How investors can take advantage of disruptive innovation
Australian investors now have the opportunity to invest in the future with the launch of specific funds targeting disruptive innovators.
Amazon's long-awaited arrival in Australia has given retailers and landlords plenty to sweat about as they assess the online giant's impact. But rather than swimming against the tide, Australian investors now have the opportunity to invest in the future with the launch of specific funds targeting such disruptive innovators.
On 14 November, Nikko Asset Management (Nikko AM) and Morgan Stanley Wealth Management announced the Australian launch of the Nikko AM-ARK Disruptive Innovation Separately Managed Account (SMA), which they described as "the first of its kind in Australia".
Founded in 2014, US-based ARK Invest specialises in disruptive innovation, which chief executive and founder Catherine Wood defines as "the introduction of a technologically enabled new product or service that permanently changes an industry by creating simplicity and accessibility, while driving down costs".
Importantly for investors, ARK also sees disruptive innovation as key to the long-term growth of company revenue and profits, as seen in the rise of Amazon along with such companies as Facebook and Uber.
Wood said the Australian fund focused on five key disruptive innovations, comprising genomic or DNA sequencing, "which will change healthcare"; robotics and automation, "which is going to create a lot of jobs"; energy storage, including the shift towards electric vehicles; next-generation internet, focused on artificial intelligence and the "Internet of Things"; and blockchain technology, "which could be explosive".
"When we first started putting blockchain technology in our portfolios it was worth around US$6 billion and it's now worth US$130 billion in market cap. Apple is worth US$900 billion and Amazon US$450 billion, and we think this is a much bigger idea than either Amazon or Apple," she said.
According to ARK, bitcoin transactions are expected to reach US$2 trillion a day by 2020, double the current level, with the enabling of real-time trade settlement "freeing up hundreds of billions of frozen dollars".
Wood described Amazon as one of her biggest investment successes, having owned the stock since 1996, when it was capitalised at under US$1 billion.
"Amazon was under assault from investors as it was investing aggressively to capitalise on a huge opportunity … but I understood Jeff Bezos's goal that it would ultimately deliver a long-term triple-digit return on invested capital. We're not at the long term yet and it's already worth nearly US$500 billion," she said.
Wood said her firm had built a research ecosystem of entrepreneurs, private equity investors, professors, and others to find the next disruptors, using social media platforms such as Twitter along with more traditional financial research.
For investors seeking the next Amazon, Wood said a key decision is "deciding if it's a feature or a platform. For example, Snapchat is a feature, and Facebook is copying and crushing it".
Key metrics
ARK bases its investment decisions on a number of key metrics. Wood says ARK focuses on seven, of which the most important is talent.
"If we see a talent exodus from a firm, we are certainly going to be cutting back, if not exiting," she said. She pointed to the example of Apple, which at one stage had 600 autonomous car engineers but suffered a talent exodus when its key executive moved to a rival.
Other key metrics comprise barriers to entry, execution of strategy, market share, and thesis risk. The latter includes the effects of government regulations on a platform, such as China's move to ban bitcoin exchanges that saw the industry move to Japan.
The final key metric is the hurdle rate of return. "Our minimum expectation is that every stock in our portfolio will deliver a 15 per cent compound annual rate of return over the next five years, so a doubling over five years," Wood said.
Asked if any Australian stocks met the criteria, Wood said ASX Limited (ASX: ASX) was potentially of interest due to its blockchain exposure, while she also admired biotechs Cochlear (ASX: COH) and CSL (ASX: CSL).
The ARK Innovation ETF's major holdings as at 15 December included the US-listed Bitcoin Investment Trust, Tesla, Stratasys, and Twitter. The fund was showing a one-year return of 54 per cent as at 30 September, with a 21 per cent annualised return since inception.
Other funds focused on disruptive innovation include the recently listed Evans & Partners Global Disruption Fund (ASX: EGD). As at 30 November, the fund's holdings included Amazon and Chinese internet firms Baidu and Tencent.
Another fund, Loftus Peak Global Disruption [8425], includes similar global stocks. As at 30 November, it was showing a one-year return of nearly 35 per cent compared to the 22 per cent return of its benchmark, the MSCI All Countries World Index.
However, investors in disruptive innovation should not expect a smooth ride.
Wood sees the potential for the current disruptors to become disrupted, such as by quantum computing, which could "disrupt everything … not just our portfolios, but every portfolio out there," potentially within a decade.
And with everything from flying cars to "crypto-assets" such as bitcoin seen becoming mainstream, Amazon is unlikely to be the last disruptor venturing to these shores. Australian investors had better get ready.
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Anthony Fensom is a Morningstar contributor and owns shares in ASX and CSL. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.
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