Investing in megatrends for long term capital growth

Finance & Fury Podcast

Welcome to Finance and Fury. This episode we are going to have a look at investing in megatrends.

When investing – there are many different approaches people can take – people have different return requirements – hence, when constructing a portfolio of investments, you may try to isolate certain sources of return – such as capital growth or income focuses

1. If you are retired and needing a passive income, then an income focus is more important – so purchasing share that pay FF dividends, or owning a property that has no leverage or debt on it will be the focus
2. If you are an accumulator – you may wish to focus on capital growth, or target sectors of that don’t typically pay out high level of income returns, but have the potential for higher levels of capital growth – such as technology or healthcare shares
3. As part of this focus on capital growth – one method that is available to investors is to target specific investment themes – or “megatrends”
   1. This is where investors focus on high growth opportunities in sectors of the economy that are expected to grow at higher rates than the economy at large
4. So in this episode - we unpack what megatrends are, how they can be identified and invested in, and what they can offer investors as well as the dangers to look out for

What are megatrends?

1. A megatrend is a long-term structural shift that transforms economies – I studied these trends in a course at Uni, UQ which offered – Evolution of Economic Systems
   1. It involves trends of technological and demographic changes – as well as creative destruction
2. To be classified as a megatrend – they have to have defining characteristic that distinguish them from normal economic cycles in the way that any changes they create are enduring – i.e. long lasting beyond a normal business cycle
   1. One of the biggest examples in the past 100 years is that of the creation of cars - this ended the industry of horse drawn carriage industry within 30 years
      1. This created major economic destruction – as not only did it displace a use for horses which were seen as a major economic good, but also those involved in providing carriages, driving those carriages as well as breeding the horses – ask yourself, who would invest in horse drawn transportation in the modern era? But go back to 1850 and this was a major business
      2. The invention and effect of cars (or automobiles) was dramatic and long lasting - Creating cars did not just make humans more mobile, it also created the modern geography of cities, including highways, suburbs and shopping centres.

• But it did take a number of years to get off the ground – as initially cars were only available to the wealthy who could afford the new novelty – but as supply ramped up with many competitors coming to the market, prices started to drop to the point that cars started to become affordable

1. The introduction of the television is another example – this was first introduced to Australia in 1956 in a commercial capacity – and by 1975 there was a television in most households
   1. Television wasn’t just a revolution for media and entertainment, it has also had profound social and cultural impacts.
   2. We have also had the megatrend of the internet – But this is where two or more megatrends can combine to create another dominate force in the economy, which translates into investment opportunities – In our current world – this would be in the form of streaming services, like Netflix
2. What megatrends all have in common is they are intertwined with demographic and technological changes -
   1. However – to take off fully, they typically need to be allowed to occur by governments – i.e. the legislative power – we saw this back in England with cotton gins – which are a machine that quickly and easily separates cotton fibres from their seeds, enabling much greater productivity than manual cotton separation – this is also called ginning – but in the UK back in the day, to be granted a business licence you needed to seek royal assent - so the inventor of the cotton gin went to the Queen of England for a licence to start a business using this new technology, but was denied due to the economic destruction this would have caused – so they went to France and got granted the right to start their business
   2. Like all megatrends - the uptake in the use of the technology or service is usually exponential; at first there is a time-lag for adoption, then soon the megatrend is everywhere – which is why the UK soon allowed cotton gins to not fall behind the garment production of the French
3. Needless to day - Megatrends can have implications for investors who can correctly identifying and act on them
   1. Those who invested in media businesses in the 1960s, went on to reap super profits. So too did those buying into computer businesses like Microsoft, Apple and IBM in the 1970s for the PC revolution. This is all an exercise in hindsight of course, however, illustrates the power that megatrends can play in shaping markets and investment outcomes – but there are also megatrends that just turn out to be part of a normal business cycle before creative destruction swallows them up – such as blockbuster

Examples looking forward - Transformative Technology, Society & Lifestyle, Health & Wellness, and Environment & Resources.

