As more companies embark on their digital transformation journey, cloud computing has become one of the fastest-growing tech sectors over the past few years. Accelerated by the Covid-19 pandemic, the demand for cloud computing is poised to grow exponentially — presenting investors with ample opportunities, says Capital Group investment director Andy Budden.
“The pandemic has definitely helped cloud computing companies to grow their revenue at around 30% to 40% throughout the outbreak period. While it is tempting to say these companies have done so well that the investment opportunity is over, we believe there is a lot more room for growth,” Budden tells The Edge Singapore.
Worldwide end-user spending on public cloud services is forecast to grow by 23.1% in 2021 to US$332.3 billion ($448.4 billion), up from US$270 billion in 2020, according to a report by Gartner published in April. It adds that offerings which support or deliver public cloud services are experiencing tremendous growth despite macroeconomic headwinds.
“With the sheer volume of data created daily, companies will need to continue finding cost-effective data management solutions. At the moment, we are producing 64 zettabytes of data every year — equivalent to 3.6 billion of the most advanced hard drives that you can buy today. This figure is growing by around a quarter every year, so the demand for cloud computing services is only going to grow,” says Budden.
To address the opportunities in the cloud computing area, Capital Group has created a framework that breaks it into three layers: the enablers, solution providers and beneficiaries.
The enablers consist of companies that produce the hardware components required for cloud computing services, explains Budden. A big chunk of these are semiconductor companies, which today powers everything from mobile phones, fridges and cars. It is an industry with attractive growth prospects of an estimated 8% per annum over the next seven years, says Budden.
Aside from semiconductors, the enablers also include the producers of other components. This includes central processing units (CPU), graphics processing units (GPU), memory chips and microcontrollers, all which are growing at 7% to 10% CAGR — save for GPU which is growing at over 30% CAGR. Budden says aside from being high margin, the industry is also an oligopoly.
To illustrate his point, Budden says there are only a few large companies producing most of the world’s supplies of high-performance components and equipment. These include 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.
The next layer of opportunity — solution providers — include companies that provide for the cloud infrastructure. This segment is dominated by a few large players, such as Amazon Web Services, Microsoft Azure and Alphabet, who, amongst themselves, command almost two-thirds of the market share, says Budden.
These infrastructure providers have paved the way for smaller companies to come up with their own software solutions, which also forms part of the second opportunity layer. “Over the last three years, we have seen more than 250 software IPOs. Worldwide, there are about 20,000 software-as-a-service companies serving industries ranging from education to mining. Some of them are going to be spectacularly successful, and we are trying to find these champions of tomorrow,” Budden adds.
The final layer, beneficiaries, are companies that use cloud technology to create growth in their different specific industries. Aside from making a significant impact in higher efficiency and productivity in industries such as agriculture and energy generation, cloud computing technology has also transformed the future of healthcare.
Powered by the cloud, more precise diagnosis and treatment are available today. It also allowed for cheaper and faster DNA sequencing, which has tremendously improved the delivery time for a new drug. “In 2015, it would have taken nine years for a vaccine to be produced for delivery. In comparison, the Covid-19 vaccine only took nine months. It is definitely exciting to see how much of an impact the technology has led to,” says Budden.
Tapping into the cloud
One way investors could access investment opportunities is the Capital Group New Economy Fund. The growth-oriented global equity strategy invests in innovative companies and its beneficiaries.
Instead of a single fund manager, the fund uses an active investment approach which harnesses high-conviction investing from seven investment professionals working independently to produce smoother returns, says Budden.
The Capital Group New Economy Fund is a member of the Capital Group New Economy Composite, which was launched in 1983 and outperformed the All Country World Index over its lifetime at almost 12% per annum. The fund itself has provided investors with 10.7% return year-to-date, according to its August fund fact sheet.
As at Aug 31, the fund’s top five holdings are Microsoft (4.2%), Netflix (3.9%) Alphabet (3.5%), Broadcom (2.4%) and Amazon (2.4%).
Geographically, the fund’s focus is mainly in North America (77%), with Pacific ex-Japan only accounting for 2.4%. “I am happy to say that we did not have any meaningful exposure to the education stocks in the portfolio, so we have effectively navigated all the recent volatility in China,” says Budden, referring to the sudden slew of new rules imposed by the Chinese government on previously high-flying companies in this space.
As the fund is not a macro fund and instead focuses on the holdings of individual companies, it is important for Capital Group’s team to ensure quality research into the stocks and get their revenue and earnings forecast right, says Budden.
“We are currently watching very carefully some of the factors that will have an impact on the global economy. We are vigilant on inflation, interest rates and how growth evolves in the big economies especially in the US and China.”
Budden acknowledges that there are concerns surrounding environmental, social, and governance (ESG) among tech companies. He says Capital Group considers ESG essential for making high-quality investment decisions as they impact long-term shareholder value. This is why ESG is integrated into building the portfolio.
“Most investors would look at the New Economy Fund as quite attractive from an ESG perspective, as it has no investment in tobacco and firearms. While it does have very limited holdings in energy, there are companies that are transitioning towards renewables,” says Budden.
But no portfolio is perfect, he adds. The portfolio does have some holdings in Internet companies that have large amounts of consumer data. Budden says the rapidly evolving situation as countries around the world grapple with how to regulate such companies is something that the firm is closely monitoring.
Moving forward, Budden says he is excited about the future of cloud computing as well as the fund’s performance in the coming years. He says: “Overall, the earnings growth for the portfolio is expected to be around 20% to 25% per annum. In the short term, the valuations of the markets will go up and down, but in the long term, the portfolio should do well. So, it should be suitable for long-term investors who want to grow their capital.”
Photo: Capital Group
