Disrupters are everywhere. Andrew Holt looks at what makes a disruptor, where investors can find them and where to put them in their portfolio.
For investors, one of the main themes in the coming years, even the next decade, will be disruption. The list of disrupters is dominated by the spheres of technology and climate change as well as areas such as food and transport. No area of life will escape their impact, meaning that there will be huge implications for investors.
How are investors to identify these disrupters? As it is a clear truism to state that by definition disruption would not be disruptive if everyone already knew about it. True disruption is an unknown unknown, to use the eloquence of former US defence secretary Donald Rumsfeld. Such a position makes any assessment of disrupters now, or in the future, highly problematic.
And even the system used in the form of financial markets, seldom help, because despite what is still taught in the top business schools and perpetuated in leading think tanks, markets are inefficient and are often slow to recognise genuine disruptive innovation or are reluctant to accept the impact of disruption until it has become blindly obvious what has happened. This nevertheless creates a fascinatingly fertile hunting ground of companies and industries with unanticipated growth potential and investor zeal.
A perfect scenario it could be said for active managers, who have the flexibility, speed and resource to pinpoint under-appreciated companies and invest at the right time and price. Given its significant impact, investors cannot ignore disruption, even if it is highly difficult to pinpoint where it is hiding.
The theory of disruption
The term disruptor is used so frequently today it is hardly considered appropriate to ask: what exactly is a disruptor? What defines it? One thing is for sure, the idea of disruption is not new. Disruption has been the hallmark of capitalism ever since the Luddites campaigned against the introduction of machinery in the early part of the nineteenth century.
But it is in the Innovator’s Dilemma, published as recently as 1997 by the late Harvard professor Clayton Christensen, that we have the modern theory of the disruptor.
Christensen noted disruptive innovation is an innovation that creates a new market and displaces established market-leading firms, products and alliances. A reasonably simple explanation.
Regarding these innovative and disruptive new technologies, Christensen noted: “The technological changes that damage established companies are usually not radically new or difficult from a technological point of view. They do, however, have two important characteristics: First, they typically present a different package of performance attributes – ones that, at least at the outset, are not valued by existing customers.
“Second, the performance attributes that existing customers value improve at such a rapid rate that the new technology can later invade those established markets.”
Christensen distinguished between so called ‘low-end disruption’, which targets customers who do not need the full performance valued by customers at the high end of the market, and ‘new-market disruption’, which targets customers who have needs that were previously unserved by existing incumbents. To illustrate disruption, Christensen used some strange examples from the worlds of hard-disk drives and mechanical excavation.
But disrupters, in short, can be identified as companies that have the potential to change or entirely displace existing companies and industries. Such companies can have innovative technologies or operations that are more efficient or make the old way of doing business obsolete.
Some of the largest organisations in the world can be defined precisely by this definition of a disruptor: companies that were foremost in introducing new business models and changed established industries to create entirely new ones. Prominent examples are, of course, Amazon, Facebook and Netflix.
The latter has changed how we watch films in the comfort of our own home. Technologies here have changed from VHS and DVDs to streaming services, this has created investment opportunities amid disruption.
This example indicates the need to exploit or create new trends as a disruptor: Netflix ushered in a new age of streaming whereas Blockbuster stood still and failed to realise its position was under threat until it was too late.
The rollout of 5G could create further disruptive opportunities in this space. The same movie that might take several minutes to download on a 4G network may take just a few seconds on a 5G network.
The added challenge for some innovators, the Innovator’s Dilemma, is the decision a business must take between cater- ing to current customer needs or adopting new innovations and technologies which will answer their future needs.
On a final theoretical note of disrupters, it has been observed there are seven drivers of disruption, although not all need to participate at the same time and on every occasion. These are: automation, artificial intelligence, brand fragmentation, digitalisation, the environment, breakthrough science and platform business models – which can collectively permeate every part of the stock market, producing, in turn, winners and losers.
Disrupters of the future
Disruption and disrupters seem to be everywhere, and in their sometimes unsettling impact, they can suffer from negative coverage. This is, in part, because as an idea the positive part of the disruptor dynamic impact is not always obvious. But with such disruptive change comes benefits, especially it should be noted, for investors.
Companies like Amazon show how tech disrupters are innovating whole areas of our daily lives. Although people will experience this innovation in other ways, in the slow decline of high street retail, for example.
But the important part of disruption is that the successful companies of the future, like those in the past, will be those who not only adapt to change but embrace it, or more importantly, even bend change to their will.
As one fund manager notes: “As an investor in disruption, I aim to look beyond the headlines and imagine what the future will look like. A modern investor needs to understand the power of disruption, to identify which companies are likely to benefit, and which are set to become victims.”
So how can investors identify future disrupters? Is there a framework to work from? While disrupters can be found across many areas of the economy, automation, communications, finance, medicine, and technology should be on investors watch lists.
With such disruption, investments may well carry some unique characteristics to evaluate, which investors would do well to take note. For example, in some cases disrupters may exhibit higher than average levels of volatility, as investors may have differing opinions on the near-term prospects for these indus- try-changing companies. This can create opportunities for investors with a long-term focus – ideal for pension funds.
Yet, at the same time, it could be said to also reinforce the importance of diversification. Thoughtful portfolio construction could mitigate company-specific risks and portfolio volatility. Disruption could therefore make futurologists of us all. In fact, it could become an investment theme. Only the future can tell.
