Internet of Things. Autonomous driving. Smart cities. These are just some of the use cases of greater network and connectivity that may completely change the way we live in and interact with world around us. How do we invest in the right companies and sectors to capture this growth potential, and how do fund managers perform due diligence on such companies?
Read on for expert insight from global asset manager Fidelity on how to invest in future connectivity.
We are living in a golden age of connectivity, in terms of the speed and data intensity of communications, as well as the number of people connected. It is a long duration, material trend, which is leading to innovation and disruption across multiple industries. This creates investment opportunities across companies that enable and benefit from this connectivity.
Leveraging the perpetual theme of Future Connectivity
Connectivity is a basic human need. Ever since early man-made cave paintings, we’ve sought new and better ways of communicating, or faster, richer and mass communication. As connectivity technology improves, it impacts every part of the economy – from consumer scenarios (media, dating, food delivery, gaming), to finance (payments, lending), to industrial applications (Internet of Things, autonomous driving, security).
Just as 4G enabled new applications like maps, music/video streaming and social media, 5G rollout – with its promise of significantly higher data bandwidths and connection reliability – is having a material impact on our digital lives. With carriers adopting cloud virtualization, and increasingly shared infrastructure lowering costs and improving quality, 5G is a key enabler for next generation technologies like IoT, industrial automation, autonomous driving, and AR/VR. The use cases go beyond merely faster mobile and consumer applications, to encompass a host of enterprise and industrial activity which can be further optimized and made far more productive. And 6G, and all kinds of new connectivity opportunities, lie further ahead, promising long-running returns for investors in this space.
Connectivity is also breaking down national barriers, and creating companies with unprecedented global scale in ecommerce, cloud, or social media. Enormous global platforms are benefitting from a virtuous circle of sustainable growth – with support from unprecedented connectivity, leading to lower customer acquisition costs and high incremental margins, and where these global winners have a better product than local competitors, leading to higher customer loyalty and advocacy, which leads to even stronger global reach for these platforms.
The digital economy now forms a substantial part of the overall economy. But despite this, most commerce categories are still very early in this transition from offline physical commerce to ecommerce. Across many areas – online groceries, dating, and food delivery for instance – ecommerce is only just getting started.
Theme viewed through prism of three categories
We’ve divided investment themes in Future Connectivity into three areas: Enablers, Networks, and Innovators. Each area has different economic and investment characteristics.
They are the companies that provide the equipment, devices and components that enable high speed networks – for example Ericsson, which makes communications equipment. These companies are mostly found in the technology sector. The Enablers have very cyclical revenue, but fortunately, we are right at the start of the 5G cycle.
These are businesses which own connectivity networks – typically telecom companies such as Verizon, Charter and Cellnex. The Networks have very steady long-term growth, with pockets of high growth in areas like cable and mobile towers.
These are companies taking advantage of the opportunities provided by high-speed connectivity networks to offer products and services to customers and users. They are typically internet, new media and gaming companies like Alphabet, Alibaba and Tencent. Some of the long-term drivers of innovation are digital advertising, mobile commerce and digital entertainment. The Innovators are the segment that benefit from huge structural growth in various areas from mobile commerce to over the top video and mobile gaming, which is likely to continue for some time.
Quantum and duration
The revenue quantum and growth of the Innovators is significantly larger than that of the other two areas, but there are opportunities to be found across all three categories. And while Network companies’ growth and ROCE numbers may look less impressive compared with the other two areas, businesses in this space tend to have steadier, less volatile income and returns, which adds a defensive element to the theme, and stabilizes returns during periods of market volatility and drawdown, as seen during the historic COVID-19-related selloff in March 2020.
Paying attention to externalities beyond traditional fundamental analysis
The Future Connectivity universe compares favorably with many other investment sectors on traditional sustainability/ESG criteria like climate impact, equal opportunities, and responsible product sourcing. Instead, it is more relevant to consider how externalities – some good, some bad – tend to crop up as side effects of their innovation.
Silicon Valley is full of maxims like ‘fail fast, fail often,’ ‘move fast and break things’, and ‘pivot to failure.’ Companies are encouraged to operate pretty much as quickly and aggressively as possible: rules of engagement are not set for these innovators and their innovations. As a result, by definition these firms are almost certainly subject to considerable future regulatory risks. These risks develop over time as innovations become mainstream. Understanding such risks is critical to investing sustainably - and thereby, successfully - in the Future Connectivity universe:
▪ Misinformation: Whether or not internet sites/social media apps are being used to disseminate false or misleading information, or fake news
▪ Privacy: The extent to which businesses respect and safeguard users’ personal data
▪ Online fraud: What measures are companies taking to protect customers from fraud/how vulnerable are they to cyber attacks, ransomware, and fraud?
▪ Online welfare: How seriously do internet firms take online welfare issues (cyber bullying, suicide and self harm promotion)
Conclusion: a structural, thematic growth opportunity
Future Connectivity is about far more than just telecom networks or IT. Instead it encompasses the enablers of connectivity and those companies benefitting from it to create innovative products and solutions. We are seeing innovation and disruption across all sectors and industries, thanks to ever cheaper and faster computing, along with ubiquitous devices.
Despite the rapid advances we have seen in ecommerce over the last 20 years, we are still just at the start in many categories like groceries, car sharing, food delivery, online dating, online education and telemedicine; with very large total addressable markets and very high growth rates:
• Digital workspace (enterprise/education moving to cloud/online/mobile): US$214 billion market growing at 20-30%
• Digital entertainment (video, music, gaming, dating, apps moving digital): US$150 billion market growing at 10-20%
• Digital advertising/search/social (advertising following consumers to mobile): US$19 billion market growing at 20-40%
• More mature categories like US$2.5 trillion global mobile commerce market, still growing at 10- 20%, meaning massive ongoing opportunities
This article was originally published by Fidelity.
Fidelity is known for their research capabilities, with one of the largest buy side research teams in the industry. They have more than 400 investment professionals based in 16 offices globally. Fidelity has a large presence in Asia, and Endowus has partnered with them to provide our clients access to their best-in-class, award-winning funds — including funds approved for CPF investors.
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