Amid solid economic growth expected this year, digital disruption will continue to be an investment theme that provides investors with a wide range of equity opportunities, says Capital Group investment director Andy Budden.
Digital disruption has been a huge investment theme in equities for the last decade, as investors reap the returns provided by high-growth, high-margin tech companies. Budden tells The Edge Singapore that he expects the theme to continue for the rest of the current decade as well, as attractive companies spread across various markets, sectors and industries.
“The real investment success of the digital revolution has so far been limited to a small number of US companies. However, this is no longer the case. We are seeing opportunities around the world, within varying business verticals. For example, retailers are doing a great job of fusing their online capabilities with their real world capabilities to provide customers with an integrated experience,” he explains.
From Budden’s perspective, there is a steady stream of “great innovations” that are solving existing problems and by doing so, creating value for investors who have backed these innovations. For example, clothing and electrical device companies are equipped with new ways to improve their relationships with customers and are increasingly selling to them directly via digital means. By doing so, the sellers can keep more of the margins for themselves, he reasons.
Other industries, such as railway and shipping companies have also used technology to improve their efficiency and performance amid an increasingly competitive landscape, says Budden. According to a report released by KPMG in February 2021, digital transformation is reinvigorating the shipping industry through new applications to streamline operations, customer experience and efficiency.
In shipping, digital platforms, real-time tracking data, big data, Internet of Things and other integrations are leading the way to the disruption. With a potential of more than 15% reduction in operating expenses, a rapid growth in the number of connected ships is expected in the next five years, says KPMG.
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As Internet penetration continues to grow from its current 15%, there is a lot more growth to be expected from the digital revolution, says Budden. Capital Group estimates the annual spending rate on digital transformation will almost double over the next five years. “This makes it a very exciting place to invest,” he adds.
Investing in companies with higher pricing power
Overall, Capital Group expects the world to see solid, albeit slower economic growth in 2022. The US economy may grow from 2.5% to 3% range, while some European economies are expected to grow slightly faster at 4% to 5% range, says Budden.
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“Outside of these economies, the International Monetary Fund is expecting China to grow at 5.6%. We suspect it is going to be a bit slower than that. China is definitely still growing, with some rough patches.”
Meanwhile, Japan’s prime minister Fumio Kishida unveiled a record-breaking stimulus package worth approximately JPY56 trillion Japanese ($663 billion) last November. While this does not guarantee economic strength for many years, it does mean that Japan’s economy this year should be “quite good” this year, says Budden.
“The Japanese government also has some interesting ideas about reform and innovation. The ‘Digital Garden City Nation’ concept is quite interesting in the clean energy strategy as well,” he adds.
Digital Garden City Nation aims to achieve rural-urban digital integration and transformation. The vision focuses on four broad initiatives — building digital infrastructure, developing and securing human resources with digital skills, implementing digital services to solve rural issues and initiatives to leave no one behind.
Against the background of resilient economic growth, it is likely that higher inflation will be around for longer, says Budden. This is due to the high possibility of disruption caused by the ongoing Covid-19 pandemic, as well as the risk of future variants. “What we have learnt through the Omicron variant is that past and new variants still disrupt production, shipping and business in general. This means that we could still continue to see these supply shocks as we go through the next year or so.”
In Capital Group’s view, one “interesting” way to invest amid this landscape is to invest in companies that have high pricing power — if a company has the ability to push for higher costs and pass them on to the consumer without impacting the demand, then they are able to better navigate the period of higher inflation.
“These could be the luxury goods companies, for example. They tend to have very strong brands and are very good at restricting supply, giving them high pricing power. Another example would be online entertainment companies, such as those operating within the gaming and streaming areas. These companies have become new consumer staples, which means that they could and have increased prices without impacting demand,” says Budden.
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He adds that semiconductor companies also fall within the same category, given the high and continuous demand for chips. This is a high-margin industry that is also an oligopoly, as most chips are made by three companies, allowing them to have the pricing power needed to get through the period of high inflation.
The three companies are Advanced Micro Devices (AMD), one of the leading providers of CPUs and GPUs used to compute power in data centres; Samsung Electronics, which is the largest dynamic random-access memory (DRAM) and NAND (flash memory) supplier commanding more than 40% and 30% of market share, respectively; and STMicroelectronics, the second largest player in embedded processing.
Rewarding opportunities in China and strategies to adopt
One of the more notable market trends last year took place in China’s stock markets. The tech sector crackdown, the collapse of Evergrande and the prospect of some of China’s biggest stocks being delisted from US stock exchanges have made investors nervous about investing in China assets. While some may deem China as “uninvestable”, Budden says investing in China can still be very rewarding, but it has to be done with a very deliberate approach.
“Investors should understand the priorities of the Chinese authorities and invest in companies that are aligned with those priorities. Clearly, the priority for the Chinese government is common prosperity, which leads to a big focus on affordable, accessible and high-quality housing, education as well as healthcare,” he adds.
Within healthcare, for instance, there are a number of biotech companies emerging in China that are poised to be global champions. There is also an emergence of contract development and manufacturing companies (CDMO), or companies that provide outsourced services to help pharmaceutical companies research and develop new drugs.
In 2019, the total size of China’s CDMO market was RMB44.1 billion, of which the chemical CDMO scale was RMB39.22 billion and the bio CDMO scale was RMB4.88 billion, according to insights firm ResearchAndMarkets. It estimates that by 2025, the total size of China’s CDMO market will be RMB131 billion ($28 billion), with a compound growth rate of 19.9%.
Some of the biotech companies in China that Capital Group has exposure to via its Asian Horizon Fund include CDMO company WuXi Biologics; pharmaceutical, biopharmaceutical, and medical device company WuXi AppTech and vaccine company CanSino.
While there are potentially valuable returns in the space, Budden says it does require adequate research to identify the companies have the right capabilities and are properly aligned with the objectives of the Chinese authorities, which is something that Capital Group is able to do with its team.
Moving forward, investors will need to have more thoughtful balance in their portfolios, says Budden. This is in contrast to the typical portfolio construction over the past decade, which have focused on growth stocks or bonds that benefited from declining interest rates.
It is also essential for investors to position themselves long-term in equities given the ongoing volatility in the asset class, especially evident over the past recent months.
“It can be very tempting to try and make decisions based on short-term news, but it is much better for investors to stay focused on the long term. Building a long-term strategy, sticking to it and not being distracted into making short-term buy and sell decisions should be the right approach for the vast majority of investors,” says Budden
Photo: Capital Group