1. Transformative Technology - Such as cloud computing, 5G, robotics, automation and artificial intelligence, and machine learning.
   1. Technological breakthrough is the most obvious and has been a defining megatrend since the industrial revolution, which created factories and modern mechanics,
   2. But investing in disruptive technology is easier said than done. With many investors missing out even when the opportunities stare them in the face.
   3. The better question to ask is where might technological breakthroughs come from this decade? One possibility is robotics, automation and artificial intelligence (RAAI), or “industry 4.0”.
      1. There was Industry 1.0 – this was the Mechanization and the introduction of steam and water power
      2. Industry 2.0 Mass production assembly lines using electrical power, Industry 3.0 – was about automated production, IT systems, and robotics

• Industry 4.0 is about looking forward – it includes smart factory, Autonomous systems, IoT (or the internet of things), machine learning - Industry 4.0 is the increasing automation of manufacturing and services, such that machines manage other machines—via “machine learning”. In concrete terms, industry 4.0 is where businesses use modern robotics, the internet, and big data to create remotely controlled factories, self-driving cars, and self-programming computers and more.

1. When looking at existing businesses as an example - Amazon’s giant warehouses come to mind
   1. Historically, warehouses consisted of static shelves. Workers would come and add or remove items to and from the shelves as supplies and demand came in – each industrial revolution has increased the capacity of this economic environment – from people having to carry the goods through horse and buggy and manually lift the goods to shelves – to having trucks transfer the goods and machines like forklifts doing the heavy lifting
   2. However – looking forward – In an Amazon warehouse, the shelves are all mobile and moved by robots. The robots move items as customers buy them via a complex barcoding and computer system. Thanks to machine learning, the robots holding trending or popular items, have learnt to move nearer delivery points. In this picture, much of the work done by humans, has been replaced by machines
2. This trend once introduced will likely not decline – so there is potential for further investment growth in this market segment

2. Society & Lifestyle – This comes in the form of demographic changes like aging populations, the growing middle class in emerging economies and the further expansion of social media
   1. This is one of the more complex megatrends due to the tie into other megatrends – as an example -in emerging markets, especially India, the population is getting younger – however - in developed countries, especially Japan and North Europe, populations are ageing – so in some areas of the world – there is an ever-greater amount of social life that moving online where millennials’ purchasing power is increasing, but in others the older population make up more of the social fabric of economic spending – what they spend money on also differs – however – across the board, online spending is increasing as well as socialisation online as well as working environments and socialisation
   2. The major winners of social life moving online have been Facebook, Apple, Netflix, Google and the other so-called “FANG” stocks. Facebook and Google have replaced newspapers as the primary distributors of information and cannibalised their business models (selling audiences to advertisers)
      1. As part of a work demographic trend - Women entering the workforce has caused a booming day-care industry
      2. Demographic changes promise to create winners and losers, however, investment opportunities at this stage are less straightforward. India and China collectively have 1 billion young people, most of which are heavy internet users thanks to smartphone availability. This creates a strong runway for the digital economy in emerging markets. Meanwhile, aging populations have meant Japan buys more adult nappies than children’s nappies.
   3. Aging populations have consequences for robotics and automation which will be required to meet labour shortfalls and likely consequences for healthcare – this brings up the next trend
3. Health & Wellness – this includes biotechnology, genomics and gene editing technologies of the future
   1. the healthcare megatrend has been in play for a number of years where as there in an increasing demographic of wealthy older population across developed nations, there is naturally an increase in the money spent on medicines and longevity technologies
      1. Healthcare spending is growing faster than GDP in most countries, data from the World Health Organisation indicates. This means that that the healthcare sector is taking an increasingly large share of the global economy. Most of the growth owes to government support, which is substantial and increasing. Governments’ hands have been forced into greater healthcare spending.
   2. On top of this, you have the wellness movement - Wellness refers to the growing concern with diet, exercise and lifestyle that has developed in developed countries – This predominately is within the younger generations which represents a different market share from that of the aging population
   3. But perhaps more problematically, obesity is climbing in many western countries. According to the WHO, the percentage of overweight adults is approaching 40% globally. Healthcare problems stemming from obesity are manifold – or in other words, obesity leads to many different health conditions - including heart conditions, diabetes, and some cancers – so health care providers have no shortage of demand for their services – both from the elderly population but also from younger portions of the population that require medical treatment due to obesity or other antithetical health behaviours – such as alcoholism or obesity
      1. however, healthcare technologies are also improving, tying into the first megatrend. Biotechnology has been a major area of development
   4. Environmental & Resources – this is part of the global political trend in the west to transition away from fossil fuels towards renewables and technology like battery storage – however - countries that we export our production to, such as China or India aren’t beholden to the same regulations, which is why we see the trend of any energy or pollutant heavy industry being outsourced to these countries –
      1. This brings out the next megatrend – the western developed nations are focusing on sustainable energy and emissions when it comes to production of economic output - Batteries are essential for sustainable energy, as they store the electricity produced by wind, solar and hydro. Renewables are receiving renewed attention and government policies and subsidies – weather efficient or not – this is where hundreds of billions of dollars are anticipated to be spent in this industry

