Manish Goyal shares perspectives about how technology and other innovative sectors – such as healthcare and consumers - could continue to drive growth in 2020 and beyond.
"INNOVATION IS NOT JUST TECH"
EFI GEORGIADOU:
Hello everybody. I'm Efi Georgiadou, senior investor at J.P. Morgan. On behalf of all us here I thank you so much for joining us today to discuss 'Innovation is Not Just Tech'.
I will be the moderator for you today. We have the pleasure to have with us Manish Goyal, who many of you know. A lot of you have the opportunity to meet, and most of you are invested his performance. For those who would welcome a brief introduction, Manish is a portfolio manager for the digital evolution, and the innovative strategy here at J.P. Morgan. He has 20 years experience researching and investing in technology and innovating companies.
And we thought actually that it is a timely call to listen to his views while he takes us through all the work that he has been doing tirelessly to actively manage both portfolios.
You should have a raised hand icon in your devices, possibly in the bottom of the screen. Press click on the icon if you want to play the question, and also on the slide right now in front of you, if you don't want to raise a question you can also email it to us in the email you see right now in front of the screen.
So good morning, Manish. It is an early morning for you in New York. Thank you very much for joining us.
MANISH GOYAL:
Good morning, good afternoon everyone. It's my pleasure to be here.
EFI GEORGIADOU:
Thank you. Now before I start this interesting conversation, please allow me to take 30 seconds to share with our participants today three striking numbers. Now, first of all, in 2020, healthcare data used in research and development clinical trials, precision medicine is estimated to double every 73 days. Number 2, artificial intelligence valued at by 2030 is expected to be more than the size of China's GDP. And number 3, for those looking for a new trend that is conversational commerce, what we call c-commerce. 25% of companies will be using virtual customer assistance this year. This number was 2% in 2017.
So Manish, I will pass it on to you as you know better than anybody to put context in these numbers. And I will start the conversation with all this question on and around Covid-19. Covid has accelerated the change in technology and innovation to a more sort of, say, digital world. Entire industries have been transformed, and are transforming right now. So the key question to everybody is asking how will Covid change our lives, and more specifically what are the big trends that you are seeing in the consumer and the enterprise base?
MANISH GOYAL:
A good point to start with. What we have learned from history is crisis always force people to do things differently, and initially there is a lot of resistance when people have to change the ways how they do things. And a lot of times, you know, later people rely on the new way of doing things is a better way of doing things. So if you look at the history, women joined the workforce after World War II, and the global productivity increased significantly, that was a new way of doing things back then. There was big social change, but it turned out to be for the better.
If you look at SARS, post-SARS, e-commerce took off in Asia, that was a better way of shopping. And similarly, you know, it became kind of socially acceptable to wear face masks. Now investment world we don't see people walking around wearing masks, I go to Asia four times, five times a year to visit companies. It is common to see people wearing masks on the train, in the office and when they are walking. And, you know, so Covid forced companies to let people work from home. No company had contingency plan where they thought 98% of the workforce will be working from home at a two week notice. But now 110 days into it most companies are operating well. I mean especially banks like ours, we have done a phenomenal job in terms of while people are working from home.
So this will have significant implications as we look forward. What I see is over the next 2 to 5 years there will be significant productivity that we have not seen in the last 5 years, and that productivity will result in shareholder value creation. The service technician from ASML doesn't have to fly to Korea to provide that service, he can do a lot of things online or over the video.
A lot of internal corporate trainings will move towards online and video, people don't have to fly from one continent or one coast to the other. I don't have to spend 2½ hours everyday commuting to work. These things will collectively translate into significant productivity gains.
Much of the selling in the US, in Europe or in Asia, most of the selling requires meeting the client or the customer in person. I believe that we are moving towards an area which I have coined the term digital trust, where the customer or the client will be willing to buy things or sign for product or service after a virtual conversation. So the trust could move towards a virtual setting. Now not all products and services, you know, there are software products, medical device products, there are financial services products, and there will be some line where you can draw on, but a lot of selling could move towards virtual selling.
Again, a significant improvement in sales for productivity. If you look at the consumer from my perspective, cash is dead. I am not comfortable handing out dollars to my kids, 9 years, 13 years, or even my son, who knows who was touching it, who was sneezing on it, and I'm just not comfortable. That will accelerate the transition towards non-cash payment solutions, and we will talk more about this. If you look at the consumer today much of the video interactions are like casual conversations, like the Snapchat or WhatsApp conversation with friends and family living abroad, but high value interactions will move towards video. Having a tele-medicine session with your doctor, kids taking online learning school in a virtual setting on video.
Yoga class, maths class or, you know piano lessons, they all are moving towards online. In all of these examples cash exchanges hands, there is a financial transaction happening that is high value. Again, a shift in mindset in accepting that as a okay way or a new way of doing things.
Now what does this all mean? This all means that the building block of technology, like 5G, Cloud, artificial intelligence, augmented reality, the adoption of these technologies will accelerate significantly because we are starting to do things differently. There will come a time when, depending on the type of the business, 30, 40, 50% of people will start working from home a lot more than what they were doing before Covid, and that may reduce the need for commercial risk.
So I think we have just seen how Covid further highlighted the importance of technology in our lives. We are all connected today in this setting with clients from various continents, and usually I have to fly obviously to meet the clients, but we are doing this on a virtual setting.
EFI GEORGIADOU:
Thank you, Manish, that's quite interesting. Now I'd like to move on to two topics actually, dislocation and valuations. We have seen in massive dislocations in the market as a result of Covid with the SMP showing the highest in its concentration in nearly 40 years. So what opportunities are you looking at and also how are you thinking about valuations?
