Cover Story: Investing themes from the pandemic

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on May 11, 2020 - May 17, 2020.
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The Covid-19 pandemic has changed the way people work, shop and consume entertainment. The stay-at-home orders that have been in place for weeks across various countries have prompted many to use technology tools to do everything remotely. As more consumers become used to the convenience of these solutions and businesses adapt to accommodate them, some experts expect this trend — which has already benefited several technology stocks — to stay after the pandemic ends.

In fact, the digitalisation of these services had already been occurring prior to the pandemic. The drastic actions taken by governments to curb the spread of the virus merely accelerated the growth of this trend, say industry observers.

“Can you imagine going through this 10 years ago? How painful it would have been to do it without a smartphone, Netflix or online food delivery services! This tragic event has led to the greatest global social experiment we’ve ever had, in that [many] people are being told to stay at home for as long as two months. This has led to an explosion in demand for these online services,” says Richard Clode, portfolio manager on the global technology team at Janus Henderson Investors.

Some have drawn comparisons between this situation and the rise of fintech innovation after the 2008 global financial crisis, when people lost faith in the traditional financial industry. Fintech start-ups disrupted the market and provided more affordable and transparent solutions for consumers.

“If you look at how the financial crisis changed the way we view the financial system, I would say that Covid-19 will change the way we think about remote work, e-commerce, video games and digitalisation of businesses. These trends are going to stick with us and probably accelerate in the future,” says Pedro Palandrani, research analyst with Global X, which has several exchange-traded funds (ETF) with exposure to these themes.

Already, some technology companies have outperformed the market year to date (YTD). Video conferencing provider Zoom Video Inc is up 113.20% YTD compared with the S&P 500 Index, which is down 12.12% YTD (as at May 5). In the same period, Microsoft Corp is up 12.75%, Inc is up 23.52%, while Alphabet Inc (Class A) is down 2.84%.

The Nasdaq Composite Index is down 3.44%.

“The Nasdaq is pretty much flat for this year when most markets are down significantly. There was a big sell-off [in March] but there was also a strong recovery. Compared with the rest of the market, we think tech stocks stack up very well with near-term strength and strong balance sheets,” says Clode.

Safe havens in economic turmoil

Investors should understand that while many of these tech companies are performing well, they are not immune to fluctuations in the markets. But a large number are in good financial health, which could put them in a better position during a crisis.

“The beauty of technology counters is that they have the strongest balance sheets of any sector, especially the big technology companies. When there is a financial crisis, your No 1 concern is you don’t want to invest in a company that could go bankrupt … But some of these companies have US$100 billion in cash,” says Clode.

According to his team’s research, the net cash position as a percentage of market capitalisation for tech stocks in the MSCI World Sector Indices is -2%, compared with negative double digits for other sectors, according to data as at March 11.

In Clode’s view, the tech companies have been safe havens in the economic crisis caused by the Covid-19 pandemic. The strength of this sector will be sustained as people retain their new habits after the crisis.

“When people are going through a crisis, they look at the most efficient way of doing things and saving money. Even the most conservative [companies] are forced to try new ways to survive,” says Clode.

Richard Lightbound, CEO for EMEA and Asia at ROBO Global, an investment research and advisory company with several indexes tracking the tech sector, shares similar views.

According to ROBO’s research, 56% of the members on its Robotics & Automation Index (ROBO) had a net cash positive position at the end of 2019, compared with 15% of S&P 500 Index members and 22% of MSCI ACWI (All Country World Index) members.

“These are very healthy companies. Our robotics and healthcare [indexes] strategies have a big tilt towards small and mid-cap companies, as history tells us as we come out of a recession, these companies tend to recover faster. And the consensus now is that China is probably going to lead the recovery and show the first signs of growth. So, we’ve got a big tilt towards Asia in our strategies as well,” says Lightbound.

As the valuations of tech companies are down at the moment, it could be a good time for investors to look at the sector, he adds. “If you look at our ROBO Index, we’ve got a trailing price-earnings ratio of about 21 times. That’s well below the six or seven-year average of 25 times. If investors are thinking about entry points, this could be a good time to do so.”

Clode says the vast majority of tech companies are not overvalued owing to their strong growth prospects and balance sheets. However, some segments — such as software for cloud computing — are as the prices skyrocketed during the US-China trade war.

In addition, the influx of private capital from the likes of the SoftBank Vision Fund has driven up the valuations of some high-growth tech counters, Clode observes. But since SoftBank has announced write-downs for its funds this year, valuations may become normalised.

“When I invest in companies that go for listing, hopefully the valuations will be lower because the last round of fundraising they did in the private markets was lower than [before]. The founders have to show me that they can generate profits, which is a big change in behaviour from what we’ve seen in the last two years. That sort of high growth and high valuation bubble are deflating in many areas,” says Clode.