So these are the four main areas of megatrends - The criticisms of investing in thematic trends – you are buying overpriced growth shares –

1. Purchasing into thematic ETFs can result in buying expensive in vogue share, where their valuations have stretched too far due to people over purchasing these shares – i.e. they can have a negative earrings but be overpriced
   1. This is due to the market likely being already aware of the megatrend and hence has already “priced it in” to a shares price – which can often occur overoptimistically
   2. Tesla is an example - featured prominently in criticism to this effect in recent years, with many investors saying that Tesla is a “bubble”. This line of criticism is often extended to argue that investors are better off buying into “value” stocks, which are companies that trade on lower price-to-book or price-to-earnings. Or simply buying a passive market weighted index fund like the S&P 500 and not taking any long-term views.
   3. This brings up another point - that just because a company’s share price looks expensive, does not mean it cannot rise further – this is based around traditional metrics – where if a company has a PE of 40+ it is considered growth – but this could mean that other people still want to buy and the PE rises further
      1. As an example - the rise of Afterpay is an example of this dynamic – a company with no PE due to having lost 10s of millions of dollars each period can be valued at the same market cap as Telstra

How to access – you can try and select the share you think is going to do well yourself

In my opinion – the better way would be to buy a basket of shares in a megatrend – through an ETF - there are many ETF providers for this form of investment thematic

1. Megatrends can offer investors a lot - But trying to guess what the next trend is and accessing them has not always been straightforward.
   1. Previously, investors would have to research and identify the trend themselves, do all the work identifying potential winners, then go buy them
   2. With the rise of thematic ETFs over the past few years - megatrend investing has become more readily available
      1. Thematic ETFs are a new arrival in Australia and have become a popular tool for investors
      2. Thematic ETFs work like the familiar ETFs and index funds: they follow indexes. However, the indexes they track are devised specifically to target megatrends - They can in some instances be built by research houses or consultancies with specialist knowledge of a megatrend.
   3. How to select a thematic ETF - When selecting thematic ETFs, investors need to ask a series of questions.
      1. First and foremost is about the megatrend the ETF aims to target. Do investors find the megatrend convincing? How sustainable is the growth? And what does the evidence and data say about the theme?
         1. You can select an EFT for each specific megatrend – AI to demographics – so do you purchase one, or split between each?
      2. Secondly, investors must ask how the thematic ETF targets the megatrend. Does a thematic ETF offer true to label exposure to this megatrend? How does it go about identifying the companies driving a trend? How are they weighted when they are purchased? What is the overlap between this fund and any other funds or ETFs an investor might already have? A good thematic ETF should give true to label exposure, have a process for picking the right companies, and not hug a famous benchmark.

In summary – these investment trends can provide additional growth for the future – but only if the trend continues

Getting the right selection is important – historically this has been hard for an individual to achieve – but in recent times with the increase of professional managers providing these services through ETFs – accessibility has increased – but the issue comes back to identifying the correct megatrend and then relying on the ETF to purchase the correct companies to capitalise on this trend

A google search can give you a list – let you come up with you own decisions – this isnt advice – but some of the major providers are ETF securities, Blackrock with ishares and statestreet are just to name a few reputable providers to look at

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