It is our ability to invent and develop ideas that has transformed us from primitive man surviving in the world to being able to control it for our benefit. Throughout time, there have been step changes that have accelerated this process.
The Industrial Revolution ushered in tremendous social and economic changes that have swept the world, forming the bedrock of the urbanized modern world we now live in. The latest shift is arguably the Digital Revolution. Based on electronic machinery, computers have evolved rapidly and are now embedded in our daily lives. This process is nowhere near its end and will continue apace for years to come.
The Importance of Technology in Investing
Over the last 11 years, the IT sector has generated virtually all the earnings growth of the U.S. economy, outperforming for over a decade. However, there is no use in investing in tech for its own sake.
Thirty years ago, I heard a fund manager say that the house view was not to invest in the “bleeding edge of technology” – a quite understandable position for them to have taken. Early-stage investing is very risky and amounts to venture capital because you might back the wrong invention.
Think back to Betamax versus VHS for home video tape in the 1970s and 1980s, or even further on with Blockbuster video stores taking on the cinema industry. Few foresaw streaming platforms disrupting the entire media landscape. We have traveled through several iterations of moving image display, access, and storage.
If investing early in innovative companies is very high risk, the question becomes: if the future is based on innovation, how can we invest successfully in it and not lose our shirts?
I focus on the broad picture, not any particular piece of technology, no matter how compelling the argument. We need to correctly identify the direction of travel and align ourselves with it. Change is relentless and will happen no matter what people might try to do to keep things the same.
Technology: A Catalyst for Positive Change
Technology is key to transforming industries and societies for the better, making more efficient use of scarce resources, reducing emissions, and enabling things that were previously impossible. It permeates almost every industry and walk of life:
- Smart Agriculture: Tailoring treatments to the conditions and crops of every square meter of ground, increasing yields while massively reducing the use of fertilizers and pesticides.
- Lifecycle Management: Building systems to control the construction process and subsequently manage completed properties, reducing errors, wasted resources, and unnecessary emissions.
- Transportation: Electric vehicles, autonomous driving, fleet management, ridesharing, and vehicle and aircraft platooning are all using technology to increase transport efficiency, reducing resource consumption and emissions.
- Cloud Computing: Centralizing and sharing computing resources to provide huge efficiency gains, reducing energy consumption and cooling requirements, while eliminating duplication of effort and capital investment.
- Data Analysis and Artificial Intelligence: Using unprecedented pools of data, sophisticated analysis, and machine learning to give early warnings of epidemics or earthquakes.
Beware of Bubbles
During the gold rushes in America, the consistent winners were the guys selling the prospectors the tools they needed or those offering services to the lucky few who found gold. Keep reminding yourself of the direction of travel, not a specific application. Few people thought Blockbuster Video was a poor business idea.
21st Century Computing
Since about 2005, computers have begun to emerge into the real world and to change it directly. Humans have been taken out of the loop, and processes run exponentially faster.
Think about the first smartphones. Previously, if you had a photo on a phone screen and wanted to flip it from portrait to landscape, there was a whole series of steps to instruct the phone. With the smartphone, you simply turned the screen, and the picture moved automatically.
Consider the implications:
- Cars that sense their environment.
- Farms that deliver scarce water and fertilizer only to plants that need them.
- Automated health systems that call for help when you fall ill, informing the ambulance of your condition and location.
Investors tend to jump from theme to theme, constantly chasing the hottest names and ideas. Instead, focus on the underlying trend and invest in the companies that enable this “direct connection,” supporting all the above – and whatever comes next.
Just because an investment claims to be all about new technology does not make it a great investment. Software-as-a-Service (SaaS) companies have a phenomenally efficient model to deliver their software, creating huge value. But how is that value distributed?
Most goes to the customer in the form of cost and efficiency benefits, driving very high growth rates. For firms based in San Francisco and Silicon Valley, research suggests that significant amounts of remaining investment go to management and employees due to extreme competition for engineering talent.
SaaS companies in Silicon Valley must be treated with skepticism regarding their ability to create long-term value. They can certainly be traded on news-flow acceleration, but their current business models do not actually create value for investors.
Focus on the Big Picture
Don’t be the investor who buys into a business that has reached its peak and has nowhere to go but down. There are great ways to invest in the businesses of the future, but proceed with caution.
Instead, think big picture. The direct connection of computers has generated growth across every business sector. This connection has released the brakes on technology deployment in every sphere.
Technology is shifting from an industrial vertical to an economy-wide horizontal: in sector after sector, companies that act like technology businesses succeed, while those that don’t fail.
In every industry, investment is increasingly directed toward information technology, giving the technology sector a disproportionately large share of earnings growth. COVID-19 and its countermeasures have accelerated many of these changes: cloud computing, home-working, collaboration tools, drug discovery, diversified supply chains, streaming, e-commerce, and online payments – all of which boost technology spending.
Key Characteristics for Investment
Going back to the thought that we are not investing in technologies, but in technology businesses, we need to revisit the basics. Look for the following characteristics when investing in this sector:
- A strong underlying technology trend, principally direct connection.
- Strong barriers to entry.
- A company’s ability to create economic value because of that trend.
- A reasonable division of generated value between outside shareholders and other stakeholders.
Our experience shows that most investors and fund managers focus too much on the first two and don’t pay enough attention to the final two, which are key to driving long-term value for investors.
Avoiding Concentration Bias
Diversification helps reduce risk. One concern for investors in this sector is having too many eggs in one basket. The dominance of the Magnificent 7 is well documented, as is its influence on the broader equity market.
If you track the index, you risk being over-exposed to a small selection of mega-cap companies. Instead, aim for a broader spread of investments to mitigate downside risk when things go wrong. Remember, the current mega-caps are the companies that won the last round of disruptive innovation, and they now have everything to lose in the next round.
When considering whether to invest via passive or actively managed funds, it’s worth paying an expert to actively select a broad portfolio of 30 or more companies. Ideally, your investments should not lean towards benchmark weighting.
Keep Your Balance
Investing is like walking – it helps to maintain balance. Avoid overloading your portfolio with too much of one thing. Balance it out with investments that have a future, even if their growth prospects might seem less exciting.
Recap
- Don’t invest in technology at any price – that’s how bubbles burst.
- Spread your risk – avoid becoming over-exposed to any single investment, no matter how compelling the argument.
- Stay in for the long haul – volatility will occur, but innovation will continue regardless.
Disclaimer: Please be aware that investments carry varying degrees of risk, and as their underlying value can fall as well as rise, you may not get back the full amount invested.
