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How to Invest in Innovation

by internationalbanker

By Hilary Schmidt, International Banker

The Fourth Industrial Revolution represents a period of dramatic change. As a slew of new technologies usher in a period of new business models and rapidly changing consumer preferences, it’s a case of “out with the old” across virtually every global industry. Under this climate of unrelenting innovation, a number of profitable opportunities now present themselves to investors.

“Secular trends are transforming our world at an unprecedented pace and, as a result, the future may arrive faster than investors expect. Foundational change in the cost to create and transmit data, amplified by increased regulation and demographics should create an environment of accelerating economic change,” Franklin Templeton Investments, the US investment company, observed. “We continue to see steady long-term adoption of e-commerce, software-as-a-service, social networking, cloud, medical technologies and e-payments. We are also optimistic on future investments such as in autonomous driving, genetics, immunotherapy, new composite materials, quantum computing, blockchain, drones, virtual & augmented reality, IoT (Internet of Things) and artificial intelligence.”

Franklin Templeton also identified three core tenets that have guided the firm over several decades when investing in innovative companies.

  1. Innovation drives long-term wealth creation: The firm contends that innovation is the main driving force behind value creation in the global economy and that we are now in the middle of a period of unprecedented innovation. Global e-commerce, genetic breakthroughs, intelligent machines, new finance and exponential data are five tech themes generating particular excitement at present.
  2. Investing in innovation requires active management: Although innovation-linked themes are promising, active management of them remains fundamentally important, especially given that they are advancing at different paces and will become investable at different times. “That’s why we think active management can prove its worth—guiding investors to these platforms when they intersect well with a good investment.”
  3. Innovation is everywhere: It covers all areas of the global economy, and as such, investing in innovation can occur across a wide array of sectors, market-capitalisation sizes or geographical locations. Innovation is not confined to the technology sector, moreover.

It may seem that investing in innovation from the outset can be a minefield, however, especially given the sheer number of new technologies that have come to the fore in recent years. For investors, this can make deciding which sectors have genuine long-term growth potential and which are perhaps more hype than adoption at this stage a decidedly challenging task. Nonetheless, a number of investment firms have identified some of the most promising innovation themes over the next several years. At San Francisco-based advisory firm Main Management, for instance, innovation represents one of five to ten long-term, secular growth themes in which the company invests. Under this theme, the strategy seeks to gain exposure to genomics, fintech (financial technology), e-commerce, robotics and artificial intelligence (AI), cyber-security, clean energy, cloud computing, autonomous tech, gaming and e-sports, and pet care.

These sectors, according to Kim D. Arthur, the portfolio manager of Main’s Thematic Innovation Rotation investment strategy, represent potentially disruptive technologies with large, addressable market shares and the potential for widespread adoption in the coming years. “For example, Clean Energy is largely solar for the time being, which is a proven technology but has yet to hit widespread adoption. Yet, potentially everyone who lives or works somewhere that has a roof has the ability to install solar panels,” Arthur told Nasdaq in November. “The addressable market is enormous and has hardly started to be tapped. An increased focus from governments on reducing carbon emissions and fossil fuel reliance, as well as the desire to be self-sufficient when it comes to power are two powerful catalysts that can drive adoption in the coming years.”

Arthur highlighted the somewhat unique method of innovation investing, one which relies less on financial metrics, such as the book-to-price ratio, and focuses more on qualitative factors, including “observations around consumer behaviour and technological advances”. She also confirmed that most of Main Management’s innovation investing is done by using exchange-traded funds (ETFs), which “makes it easier to gain exposure to a variety of underlying names involved in a given theme or sector.”

Among 2020’s most successful funds in the innovation space was the ARK Innovation exchange-traded fund, which aims to invest at least 65 percent of its assets in domestic and foreign companies engaged in disruptive innovation in both developed and emerging markets. According to ARK itself, those companies include ones that rely on or benefit from the development of new products or services, technological improvements and advancements in scientific research relating to the areas of DNA technologies (genomic revolution), industrial innovation in energy, automation and manufacturing (industrial innovation), increased use of shared technology, infrastructure and services (next-generation internet) and technologies that make financial services more efficient (fintech innovation).

The fund returned a whopping 153 percent during 2020, which placed it among the year’s top three best-performing ETFs. This year, however, has been decidedly more mixed for ARK, which saw its assets under management balloon to $28 billion by its February 2021 peak, but with renewed concerns over the return of inflation and rising interest rates, the fund lost almost 35 percent of its value from that February peak (as of May 12) and is around 18 percent down year-to-date. And while the ETF’s investors are mostly holding on through this downturn, it seems increasingly unlikely that 2020’s phenomenal gains will be replicated this year.

Looking elsewhere, one of the best-performing innovation ETFs in 2021 so far is the HANetf HAN-GINS Tech Megatrend Equal Weight UCITS ETF. This fund seeks to replicate the performance of the Solactive Innovative Technologies Index, which in turn tracks leading IT (information technology) companies in sectors including robotics and automation, cloud computing and big data, cyber-security, future cars, genomics, social media, blockchain, and augmented and virtual reality. In the year through April 2021, this ETF generated more than 65 percent in returns, placing it among the very best performing funds in the innovation space.

There are also innovation funds that focus on more specific sectors. The iShares Healthcare Innovation UCITS ETF is one such fund, which tracks the iSTOXX FactSet Breakthrough Healthcare Index. This index comprises companies worldwide focused on innovation within global healthcare services across both developed and emerging markets. The ETF has generated nearly 40-percent returns over the last year through April 2021 and nearly 60 percent over three years. And ARK’s Autonomous Technology and Robotics ETF is composed of companies focused on energy, automation and manufacturing, materials, and transportation—with development in autonomous transportation, robotics and automation, 3D-printing, energy storage and space exploration.

Thematic funds focused on innovation are far from being in short supply. Investors have a wide array of options for gaining exposure to this sector. And should specific ETFs not provide the exact exposure one is seeking, an investor can always create a mixture of individual stocks and funds that closely replicate an established portfolio, with the necessary adjustments made. Ultimately, innovation is transforming industries and creating a multitude of investment opportunities along the way. Although more companies are staying private, more companies are also staying longer; a substantial number of publicly listed innovation companies with enormous potential upside are still out there.


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