Why it can be dangerous to invest by sectors
Kent Kwan is co-founder of AtlasTrend. With 15 years of professional experience in investing and international financial markets, Kent has successfully managed more than $1 billion in funds invested in international-listed shares.
It is a long held tradition in the investment markets that shares and managed funds are separated into industry categories e.g. resources, healthcare. Many people will base their investment decisions on the perceived growth or defensive characteristics of these industries.
For example, financial planners might advise those in retirement to invest in lower risk and lower growth industries such as utilities whereas for younger clients they may advise investments in higher growth industries and companies.
This used to make sense in the 20th century but I fear it is now an outdated way for approaching investing. In fact, it might even be downright dangerous from a risk perspective to filter investments based solely on notional industry classifications.
Why is this the case?
It is all because in the 21st century the rapid pace of technological development and innovation has already started to turn many traditional industries and companies upside down.
Technology & innovation will disrupt all traditional industries
It is a big statement but I can’t think of one major industry globally which will not be significantly disrupted in some way by technology or innovation in the next 5 to 15 years. In many cases, these innovations have impact across multiple sectors. Let’s take the following two examples of industries which are traditionally seen as very defensive with little risk to their future earnings profile.
Utilities industry
The utilities (power generation) industry has long been recognised as one of the most defensive industry available for investment. The theory being centralised generation of electricity will always be required and large power stations will for the foreseeable future have no competition.
However, there is now ongoing rapid improvement in solar energy and battery storage technology. This improvement is happening so fast that the world is probably less than a decade away from solar energy generation on your rooftop being able to provide all your home energy needs at below the cost of what a traditional utility can supply electricity.
When this occurs, you can imagine what will happen to the profit and loss of traditional utility companies. There is a real possibility that some utility companies become obsolete. What is now regarded as the most defensive of sectors for investing may well become the riskiest of sectors.
Healthcare industry
The use of technology such as big data analysis (the use of computing power to analyse huge amounts of data to find useful trends) is already having great impact across the healthcare industry. For example, it can significantly shorten new drug research time, diagnose diseases, personalise medical treatments and provide much earlier indications of health issues.
For healthcare companies to prosper, it will no longer just be about people becoming sick and providing medical care. It will instead be driven by which company can best utilise innovation and technology to prevent people becoming ill in the first place and using appropriate data analytics to provide the best course of medical treatment. As a result, what was an industry with relatively defensive investment characteristics is rapidly morphing into an industry with very different and divergent traits.
What does it mean for your investing strategy?
You should reconsider filtering investments based on traditional notions of sectors or perceived growth / defensive characteristics.
The better risk adjusted way to invest is to focus on what long term themes or trends are driving significant global change or global innovation. Then invest in the specific companies that benefit from these trends and avoid those that will be disrupted by that same trend.
Let’s take online shopping as an example of a long term innovation trend.
Statistics globally show the trend towards online shopping is growing rapidly though still in its infancy. For example, only 7.5% of all retail goods and services sold in the US are sold online. There is near certainty this trend towards online shopping will continue to grow rapidly over the next 10 years.
The winners and losers from this trend are quite varied across many industries.
Winners: Online retailers should be the obvious winners but it is likely the ones who are first movers and have scale that will be the true winners. Traditional retailers who can leverage their existing customer bases to the online world will also benefit. Since every product sold also has to be stored first, packaged and then delivered, freight companies and large scale logistics warehouse developers are also set for a great decade. Looking slightly further into the future, companies that are able to develop online shopping autonomous delivery technology (self-driving cars or even drones) may create a completely new industry.
Losers: Traditional retailers who are not engaged with their customers online will no doubt suffer immensely. Real estate companies that own mid-tier shopping malls together with car park companies near these malls will find growth quite difficult to come by. Food and beverage outlets that depend on shopping mall foot traffic may also find their businesses in decline.
Going forward, successful investing will need an understanding of the global trends that impact multiple industries and companies. If you are an investor at heart, this should be great news because it will broaden your horizon to brand new investment opportunities you may have never considered before. At the very least, it should help you avoid some potentially costly investments in certain sectors that are set to be disrupted.
Are you comfortable with your investments? What do you make of this advice?
Let us know in the comments below.
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Any advice contained in this communication is general advice only. None of the information provided is, or should be considered to be, personal financial advice.
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