rapidly and should continue to fall. Contrast 2011 figures of $6m per genome and a time to sequence of 10 days with current levels of $1000 and 6 hours respectively. The Broad Institute (a medical research centre operated jointly by Harvard and MIT) is currently decoding one human genome roughly every 30 minutes, and estimates that by 2025, some 1bn people globally may have had their DNA sequenced. This matters since many drugs used on ill patients today are not effective (some $50bn is spent in the US on ineffective cancer drugs alone according to McKinsey), while many people that carry chronic conditions remain undiagnosed. Novo Nordisk, for example, estimates that around half of the people who have diabetes are not aware of their condition. The implications both for the healthcare industry (and for food manufacturers) are considerable.
Doing things better
Not only do we want longer lives, but also easier ones. Robotics and automation provide one way of achieving this end. The substitution of labour for capital makes fundamental economic sense and the displacement of workers by robots is certain industries does not simply imply widespread unemployment, more a recalibration of certain roles. Extensive work conducted by McKinsey highlights that increased automation could accelerate productivity each year over the next decade by 5.5% in the automotive industry, 4.4% in agriculture, 3.4% in retail, 2.9% in food processing and 2.2% in healthcare.
The robotics industry today is currently worth $32bn (according to the International Federation for Robotics, once supporting services are included too), but is forecast to grow at a compound annual rate of some 15% through to the end of this decade. While the two largest end-markets for robots are currently electronics and automobiles, the rate of adoption is accelerating rapidly in the metals, chemical, food and pharmaceutical sectors. There are also large global disparities, with Japan and Germany leading the way at around 300 robots for every 10,000 employees. This compares to roughly half this level in the US and figures of below 50 in emerging economies such as China, India and Brazil.
It is wrong, however, to think of robots solely in an industrial capacity. Service robots may well be able to perform a number of valid roles, particularly in supporting the elderly (dispensing drugs, providing security and assistance). Meanwhile, automation may change significantly our relationship with the car. Japan, for example, is currently contemplating robotic taxis in time for the 2020 Olympics. Furthermore, just as the human body can be thought of as a data-set, so should a car. The average new vehicle coming off a production line today already contains around 10m lines of code (according to research carried out by the Munich Technical University) and software will enable around 80% of future automobile innovation. By 2030, Citi estimates that the driverless car market could be worth some $30bn.
Efficient energy storage could be a panacea for the energy industry, saving billions and making use of abundant natural resources such as sun and wind. This matters, because global energy consumption is forecast to double over the next 50 years according to the Energy Information Administration, a US Government body. We are not there yet with storage, but over $5bn have been invested in battery storage technology projects in the last 25 years, during which time the cost of the storage battery has fallen 90%. Batteries are becoming increasingly cost efficient and are easily scalable. Against this background, the storage industry could be worth as much as $50bn by 2030.
The most ambitious project in this respect is the ‘gigafactory’ being undertaken in conjunction between Tesla and Panasonic. When complete (in 2020 and at an estimated cost of $5bn), Tesla believes that its complex will be able to manufacture storage batteries on a mass-market basis that can be sold to utilities and heavy industry as well as to households for their own needs. Such batteries would also be used for Tesla cars. Chief Executive Elon Musk said in August last year that it had already received reservations for its products totalling $1bn.
Where to invest
Many of the trends described above naturally overlap and intersect. 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. What our preferred businesses share in common are five factors: clear and direct exposure to the theme(s) in question; leading market positions; above-average spend on research and development; strong financial track records; and high-quality management teams.
Investors should note that 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.
The power of mobile broadband: Alphabet (Google), Amazon, ARM
Finance reconsidered: MasterCard, Visa
Living longer: Christian Hansen, Illumina, Kerry Group, Novo Nordisk
Doing things better: Duerr, FANUC, Valeo
Energy storage: Tesla
The above businesses have averaged 31% annualised returns over the last five years in absolute terms on an equally weighted local currency basis (versus 8% for the MSCI World). During the course of 2015 they gained an average of 30%, relative to a 3% decline in the global market using a similar methodology.
All of our previously published thematic research may be found on Heptagon Capital’s website. Over 2016, we will look to publish further notes on selected new topics.
Alexander Gunz, Fund Manager, Heptagon Capital
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