Interesting areas to look at

E-commerce has gained popularity in a big way at this time, as a diverse cohort of users is signing up for these services out of convenience and need.

“Amazon is a great example. For years, they’ve been trying to get people to shop for groceries online and suddenly, over a couple of months, they succeeded. A lot of these habits are going to stick because after people set up their accounts and use the services for the first time, they become comfortable with it,” says Clode. The same momentum was observed in online food delivery services such as China’s Meituan Dianping, GrubHub in the US and in Europe, he adds.

Businesses have also realised that they need to have an online presence to reach their customers at all times. Companies such as Shopify Inc, which provides e-commerce solutions for businesses, stand to benefit from this trend, suggests Palandrani.

This, in turn, drives the adoption of logistics and warehouse automation, Lightbound observes, as companies want to fulfil orders but reduce human workers. Factory automation accounts for 11% of the ROBO Index, and includes companies such as Daifuku, which provides factory automation and logistics services in Japan.

As people are stuck at home, online entertainment is also thriving, benefiting companies such as Netflix Inc and Twitch, a video game streaming website owned by Amazon. Netflix is up 31.37% YTD (as at May 5).

According to TwitchTracker, the total hours of content viewed in March was 1.2 billion, a jump from 982 million hours in February. Huya Live and Douyu, which are listed on the New York Stock Exchange and Nasdaq respectively, are the leading game streaming platforms in China that have benefited from this trend, says Clode.

Likewise, video games have seen an increase in users. For instance, Activision Blizzard CEO Bobby Kotick recently told the media that most of his company’s games are seeing record levels of engagement at this time. Its share price has risen 13.69% YTD (as at May 5). “Activision Blizzard launched its new game, Call of Duty: Warzone, in March, and they saw a record number of players acquired over the shortest period of time. It took Fortnite, another popular video game, 11 weeks to achieve what this game did in 10 days,” says Palandrani.

Could this trend stay beyond the pandemic? Looking at China’s experience, that might be so, observes Clode. “In China, the activity on the gaming sites didn’t go down even as people went back to work. They still felt uncomfortable going out. Since there are online games that have a social component, some people may choose to socialise in a team game rather than hanging out in person. In the near term, this trend is sustaining.”

Another huge behaviour change during this period is the rise of remote working. This has driven up demand for online workspaces, digital tools and video conferencing.

“Zoom had 10 million users at the end of December. Now, they have over 200 million users. Microsoft Teams hosted 900 million video meeting minutes per day in mid-March. By the end of March, it was 2.7 billion meeting minutes per day,” says Clode.

He thinks the remote working behaviour will continue. This will impact business travel going forward, as employers realise the cost savings that can be achieved by setting up virtual meetings.

“A good example for this is Apple. It was revealed last year that they were the largest corporate client of United Airlines, as they spent US$150 million every year for corporate travel. They booked 50 business class flights a day from the US to China because their supply chain is based there. Now, for the first time, they have to launch a new phone this year without having their employees physically checking on the supply chain in China. They have to do this virtually,” says Clode.

Supporting all these trends is a bigger sector that many tech investors are bullish on: Cloud computing. It refers to the use of a network of remote servers hosted on the internet to store, manage and process data.

Already, big tech companies such as Amazon, Microsoft, Alphabet and Alibaba are investing huge amounts in cloud computing.

“When companies have a huge surge in network demand because all employees are working from home, they are not fulfilling the extra demand with their own servers. They are getting extra capacity from Amazon, Microsoft, Google, Alibaba or Tencent in China,” says Clode. The same goes for e-commerce sites such as Lazada, which is hosted on Alibaba Cloud, and telemedicine and remote education services.

New companies will no longer buy their own servers, Clode observes. Older companies will seek cloud solutions, as it is more flexible and can enable remote working. Other than the cloud service providers, this trend will also benefit companies that supply the chips, networking equipment and software.

“That’s the reason why we own Nvidia, Broadcom and Samsung Electronics [in our portfolios]. Samsung sells memory chips, Broadcom sells Ethernet switches while Nvidia sells AI-accelerator chips for data centres. Their biggest customers are Microsoft and Amazon. We also own companies like Ciena, which provides optical cables to link data centres. This is one of the biggest themes in our funds,” says Clode.

Lightbound also has huge exposure to cloud computing in ROBO’s strategies. “In our Artificial Intelligence (AI) Index, about 40% of the companies are enablers and providers for the data centre ecosystem and 70% of these companies have a net cash position,” he says.

