Win with Innovation...
Updated: Aug 8, 2018
Aligning your money with the forces of human ingenuity has long been a winning investment. However, finding the right idea and people to execute it at the right period in time has historically been a formidable challenge. Innovation and implementation of new concepts is more art than science, while change can be tantalizing and it can fuel massive opportunities. However, change by itself is difficult. As an investor, you have to identify it before it occurs. Consumers have to change their behaviors to create a viable market to underpin it. These two events are often contradictory and illusive. As value investors, we seek enduring dynamics, things you can allocate time and capital to today with the odds stacked in your favor, so that you have a reasonable chance of it being a solid long term play, ideally with some catalysts for significant upside driven by innovation. In his excellent book “Engines that move markets – Technology investing from railroads to the internet and beyond.”, Mr. Nairn comes to the following conclusions, after a comprehensive review of the history of market-shaping industries and their impact on how we invest:
“The best technology does not always win. Winning the technology battle is no guarantee of financial success. Insiders usually make the best returns from new technologies. The only surefire way to make money from new technologies over any extended period of time is through monopoly protection.”
With the benefit of an even longer look back in time through Fernand Braudel’s seminal work “Civilization & Capitalism 15th-18th Century: The structures of everyday life”, we get the following brilliant set of insights:
“In the realm of technology, co-extensive with the whole of history, there is no single onward movement, but many actions and reactions, many changes of gear. It is not a linear process. (...) The history of inventions, taken by itself, is therefore a misleading hall of mirrors. (...) In other words, there are times when technology represents the possible, which for various reasons – economic, social or psychological – men are not yet capable of achieving or fully utilizing; and other times when it is the ceiling which materially and technically blocks their efforts. In the latter case, when one day the ceiling can resist the pressure no longer, the technical breakthrough becomes the point of departure for a rapid acceleration.”
Where is the value at?
Our current crop of high profile innovators seem to be adherent to Mr. Zuckerberg’s, perhaps ill-advised, motto “Move fast and break things” in the pursuit of the next disruptive idea at breakneck speed. However, away from the headlines, innovation as an expression of inherent human ingenuity, continues its long slog of evolution while innovative concepts just as disruptive and perhaps more lasting in nature materialize every day.
Actors in less flamboyant and more industrial sectors such as energy, transportation, chemicals & agriculture are instead channeling the “Bell Labs way” of “move deliberately and build things.”
Revolutions happen fast but dawn slowly. Bell Labs and subsequent imitators have achieved real disruptive improvements but at a more incremental pace – achievements that we are still harvesting today. Bell Labs invented the transistor in 1947, which is now the building block of all digital products. Billions of transistors now reside in the chips that power our phones and computers. They created and developed the first communications satellites, the theory and development of digital communications and the first cellular phone systems. They built the first fiber optic cable system and subsequently created inventions to enable gigabytes of data to zip around the globe. These are just a few of the practical technologies Bell Labs was responsible for. It literally gave Silicon Valley its name.
Taking all this into consideration, how does one go about allocating funds to innovation focused strategies?
A starting point should be to identify sectors of the economy supported by long term trends but where a “bottleneck” or, even better, a “finite supply meets infinite demand” type of situation is forming. Challenges faced by crucial economic sectors present opportunities where human ingenuity can best be expressed and long-term value created. Historically, agriculture and fresh water, energy and transportation, healthcare and pharmaceuticals, and unfortunately military hardware, are examples of such economic sectors. Throw in automation, supported by our constant pursuit of increased productivity, which has a strong wind in its sails as we seek to overcome the demographic challenges faced by most of the world's major economies, and you have a comprehensive investment universe to consider.
Let's take a look at automation, enhanced by Artificial Intelligence (AI), which is applicable across all these attractive sectors and is set to create the next great leaps in productivity and profitability. Automation is not a new phenomenon, question about its promise and impact have long accompanied its advances. More than 50 years ago, US President L.B. Johnson declared:
"Automation can be the ally of our prosperity."
