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The sharemarket has a habit of overestimating megatrends at the start, then underestimating their strength and duration when things get interesting and valuations improve
The so-called “FAANG” stocks are an example. The earnings potential of Facebook, Amazon, Apple, Netflix and Google (through parent Alphabet) is no surprise. Yet soaring share-price gains in FAANG stocks last year shocked a market that underestimated their growth.
Locally, the same is true of Seek, REA Group and Carsales.com. I recall some fund managers who argued for years that these stocks were overpriced. They underestimated the migration of advertising from print to online – a trend that still has further to run.
The same pattern will be apparent with stocks exposed to Industrial Revolution 4.0 – a catchy title for the combined effects of big data, cloud computing, the “Internet of Things” (connected devices), machine learning and automation. The connecting force is artificial intelligence (AI) that uses algorithms to crunch big data and inform machines.
If one believes the hype, one in two jobs is ripe for full or partial automation from technology; companies worldwide will spend trillions of dollars annually on fighting cybercrime; tens of billions of internet-connected devices will revolutionise supply chains and commerce; blockchain technology (a form of shared ledger) will wipe out layers of intermediaries across industry; and data will become the next great company asset.
It’s impossible to know for sure how these trends will play out. But from an investment perspective, three things are certain. First, long-term investors, such as Self-Managed Superannuation Funds (SMSF), need some exposure to these trends. No investor should bet the house on them, but a small allocation in a growth portfolio makes sense.
Second, investors need a long-term horizon (five to seven years) and a diversified approach that uses managed funds. For most retail investors, being exposed to a portfolio of Industrial Revolution 4.0 stocks makes far more sense than trying to pick a few big winners. There will be more losers than winners – and plenty of volatility – as these trends intensify.
Third, Australian investors must look overseas for exposure. ASX has done a great job attracting offshore technology companies, and a few local ones, such as Altium, have become billion-dollar “unicorns”. But most action in AI is in the United States and Europe.
After years of hype, 2018 could be a turning point for AI. Just over 97% of Fortune 1000 companies are building or investing in big-data or AI initiatives, according to the Big Data Executive Survey 2018 by NewVantage Partners, a US information-management consultancy.
NewVantage Partners says 2018 is the year AI has gained meaningful traction with leading corporations. Other surveys report similar findings: more companies worldwide are starting to invest in AI technologies. It’s still early days for most, but when AI investment takes off, so too will earnings and valuations for leading AI providers.
It’s a similar story in cybersecurity. There’s no shortage of alarming predictions about the frequency and cost of cybersecurity attacks, usually from consultants trying to sell a service. Or the trillions industry will need to spend each year to combat cybercrime.
But according to governance surveys, boards now view cybersecurity as a top-three organisation risk. Robert Jackson, Commissioner of the US Securities and Exchange Commission (SEC), in March described cybersecurity as “the most pressing issue in corporate governance today”. The reality is more boards approving plans to invest in cybersecurity technology.
If various business surveys are right, a tsunami of investment in AI and cybersecurity technologies will hit in the next few years. When the market starts seeing AI hype translate into hyper earnings growth, the Industrial Revolution 4.0 megatrend will go up a few notches.
Now is an interesting point to invest in the trend. This year’s sell-off in US technology stocks, including the FAANGs, has created a more attractive entry point for long-term investors in AI and cybersecurity.
Australian investors do not have much choice in active or passive fund exposure to these trends. Some exchange traded funds (ETFs) and listed investment companies in this space provide exposure to technology-led disruption that could be the mother of all megatrends.
Here are three funds to consider:
I identified HACK for The Switzer Super Report in August 2017. HACK has rallied from $5.20 at the time of that report to $6.41. Snapping up HACK after its sell-off in the second quarter of 2017 reinforces the benefits of selective buying in technology during corrections.
HACK aims to track the yield and performance of the NASDAQ Consumer Technology Association Cybersecurity index, before fees and expenses. The index has a high weighting in cybersecurity-related companies, such as Check Point Software Technologies, Symantec Corp, Cisco Systems Inc., and Palo Alto Networks Inc.
Simply, an investment in HACK provides exposure to a basket of the world’s best cybersecurity stocks through a simple, low-cost, ASX-quoted ETF that is bought or sold like a share. As with any ETF, investors must be content with receiving the market return (from the underlying index). Those looking to outperform the index should choose active funds.
Currency is a critical consideration with unhedged ETFs, such as HACK. A rising Australian dollar would weigh on returns, but I expect our currency to drift slightly lower against the Greenback over the next 12 months as United States interest rates rise.
In Australian-dollar terms, HACK returned almost 17% over six months to March 2018.
ROBO is another interesting newcomer and an example of ETFs providing exposure to emerging investment themes that are hard to access via ASX.
Launched in September 2017, ROBO tracks an index comprising AI, automation and robotics companies worldwide.
The index is spread across industry sectors, but many companies within it would not be familiar to Australian investors. By size, many stocks in the index are mid-caps by Australian standards, meaning the ETF has higher risk, which is expected given the emerging nature of robotics.
ROBO’s annual management fee is 69 basis points. Back-testing of the index shows strong returns since 2007, but investors should never extrapolate past performance to the future.
The underlying index returned 33% annually over two years and 25% annually over five. The year-to-date return of 4.2% (to February 2018) was affected by the sell-off in global tech stocks. The pullback could be an opportunity for long-term investors.
Like HACK, ROBO is unhedged for currency movements, meaning investors must have a view on the Australian dollar.
I wrote about the Listed Investment Company (LIC) for this report in August 2017, identifying it as an option for investors wanting exposure to companies benefiting from industry disruption. The LIC has rallied from around $1.65 at the time of that report to $2.
Evans says the LIC is designed to own companies that have proven abilities to disrupt existing markets and companies, as well as a selection of smaller innovators that can disrupt existing industries and companies. The underlying fund owns stocks such as Facebook, Microsoft, Alibaba, Alphabet, Amazon and PayPal.
It suits long-term investors who want to grow their portfolio through exposure to larger tech companies, rather than investing in smaller, more speculative ones.
In some ways, the fund can be used as a hedge against disruption: for example, an investor with a portfolio of industry incumbents that are being disrupted by newcomers can use the LIC to gain exposure to companies doing the disrupting and spread the risk.
Evans & Partners has a solid reputation in global investing and an experienced investment committee. The LIC has returned 13% over six months and traded at a slight premium to its net tangible assets (NTA) in March 2018, ASX data shows. It is one to watch if that premium turns into a discount during broader sharemarket weakness.
Portfolio investors seeking passive exposure to global tech giants can also consider the ETFS Morningstar Global Technology ETF. It provides exposure to tech companies that meet Morningstar’s economic moat (sustainable advantage) criteria and are trading at low market price/fair value ratios, according to its methodology.