It is worth noting that some of these digital trends overlap with the healthcare sector. In ROBO’s healthcare index, the sectors that are outperforming are telehealth and data analytics. “In telehealth, we’re looking at companies like Teladoc Health and Ping An, which have apps that allow you to talk to your doctor online. We saw these companies grow through the crisis,” says Lightbound.

A long-term trend

According to the Janus Henderson Global Technology Fund factsheet (as at March 31), its three-year, five-year and 10-year returns (annualised, in pound sterling) are 13%, 16.3% and 13.8%. It is the target fund for the TA Global Technology Fund in Malaysia.

The returns for the latter two periods are slightly lower than the index. This could be due to regulatory constraints, Clode explains. “As a UCITS (Undertakings for the Collective Investment in Transferable Securities) regulated fund in Europe, we cannot hold more than 10% in shares of a single company. The mega-caps like Apple and Microsoft have done very well and they comprise well over 10% of the index, but we can’t be overweight those stocks.”

As for ROBO Global, its ROBO Index is down 7.78% in the past year, based on its factsheet (as at May 4). Since inception in 2002, it is up 1,377.74%. The AI Index is up 32.13% in the past year (as at April 30) and 185.80% since inception in 2015. These indexes are tracked by ETFs listed in the US and the UK, among other countries.

“If you share the conviction that technology is shaping our futures and will dominate our children’s futures, you need to make sure you have exposure to them in your portfolios,” says Lightbound.

According to its website, the Global X E-commerce ETF’s average annualised return for one year was 0.29% and 16.97% since inception in November 2018. The Global X Robotics and Artificial Intelligence ETF average annualised return was 5.80% for three years and 10.16% since inception in December 2016. The Global X Cloud Computing ETF had an average annualised return of 10.55% for one year and 13.98% since inception in December 2019 (all data as at April 30).

“Thematic investments are a forward-looking investment strategy. In the long term, we will see these themes capture and disrupt the traditional sectors of our economy,” says Palandrani.

For example, e-commerce is disrupting the traditional retail sector and will likely be the main driver of growth. The same could happen with robotics and AI in the industrial sector.

“Oftentimes, when we have these mega problems around the world, it presents the biggest opportunities for investors out there. The world post Covid-19 is going to be very different and I think it’s important for investors to understand the opportunities in these areas and be forward looking,” says Palandrani.




Opportunities in Malaysia

Photo by Mohd Shahrin Yahya/The Edge

The trends in Malaysia are not unlike those seen globally. More people are ordering food or goods online and working from home. Even after the Movement Control Order is lifted, e-commerce, e-learning and work-from-home tools could continue to be used because of their convenience, according to industry observers. This will benefit companies in various industries.

“To support these trends, you need more bandwidth, storage and memory. This will benefit data centre and cloud storage providers, as well as those involved in producing hard disk drives. The shift to 5G may initially be seen as a luxury project, but I think with more demand for video conferencing, it might become a necessity,” says Lim Tze Cheng (pictured), head of research at EquitiesTracker Holdings Bhd.

“We don’t have many cloud computing, video conferencing players or online store players in the Malaysian stock market. The closest you can get are the semiconductor companies, which are indirectly benefiting from this. In terms of 5G, I don’t think it will benefit the telecommunications players that much,” he adds. This is because competition is fierce among these players, who do not have much pricing power to increase their profit margins.

Lim believes the first sector to rebound after the pandemic will be the semiconductor counters, “because if you think about what is powering all the digitalisation trends, its semiconductors”, he says.

Meanwhile, Victor Wan, head of research at Inter-Pacific Securities Sdn Bhd, believes that logistics and warehousing, digital retailing, selected food and beverage companies, and telecommunications, cellular and IT companies could be beneficiaries of these trends.

Similarly, Imran Yassin Mohd Yusof, senior analyst at MIDF Amanah Investment Bank Bhd, believes that tech companies will be the winners arising from these trends. In addition, “telecommunications companies like Axiata, Telekom Malaysia, Digi and Maxis will benefit as people require fast and stable internet connection. Logistics companies could also be impacted positively”, says Imran.

Some industry experts believe, however, that investors must be cognisant of the fact that market conditions are still very fluid, and volatility is expected. Earnings growth is unclear as the impact of the pandemic is still not fully understood.

“Also, the operating landscape is evolving and the changing conditions increases risk, even after the Covid-19 outbreak runs its course. That said, the evolution of the gig economy and prevalence of the internet economy provide trading opportunities for the near to medium term,” says Wan.

Imran recommends that investors pick stocks with defensive earnings and solid dividends to moderate any pullback in the market. “Main contenders for this would be utilities such as Tenaga Nasional, and healthcare players like KPJ Healthcare and IHH Healthcare,” he says.