Human / Machine
Creative Destruction at the Speed of Light
The world’s largest companies today are very different from the world’s largest companies a decade ago. The change reflects the increased importance of technology in the economy. If we include Amazon, the six biggest corporations on the planet are all technology-related businesses; one of those did not exist before 2004, and only two were around before 1994.
The technology sector accounts for one-fifth of the market capitalization of the MSCI All Country World Index. It is once again bigger even than the financials sector, even without including the many tech businesses categorized in the consumer or communications services sectors. The market cap of Facebook, Apple, Amazon, Microsoft, Alphabet, Baidu, Alibaba and Tencent combined is greater than that of the entire stock markets of the euro zone or Japan.
Powerful economic and indeed technological forces are fuelling this dominance. Since 2007, spending on research and development and capex in the U.S. technology sector has surged by 9% per year, more than twice as fast as any other sector, according to Morgan Stanley research. Moreover, that spending has gone from 13% of revenues to 18% of revenues, and the rate of growth appears to be getting faster. At the same time, technology enterprises are getting more and more bang for their buck: thanks to technology-infrastructure outsourcing and cloud computing, the average tech start-up costs less than $5,000 today, according to CB Insights, a thousand times less than in 2000.
Once a concept is proven, it is adopted faster and more widely than an entrepreneur could have dreamed 50 years ago. Television took almost 15 years to be adopted by 50 million households, while Facebook got 50 million users within 12 months. Today, a successful internet-based service can cross that threshold in three to six months. The blistering pace of technological change presents both opportunity and risk to economies, society and jobs—adding to the pressure on governments to be more interventionist as capital threatens to take an even greater share of growth than labor.
Disruptive technological revolutions are occurring in several sectors, from transport and finance to manufacturing, medicine and retail. These disruptions promise a wealth of investment megatrends, but also, in Neuberger Berman’s own industry, a transformation in the way we research, trade and select our investments. Navigating the tensions between investment opportunities and societal disruption will be an important test for long-term investors and a key challenge for active managers seeking to analyze the true social and political risks associated with their investments.
Technology will continue to transform Main Street and Wall Street, and be a source of disruption and opportunity for both.
- Technology Market Cap
- Technology Adoption
Our Three Investment Implications
1. Thematic analysis will be more important for active investors
We believe that the asset management industry is still early into the move away from the dichotomy between passive and benchmarked-active strategies toward a more considered differentiation between commoditized passive and smart beta, scalable active quantitative strategies, and genuine high-conviction and engagement-based active management. An important way research will inform the high-conviction positions held by genuine bottom-up, fundamental active managers will be through the development of thematic frameworks. These frameworks are likely to be much more important as technological revolutions—the megatrends in society and the economy that shape our world over the long term—become more disruptive, far-reaching and frequent.
Thematic investing requires nuance and deep sectoral expertise to help identify genuine megatrends with higher conviction, but also to identify the true, actionable investment opportunities that are leveraged to those trends and themes.
Autonomous driving provides a powerful example of the challenge and the opportunity. At first glance, this may seem like a theme for the auto sector. Which company will build the most successful first-generation self-driving vehicle? Will it be a traditional auto manufacturer, or a technology company such as Google? In reality, picking the winners in the race to implement this technology probably isn’t possible. It makes more sense to recognize that self-driving cars will become an accepted mode of transport and that businesses that already manufacture sensors, semiconductors and software for other applications will benefit most clearly from this new market opening up to them, alongside secondary beneficiaries such as cloud service providers and wireless telecom operators. Investment themes often resonate most powerfully deep within supply chains.
As well as looking through supply chains and across sectors for the businesses that are leveraged to megatrends, the growing importance of technology is yet another reason why investors are likely to miss out on a substantial share of economic activity if they do not participate in the full menu of private as well as public markets. Technological innovation does not happen solely, or even primarily, at large, listed companies. The investment risks and volatile revenues of truly disruptive businesses can be ill-suited to the constraints on a public company and the risk appetite of public-market investors, but they are increasingly the characteristics sought after by the new generation of private equity practitioners.
2. Big data will define our economic ecosystem and transform investing
The monetary interventions of the major central banks and expansive fiscal policies loom largest in people’s perceptions of how the boundaries between governments and markets have dissolved since the financial crisis, while Basel III and Dodd-Frank will be familiar to anyone who works in banking and finance. Less well-known, but arguably just as far-reaching, is the European Union’s newly amended Markets in Financial Instruments Directive (MiFID II), which came into force in January 2018.
Among other things, MiFID II bans the practice of brokerages giving research away to asset managers as a perk for trading securities through them. That is likely to accelerate the ongoing cutback in securities-research resources within sell-side institutions, as they lose their ability to attract transactional business. As such, we expect more research to be conducted within asset management firms, as the external supply diminishes and the newly internalized costs incentivize more exclusive, proprietary and actionable insights.
We believe active managers will respond by seeking more efficient ways to gather increasingly granular and timely information about how companies are performing, often in a raw form that can be sliced-and-diced to generate genuinely proprietary insights. They will be able to do this because, for the first time, that information exists and is accessible. It is called big data, and we think it will be the battleground for alpha over the coming years.
3. ESG will be more fully integrated into investment processes
We believe that the technology revolution will not only require environmental, social and governance (ESG) analysis to be more fully integrated into active investment processes, but also make that integration possible at last.
Some of our most pressing social challenges, such as rising inequality, have their roots in, and the potential to be exacerbated by, the automation of our economy. As returns to capital (including robots, software and educational capital) continue to outstrip returns to an ever-decreasing pool of skilled labor, providers of capital will need to become more sensitive to the potential social disruption of their investments, and mindful of the risks of government and regulatory interventions in response to social and political tensions. At the same time, some of our most pressing environmental challenges are likely to have technological solutions—another reason why thematic thinking is likely to become a more important component of active management over the next decade.
When it comes to governance, we feel that shareholder engagement on genuinely material questions is going to be an important differentiator between genuinely active management and passive investing, and part of the trend of convergence between private markets and public markets. We think that bottom-up fundamental active managers, which often harness decades of experience and sector expertise, are among the few financial market participants that are genuinely informed about whether a company is well governed—and about the actions that can be taken when it is not. But that kind of genuine shareholder engagement requires judgment, not box-checking, and judgment requires robust and reliable data. We believe the quality of environmental and social risk reporting and data is a corporate governance issue that could be swept up in the big data revolution in investment research.
Survey evidence from institutional investors suggests that only a fifth of those that claim to be doing ESG investing feel that they are integrating ESG fully into their processes. Asked what the barriers were, some two-thirds cite the lack of standards for measuring ESG performance—essentially a data issue—and half point to the lack of ESG performance data reported by companies.1 Many others observe that there is plenty of data in the marketplace, but much of it is not financially material or useful for investors’ decision-making. While data gathering, data standardization and data reporting by companies can and should be improved, active asset managers are increasingly likely to scour the big data digital residue for independent or unprocessed insights into social and environmental risks and performance—not least because a more proprietary view of these risks is better able to inform the search for alpha.
1See Jonathan Bailey, "What Institutional Investors Are Saying About Sustainable Investing" (May 2018).