Don't think outside the box, get rid of the box

‘Learning and innovation go hand in hand. The arrogance of success is to think that what you did yesterday will be sufficient for tomorrow’. – William Pollard (English Scholar in 1800s)
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As some of you know from conversations with me in the past week, unfortunately my wife spent the best part of last week in hospital with a life-threatening blood clot. It was the last day of our short holiday in Noosa when she went to hospital to check an unusual pain in her leg. Little did we know at that point that she would not return home for the remainder of the week, immediately rushed via ambulance from Noosa Hospital to Brisbane. Thankfully, she has since made a full recovery which has given me the chance to reflect, amongst other things, on how amazing medicine, in this day and age, really is!

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The same problem ten years ago might well have resulted in a slow and uncomfortable recovery over several months. Treatment, however, has advanced so far over the past decade that she was discharged last Friday morning and back in the gym on Monday morning. Truly remarkable!

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One of my passions in life is learning about innovation and how it so rapidly transforms the World we live in. I believe we are currently living through what history will later describe as one of the greatest eras of technological advance and immense change ever seen.

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I believe what sets us apart at Emanuel Whybourne is that we dare to think ‘outside the box’ of traditional asset allocation. We believe too many investment advisors take the ”traditional’ approach when they should be taking more of a progressive and ‘common sense’ approach. The Australian Future Fund does this well.

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Recently, I was very surprised to see one our competitors asset allocation tables for an aggressive/ growth client and the expected return was not much more than 5% over a full 12 months.
My initial thoughts were, how could this be and what’s more, why would an investor bother when you understand and quantify the risks?

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The simple answer is when you apply asset allocation 101 and modern portfolio theory 101, then allow apply this theory to generate for you a suggested asset allocation, you will be left with a relatively ‘vanilla’ portfolio. This portfolio will entail large allocations to cash, hybrids, bonds and cash alternatives, hedge funds, alternative investments, large allocations to Australian equities and a small balance to international equities. (Sorry if I just put you to sleep).

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It is, however, our belief that hedge funds are not worth the risk, bonds are not really going to provide you meaningful defence in the event of a big draw down anymore, Australian equities are destined to struggle over the coming years with our domestic economy, while cash will likely yield you negative returns when inflation is taken into account. So little wonder if you are forced to make meaningful allocations to these assets because the computer says so, you struggle to generate a return.

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At Emanuel Whybourne we are proud to be different. I would be confident to say if most of our competitors reviewed our own clients’ portfolios they might say that they are overweight technology.

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This does not concern us in the slightest as it is our belief that if you’re not invested in technology – you will be left behind!

All “Technology” investments cannot all be put in the same basket, as there are several entirely different sub-categories from Fin-tech to Health-tech to Agriculture tech (Ag-Tech). It is our belief we are witnessing the birth of one of the biggest innovation booms the World has ever seen. This will have significant implications for financial markets.

When you review the top twenty stocks by market value in Australia (the ASX 20 Index) you see more than half the market value is in Financials and Materials companies. The ASX20 includes; the big four banks and three other financials, large mining companies, a Telco, a Consumer Discretionary and a Consumer Staples business, two large Real Estate Trusts and one Health Care/pharmaceutical business. The point is, in my view, less than a quarter of the top employers in Australia I would describe as innovative and I would not be surprised if we saw many of these fall from the top 20 in the next decade or so.

For far too long, Australian advisors have been building investment portfolios by including banks and resources as the foundation to Australian equities exposure. However, I believe the next 10 years will be most unforgiving to this ‘old school’ mentality. If the index is going to look very different in the next decade wouldn’t you rather avoid those companies that are going to be excluded before the event, as opposed to holding them as they potentially become less relevant (and potentially less valuable)?

Cathy Wood of ‘Ark Invest’ describes this as the ‘old guard’ being replaced by the ‘new guard’. In the 52 years from 1964-2016 the average lifecycle of a company in the S&P500 dropped by roughly 25%, according to Insight, it is likely to drop another 50% by 2026 (Source ARK INVEST: Rethinking Asset Allocation).

