A focus on disruption deserves to sit alongside growth and value in the “investment hall of fame” – and may soon overtake its more established peers as the most viable method of managing money.
This is according to James Dowey who runs the £192m Liontrust Global Equity fund. While this fund is supposed to be a core equity product, it is heavily overweight tech, accounting for 43.35 per cent of the portfolio by the end of May, with the manager saying it is vital for long-term investors to stay on the right side of disruption.
To illustrate why this is so important, he pointed to a chart showing the length of time it takes for new technology to become ubiquitous. While it took 46 years for electricity to be adopted by 25 per cent of the US population and 26 years for television, it took just 16 years for PCs in the 1970s and early 1980s and just two years for tablet devices in the 2010s.
Source: Liontrust
Yet Dowey said more important than the speed of disruption is the impact on business fundamentals.
“Back in 1960, the average lifespan of an S&P 500 company was 60 years,” he noted. “Today, it's just 20 years.
“Actually, disruption is the most powerful driver of shareholder returns out there. If you look at $1 of revenue generated by a company in any way other than disruption – so growing your share within the current product range, expanding into an existing market or acquiring another business – it tends to generate far less than $1 of shareholder value.
“But $1 of revenue growth generated by a company through disruption – so attacking a market with a new product or business model – tends to generate nearly $2 of shareholder value.
“You've got to get it right. But if you do, the returns are potentially very powerful.”
Dowey warned that disruption is not confined to the tech sector, but is permeating every area of the economy.
The manager organises his research around searching for what he calls “the magnificent seven” core disruptive drivers: automation, artificial intelligence, brand strategy, digitalisation, environmental, science & healthcare, and platform models.
And he said that if anyone wants to quantify their importance, they only need to look at the divergence in individual industries between those companies that are making the maximum use of these drivers and those that aren’t.
“Look at productivity growth,” he explained. “If you take the frontier companies in the top couple of per cent out of every industry, the productivity growth in the rest of the companies has on average been non-existent.
“Economists have thought a lot about this over the last decade and it is a big part of what's been driving this productivity puzzle: if you look at the last 20 years or so, you see stagnant productivity growth among 90 to 99 per cent of companies. But at the frontier, you've seen pretty much a doubling of productivity.
“It’s also reflected in revenue growth – 20 to 25 years ago, you would define a slow-growing company as one with revenue growth of lower than 4 per cent a year, and only around a third of the MSCI World market was in that category. Today, it's half the market. So, the disruptors are sucking the growth out of the rest of the market.”
Some value managers claim the economic lockdown caused by the coronavirus has brought forward a couple of years’ earnings for many tech disruptors, meaning anyone investing now is unlikely to see significant gains in the short to medium term. Dowey has some sympathy with this argument, saying some stocks have caught a wave of enthusiasm that is not necessarily justified by a genuine long-term opportunity with a strong probability of success.
However, when the manager ranks the five key long-term drivers for the stocks in his portfolio, Covid-19 is at number five – meaning it is the least important. Numbers four and three are the era of low interest rates and the current global geopolitical situation – with trade tensions between China and the West leading to a greater reliance on technology, for example.
However, it is the first two – the rate of innovation and the disproportionate impact of certain innovations – that he believes are by far the most important.
“Innovation is the pipeline for disruption and it's absolutely booming,” Dowey continued. “Think of Apple, which launched the iPhone in 2007, but filed the patent for its handheld computer in 1997.
“Likewise, the disruption of the 2020s has already been seeded by the innovation of the past decade. A lot of people notice we've had this low-productivity decade, but paradoxically what not a lot of people know is that in the background, upstream innovation has actually been very strong and we've seen twice the rate of patenting in the US in the last decade compared with the decade before.”
He added: “Second, not every innovation is equal. We see artificial intelligence, which is coming onstream, as a game changer. When innovations like this come along, it's important to recognise they do really big things to economic growth.
“In the 1920s, the electrification of the US was responsible for almost half of the growth in GDP per head in the economy during that decade. And then again in the 1990s, the spread of computers was responsible for about half of all the GDP growth in the US economy. We see artificial intelligence as similar to that.”
So if a focus on disruption could be as important as the value or growth styles of investing over the long term, why has it only begun to prove its worth over the past couple of years, rather than a multi-decade period like the other two?
Dowey said the answer to this is obvious – while sceptics may say the managers that have ended up in disruptive stocks over the past few years were simply lucky to be in the right place at the right time, you could easily have said the same thing about the proponents of the main investment styles.
“When you think about the intellectual history, it is no accident really when these approaches to investment became developed and established,” the manager continued.
“When did Benjamin Graham write his most famous book about value investing? It was during the 1930s when the opportunities for bounce-back following the Great Depression were enormous.
“And then Warren Buffett developed moat-based investing during a period of relative stability in the second half of the 20th century.
“It is no coincidence in our mind that the father of disruptive theory, Clayton Christensen, the famous Harvard Business School professor, originated this theory in the 1990s and then developed it over the next 20 years or so to capture the age of rapid change.”
Dowey concluded: “We feel that disruption is rising and deserves to join the hall of fame alongside those two giants.”
Liontrust Global Equity has made 26.47 per cent since Dowey took charge in July 2019, compared with gains of 7 per cent from its MSCI AC World benchmark and 6.91 per cent from its IA Global sector.
Performance of fund vs sector and index under manager tenure
Source: FE Analytics
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