Is active investment management the solution to navigating technological disruption?

The impact of technology is one of the most exciting aspects of being a professional investor. Technology can enable a business to significantly enhance its service offering, improving customer service and hopefully making an increased profit along the way – a win-win.

Monday, March 26th 2018, 9:32AM

by Harbour Asset Management

Disruptive technology, however, is when technology, or the convergence of multiple technologies, is sufficiently powerful enough to disrupt existing companies and industries, sometimes into extinction. History is littered with examples of industries being disrupted by innovative technology, such as the automobile over horses or the smartphone over traditional mobile handsets.

Though disruption has been part of life since the beginning of time, it has never moved faster than now. We are observing an innovation surge, largely enabled by technology, which is accelerating the speed of disruption.

As an investment manager, we have a fiduciary duty to our clients to research the potential impact of disruption on our investment opportunities, especially given that we predict disruptive technologies will have a larger impact on corporate earnings in the next 10 to 15 years, than that of any central bank or government.

Consequently, we believe performance gaps between the winners and losers will be untypically large and being on the right side of disruption will yield good outcomes for investors.

This is a key point of difference that an active investment strategy can add to a portfolio. Actively-researched investment decisions can assist future returns by investing in companies and industries at the forefront of technological change or those that are unlikely to be disrupted in the foreseeable future, like healthcare, aged care, and consumer staples. It is, however, equally important to be able to avoid industries likely to be disrupted, such as conventional subscription TV or petrol retailing. All of this can be achieved with an active management approach.

Attracted by lower fees, investors from across the world embrace exchange-traded funds (ETFs) and a passive approach to investment. The crux of passive investing is that investors get a slice of the entire market, without any fundamental research involved in the selection of what goes into the portfolio. This approach has worked very well since the GFC for two main reasons: 1) loose monetary policy has assisted returns for all assets, irrespective of fundamental qualities; and 2) it has become self-fulfilling - as ETFs have gained popularity, the wave of liquidity chasing the same assets has assisted prices for these assets track higher.

While Harbour’s actively-managed strategies have significantly outperformed the broader market and that of our own more passive funds, we strongly believe that we are at a key inflexion point right now, where the dispersion of returns between companies will start to widen. The era of cheap money is slowly coming to an end, but the impact on asset prices could correct much sooner.

For these reasons, Harbour analysts spend considerable time and resources travelling to learn about emerging trends and technologies that are likely to impact on investments. As an example, we have active positions in the battery supply chain for electric vehicles, one industry we think will disrupt the global transportation system much sooner than market expectations suggest.

Once we identify a potentially disruptive technology, our job becomes to validate the continued relevance of that thematic. If it fades, or something better comes along, we can change our position to avoid going down with the market alongside passive investors.

A current example in the New Zealand market is that of Sky TV, which has seen its share price fall by almost 70% since its peak in 2014, as other content providers like Netflix and Amazon Prime disrupt the traditional TV business model.

Interestingly, the largest shareholder in Sky TV is currently an ETF run by BlackRock. This ETF was designed to invest in companies with particular characteristics, as determined by quantitative models.

Now that Sky might no longer fit the inclusion criteria, it is possible that the fund will become a forced seller of a large portion of Sky TV’s shares on issue.

This is a good case study on how ETF investing might look attractive under certain conditions but could prove painful if our thesis of increased returns-dispersion plays out.

The impact of disruption is in its infancy, but momentum is building with the assistance of big data, the internet of things, processing power, artificial intelligence, robotics and a suite of complementary technologies. The future will look different from how we see it today, and so will asset prices, but we strongly believe an active approach to investments will be beneficial when navigating disruption.

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