Fifteen years ago, Information Technology companies made up 16% of the MSCI global index. Today that figure is greater than 33% of the MSCI World, with 5 of the top 5 business in that index now technology businesses. I believe this will only accelerate. The pace of disruption is accelerating as seen in this chart below.

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Our view is that the coronavirus (COVID-19) will only accelerate this trend. We have already seen an 83% increase in online retail spend year on year, coupled with a 34% increase in home improvement, at the same time department stores have experienced 30% declines (in the US). US eCommerce Penetration has experienced ten years growth in only ten weeks. This is demonstrated in the chart below. We are living in extraordinary times which calls for extraordinary asset allocation!

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Many analysts claim we are in the midst of a tech bubble like the late 90’s / early 2000’s, however we strongly disagree. During the tech bust of 2000, technology companies were trading at a 150% premium to the MSCI ACWI. Currently that premium is less than 25%. Euphoria (measured by price/free cashflow levels) was trading at 90x however the disruptive technology stocks we are invested in are currently trading at around 40x this metric.

Hamish Douglas (founder of Magellan Asset Management) is another large advocate for digital disruption, with Hamish recently quoted on an online webinar that a Biden President and Republican senate would give rise to a Nirvana or ‘Goldilocks’ outcome for markets. This means there will likely be no tax rises, no massive tax reform and no big left-wing agenda.

In Hamish’s talk, he mentioned a number of themes which he believes will continue to accelerate after COVID-19 including:

• Remote working from home
• Online shopping
• Digital Payments
• Stat-at-home entertainment
• Travel & Leisure

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Hamish continued by saying “some are pull forwards of existing trends like e-shopping, but e-commerce is going to be more structural and streaming of entertainment is also a longer-term trend.’ (source: Livewire, Douglass: Goldilocks scenario for equities, Glenn Freeman).

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I watched with interest the recent video interview by the Queen of disruptive innovation, Cathy Wood. Cathy was yet again confident on the outlook for her ARK portfolio and believes the last 6 months have validated many of the themes she invests within. Cathy believes the likely outcome of the US election will mean there will be no meaningful change to the technology sector and that “Big Tech” and “Big Healthcare” are unlikely to be broken up. Cathy believes we will likely see more stimulus particularly into travel, entertainment and hospitality sectors. She has observed they are seeing large flows of capital come out of Europe and into the US on the back of stability and that this trend may continue.

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Cathy believes the US consumer has plenty of fire power after achieving an 8% savings rate during the pandemic, so the Christmas period will be strong for the global economy and investors should be allocating at least 20% of their portfolio to disruptive innovation. This, clearly, needs to be evaluated on a case by case basis, however we certainly agree to this in principle.

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The last fifteen years in markets have been quite remarkable. We experienced the GFC in 2008 which resulted in the largest market correction our generation had ever seen. From 2009 to early 2020 we enjoyed markets rising through an extraordinary bull market. The last year has seen the fastest market crash (source: Schroders note: Record Breaking crash, rapid rebound – is this a recovery or a dead cat bounce) and one of the fastest recoveries in financial history.

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We believe what has transpired over the past 6 months has provided us with the perfect environment for the next bull market. This next bull market will be even more supported by an unprecedented amount of government stimulus, spurred on by the fastest rate of change in technology we have ever seen.

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I don’t deliver my forecast without a disclaimer. This bull market run will be far from linear. There will be clear winners and losers. Those companies left behind will be the old industrial companies who fail to innovate, whilst the winners will be companies with management teams who embrace this change.

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The World is changing rapidly and whilst most traditional investors seek safety in the index and benchmarks, we plan to position our client portfolios as far away from the index as possible.

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Chart of the Day: The pace of technology adoption during COVID-19 was staggering, this is only the beginning.

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Disclaimer: Both Tim Whybourne & Craig Emanuel have holdings in ARK Products

Regards,
Craig Emanuel and Tim Whybourne

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