Climate change: a challenge or nightmare?
Climate change can be said to be the ultimate disruptor. Two studies highlight how the issue ranges from being a major challenge to that of cataclysmic proportions for institutional investors.
On the challenging scale, climate change is the top agenda issue for institutional investors in the 2021 Institutional Investor Survey by Morrow Sodali. Hardly a surprise.
What investors do expect to see is linked to several factors. Links between climate change and financial risks and opportunities need to be identified – a regularly identified issue that still needs to be hammered down convincingly – time horizons of the expected impact of climate change on corporate strategies explained – essential for investors – and metrics, targets and achievements clearly disclosed – ditto criteria for investors.
Yet investors do not require more information, but rather want to be provided with better quality climate-related information. Specifically, a good majority – 61% – are seeking improvements in climate-related disclosures that transparently show the clear links between climate change and financial performance, instead of boilerplate statements and generic qualitative reports.
Investors are also increasingly more interested in short to medium-term targets on carbon emissions which help them in assessing the roadmaps for transition to a low carbon economy.
To address this, most large asset owners are building their own internal teams to conduct the analyses of ESG risks and opportunities for their investment and asset disposal strategies.
Further, investors want to understand the practical actions companies are taking to ensure they do not contribute to climate change and ensure physical risk resilience. A suitable reporting framework is essential in being able to address climate risk.
In a practical and realistic response, it comes as no surprise that the Task Force on Climate-related Financial Disclosures was chosen as the first-choice reporting framework by 75% of investors. A unified reporting system would help iron out much debate about the data and response to climate change. Yet all this can only go so far in addressing the disruptive part of climate change.
As is revealed by a significantly bigger problem for investors existing among the disruptive climate change scenario: one in which they should prepare for a torrid transition to a low-carbon future. This is because none of the G20 countries are on track to meet their climate ambitions, according to report from risk intelligence company Verisk Maplecroft.
There is “no longer any realistic chance” for an orderly transition for global financial markets, warns the report, because political leaders will be forced to rely on “handbrake” policy interventions to cut emissions, according to the research.
Under this analysis investors face a nightmare situation with an increasingly disruptive impact of severe weather events which are expected to take a heavier toll on the global economy in the years ahead.
Verisk Maplecroft’s head of environments and climate change, Will Nichols, warns: “These conditions will leave businesses in carbon-intense sectors facing the most disorderly of transitions to a low-carbon economy, with measures – such as restrictive emissions limits for factories, mandates for buying clean energy, and high levies on carbon – imposed with little warning.”
That is bad enough, but there is more. “Our data underscores that it is clear there is no longer any realistic chance of an orderly transition,” adds Rory Clisby, one of the report’s authors. He then highlights: “Investors across all asset classes must prepare for at best a disorderly transition and at worst a whiplash from a succession of rapid shifts in policy across a host of vulnerable sectors.”
Such a scenario sounds closer to a nightmare than a mere disruption. It could be time for investors to get out their tin hats.
Identifying a digital disruption
Digital disruption has been a key theme in recent years. And looking at it today, it is possible to identify a real emerging digital disruption trend among the numbers and projections in this space. For example, we are moving from a world with billions of devices, the so-called digital 3.0, to a world with trillions of devices – the Internet of Things (IoT) and digital 4.0. A big factor here is that as digitalisation increases and a greater number of devices and applications are digitalised, the amount of data generated has exploded and continues to grow at an ever-faster pace.
For example, in 2015 there were 584 data interactions per connected person per day – this is set to grow more than eight times by 2025 to almost 5,000 interactions per connected person per day. These are big numbers and may, in fact, just seem like nothing more than numbers. But they have big implications. “It may feel like digitalisation has been a story that has been around for a long time, but we are still in the early innings: in the US, digital GDP as a percentage of total GDP is still only 5%,” an asset manager tells portfolio institutional.
This theme, in turn, will have wide ranging ramifications, playing out in multiple scenarios, most notably healthcare, transport, robotics and the automation of knowledge work.
Right at the heart of Digital 4.0 is the cloud, and the opportunity ahead is promised to be enormous – the penetration of the cloud for example is still below 10%.
Yet, at the same time, a report by McKinsey estimates that technology will replace 400 million full time jobs by 2030. Already today, 50% of current work activities can be automated by adapting currently available technology, meaning going for- ward, the workforce will need to adapt to this extremely challenging picture.
But the roadmap for Digital 4.0 shows that the next phase of adoption within disruptive technologies involves some, or all, of the Internet of Things (IoT), 5G, data and artificial intelligence. These are believed to deliver the biggest opportunities during the next five to 10 years.
Disruption in perspective
There can be no doubt the pace of disruption is increasing, leaving challenges in its wake, particularly in the investment landscape. Companies once considered attractive can quickly suffer from disintermediation in that their products or services are becoming obsolete.
Disruption is also impacting on the lifespan of companies. In 1960, the average age of an S&P company was 60 years, today it is 20. At the same time there can be no doubt that innovation and disruption, with all its positives and negatives, is the driving force behind markets and with it, investment.
The whole disruptor narrative is fascinating, but at the same time challenging, for institutional investors, presenting massive challenges and big opportunities. And investors looking out for the disrupters of tomorrow could well be a hopeless task. As one asset owner observes: “Identifying the disrupter winners is a real challenge. As the biggest companies and disrupters of 20 years’ time, have probably not been created yet.”