Part 2: Could a disruptive innovation strategy sit in a client’s portfolio?
In 2013 McKinsey Global Institute released a report: Disruptive technologies: Advances that will transform life, business, and the global economy, which estimated the potential economic impact from disruptive innovation to be between USD 14 trillion and USD 33 trillion per year in 2025.
Investing on a theme
Disruptive innovation offers investors a thematic investment opportunity. It seeks to capitalise on changing trends caused by technology-enabled innovations that cut across economic sectors, industries and geographies. Part 1 in this series presented the five innovation platforms that are driving these trends: automation, energy storage, DNA sequencing, next generation internet and block chain technology.
Thematic investing is not a new concept. Investors have been using this strategy as a way to actively manage risk and manage their investment objectives for years. What’s different with disruptive innovation is the pace at which it is evolving and the breadth and depth of change it is triggering, making investors rethink their overall investment strategy.
“Certain deflationary forces – those associated with technologically enabled innovation and declining cost curves – will be exceedingly good for growth and profits,” explains Catherine Wood, ARK Investment Management Founder, CEO and CIO.
“Companies just have to be on the right side of disruptive innovation to enjoy them. If not, they probably will become value traps, much like bricks and mortar retail did during the last decade,” said Catherine.
The greatest potential for outperformance in this space comes when these innovation platforms converge. “Innovation enables industry growth, facilitates convergence across different sectors of the economy, and drives long-term investment opportunities. Over time, innovation should displace industry incumbents, increase efficiencies, and gain majority market share.
“Perception is key and investors should focus on promising areas of disruptive innovation, those missed or underrepresented by traditional investment styles”, said Catherine.
The potential for outperformance isn’t the only draw card. There are a number of other potential benefits of including a disruptive innovation strategy in an investor’s portfolio.
The benefits of thematic investing
The path to creating a well-balanced portfolio is to combine both higher and lower risk investments. Disruptive innovation strategies have the potential to offer uncorrelated returns through portfolios that provide little overlap with traditional growth and value investment strategies.
“Disruptive innovation focused strategies can be used as part of an investor’s long-term growth strategy, as a satellite strategy to diversify core portfolios, or as a hedge against rapid change. Over time, such a well-balanced portfolio should have the potential to deliver higher returns than risk-averse strategies,” explains Tom Staudt, ARK Investment Management’s COO.
The three main potential benefits thematic investing can offer investors include:
- Portfolio diversification – thematic investing can offer a low correlation of relative returns to traditional growth strategies and negative correlation to value strategies.
- An additional source of return – a top-down approach looks at secular trends and ecosystems to find attractive growth opportunities across sectors.
- Hedge for index-based strategies – a constant focus on secular changes and disruptive innovation can offer a portfolio hedge in a rapidly changing world and complement traditional strategies.
“Adding a portfolio with low correlation of relative returns to traditional growth strategies can potentially increase return over a full market cycle”, explains Tom.
The downside of upside
While exposure to a disruptive innovation strategy in a portfolio can offer the potential for outperformance, thematic investing can be more prone to volatility than traditional investing.
"Thematic portfolios built around disruptive innovation face certain risks. For instance, a primary risk is that a disruptive technology or disruptor company that could be one of the leaders of the future becomes disrupted itself, or does not fulfill its promise", says Tom
Given the volatility associated with disruptive innovation, it’s important to take a portfolio approach to investing and to maintain a balanced view between risk and opportunity.
For more information on the Nikko AM and ARK Invest Partnership: Nikko Asset Management and Ark Invest partner for disruptive innovation investment solutions
Parts of this document were prepared by ARK Investment Management LLC. This material is issued in Australia by Nikko AM Limited ABN 99 003 376 252, AFSL 237563 (Nikko AM Australia). Nikko AM Australia is part of the Nikko AM Group. The information contained in this material is of a general nature only and does not constitute personal advice, nor does it constitute an offer of any financial product. To the extent that any statement in this material constitutes general advice under Australian law, the advice is provided by Nikko AM Australia. ARK Investment Management LLC and Nikko Asset Management Co., Ltd. do not hold an AFS Licence.