Humans have always shifted away from work suitable for machines and moved on to other jobs. This was true in the 1930s, when the shift was away from agriculture, through the 1990s and early 2000s, when the shift was largely out of manufacturing. In short, history is reassuring about the impact of technology on employment. For some workers new technology can be disruptive, but if the past is any indication, creation eventually triumphs over destruction and the key is to ensure labor force adaption through ongoing education.
Smart automation - A friend or a foe?
A recent study by McKinsey Global Institute calculated that automation could increase global growth by 0.8% to 1.4% annually, assuming that people replaced by automation largely rejoin the workforce in other capacities. A study by Bain Macro Trends Group estimates that as much as $8 trillion could be invested in automation technologies by 2030. Falling capital costs in robotics and rising labor costs in places like China reduce the payback period for automation and in turn prompt higher investment in these technologies. China has seen a 10-fold increase in purchases of industrial robots between 2009 and 2015.
The next stage is already well under way. In the past, automation mainly referred to industrial robots and computer hardware and software designed to carry out predictable and routine tasks requiring physical strength, exertion and precision, as well as the repetition of logical tasks such as calculation. With robotics, AI and machine learning, we now see “smart automation” emerge, poised to take on a greater share of high-productivity jobs and an array of tasks that were previously the domain of humans. Smart automation of this sort includes a wide array of functions from self-driving vehicles to the diagnosing of diseases. In fact, automation is set to play a wider role across all the economic sectors we identified earlier.
In energy and transportation, as we increasingly stop burning things and harnessing technology for our energy needs, Smart Grids and maintenance and operations of installations will be powered by innovations in AI and automation. In agriculture and fresh water, we will increasingly see AI and automation-based solutions take root. In healthcare and pharmaceuticals, some AI-based technology is already saving lives with better and more consistent diagnosing capabilities than humans, while our military equipment is increasingly enabling the men and women in uniform to carry out their work with better risk management tools and greater efficiency. Areas such as mining and retail are also being transformed for the better.
Another sector that could be positively affected is education, as displaced workers must be given the opportunity to upgrade their skills effectively and young people entering the workforce will need to have advanced, relevant knowledge under their belt. Lifelong learning will be key to harness the positive impact of these strong trends, for individuals, companies and governments.
Disruption is everywhere and as the technological evolution continues its march towards increased productivity, companies and investors need to be at the forefront of this and embrace the inevitable changes or risk being left behind.
Strategic considerations for investors
It’s often said that the key to success is to invest ahead of the path of progress. In order to do this, an investment strategy that focuses on monitoring broad trends is essential. However, when implementing an active strategy that captures such broad changes, one needs to make sure that they don’t become blinded by the bright mirrors in the temple of technology. Generally, as with most investing-related matters, timing is key. It can thus be useful to monitor sustainable long-term trends in society, technology and the global economy to gauge when specific sectors are prone to disruption and to watch out for Mr. Braudel’s “ceiling that can resist the pressure no longer”, indicating that we are set for the rapid acceleration of a technical breakthrough in the selected sectors.
Taking the macro & going micro – Developing an investment universe
It has long been the case that the nature of industrial innovation in our chosen sectors tends to be housed within larger companies. Such companies have significant R&D budgets and the capability to buy up smaller operators with strong ideas, patents and human capital that can be leveraged within a larger organization with global networks and decades of experience in implementation and bringing solutions to market.
Specific sector ETFs can be useful tools for capturing a broad developing trend. In the Q4 2017 edition of the BFI Infinity InSights, Dirk Steinhoff, the BFI Infinity C.I.O., eloquently presented a compelling case for Robotics and the use of ETFs in capturing "booming ceaseless innovation in a highly competitive field." ROBO:US is one such tool for harnessing the opportunities presented by the global 'smart automation' drive, as it covers both robotics and AI. If you are investing for the future, allocating to a 'smart automation' focused strategy is crucial - DON'T FEAR THE ROBOTS, OWN THE ROBOTS.