MANISH GOYAL:
So the current crisis has created significant dislocation in the market. You look at the top five, six tech companies, [inaudible], plus Apple, plus Microsoft. All these companies are up for the year, and they're up like 10, 11% collectively speaking. But when you look at Russell 1000, Russell 1000 is pretty much flat, down for the year, modestly down for the year. 1200 basis points of data. When you look at Russell 2000 the data is closer to 18%, 1800 basis points.
Maybe the market was right in terms of gravitating towards companies who are very dominant in their position, like Apple, Google, Facebook, Amazon or Centra, maybe even benefitting from Covid, and they have very strong balance sheets. But the question we should ask is are these going to be best investments over the next 3 to 5 years? And especially with dislocation in the market where we have seen other stocks, especially on the mid caps side, maybe there is better opportunity there.
So if I look at VES for a second, our allocation to fan stocks used to be close to 25%, and today we are down to like 11, 12%. our allocation has come down because we are finding opportunities outside, more compelling opportunities outside.
Now on valuation, look, generally I talk about valuation on a forward [inaudible] basis. Today I will take a slightly different route. In 2008, the prior recession, that 10 year bond was about 3%, today the 10 year bond is less than 80 basis points. In other words, the 10 year bond is trading over 100 times earnings. Let's take a second to think this information. The 10 year bond is trading over 100 times earnings. So what should be the market multiple when 10 year bonds is trading over 100 times earnings? I don't have an answer. 15 times, 20 times, 25 times? It is not 15, that much I can tell. Now is it 20, 25, 100, I don't know the answer. So the point I'm trying to drill here is when we are looking at equity valuation, generally we take price divided by earnings. I'm just saying that we need to consider the interest rate environment where we are today.
In this interest rate environment I would say equity valuation ought to move up, just because our discount factor is lower, and on top of that we have to think about - especially when you're thinking about tech - that we have just seen the importance of tech go up. So these assets probably are likely to be built up because the business is running because of tech. So we have to think a little bit in terms of how the equity value should not be changed during this low interest rate environment.
EFI GEORGIADOU:
Great, Manish. That is a very interesting introduction, and also a very interesting approach to valuations. That will lead us to discuss both portfolios. And before I do that, and knowing you and knowing that you will take a humble approach in terms of performance, I would like to take the liberty to share year to date numbers for both digital evolution and the innovators' portfolios. So the digital evolution strategy is 18% up year to date. It's beating its benchmark by 600 basis points, and the innovators' portfolio is up 11½% year to date, beating its benchmark by 1,100 basis points.
So great results. Let's first discuss technology and digital evolution. There is a massive digital transformation taking place. Now more than any other time the consumer seems to be moving entirely online. So can you bring us up to speed with what is happening with digital payment? Are you seeing the end of cash?
So as I said, first of all, thank you for bringing up the performance, this year has been kind to us. We are very excited about it. We navigated through this reshape recovery without many scars on our backs so I'm happy about that. Talking about digital transformation in payments it is going to accelerate the way we have never seen before. People will not be comfortable handing out coins or cash to their kids, to their family members, and we will move towards non-cash payments.
Now companies who benefit from non-cash payments are the credit card companies, like Visa, Mastercard and other issuers. Then there are digital payment companies, like Paypal, Square, et cetera. And there is a whole eco chain, eco system, companies who uphold the supply chain who work within this payment system, like European companies like [inaudible] or US companies, like FIS, who are merchant acquirers, et cetera. They always benefit as the market moves away from cash to non-cash payment solutions. And this is an area where we have significant exposure. And if you look at e-commerce companies, of course, like Amazon or [inaudible] et cetera, they all will have the onward benefit, because they don't really take cash, they will all move towards non-cash payment solutions.
EFI GEORGIADOU:
That's a very interesting development really, and it's great we have these type of companies in the portfolio. So all of that is very interesting. So we have Cloud computing, data analytics, 5G, artificial intelligence, cyber security, all big enablers of the digital transformation. What are the key trends in the technology sector for you.
MANISH GOYAL:
So let's take a look into what happened in the last 5, 10 years. We believe that during the last 5, 10 years consumers who are driving a massive amount of technology adoption they were driving a digital lifestyle, they were adopting a digital lifestyle. I talk about this mobile phone. I have an iPhone in my hand, it was introduced 10, 11 years ago, and since then what we have seen is more and more things have gone digital in our life. Music, media, they all come from companies like Apple Music or Spotify or Netflix or Hula. And we don't buy DVDs, we don't buy CDs anymore. We search for things online, pay online, review them online, deal with customer service online. And in the process of doing all of that a massive amount of shareholder value was created in the stock market. Apple, Google, Facebook, Amazon, Alibaba, Netflix, TENCENT, I am close to $5 trillion. Massive shareholder value. This is while consumers were adopting a digital lifestyle. And it is not over yet. You know, only 20% of US retail is online. And I don't know the point of equilibrium, whether it is 30/70, 60/40, there is a lot more room for innovation, there is more room for growth. But the bigger opportunity, in my view, is on the enterprise side.
Today enterprises are adopting a digital process. Today, enterprises are moving towards Cloud. Enterprises are moving applications towards Cloud. Covid only accelerated that. There is a very important call for [inaudible] It's not verbatim, but something along the lines that we have seen more digital transformation in the last two months than we expected over the next 3 years. I mean this guy is serious guy, very measured with his words. And companies have to now really think hard in terms of how many applications they had that were not accessible by people while they were working from home? How many applications clients are not able to access. And they may have to move a lot of these applications into the Cloud. So this will accelerate the transition towards Cloud. The simple reason why enterprises want to move to Cloud is because it is a more elegant solution which improves employee and customer satisfaction and reduces cost. It is virtually a win/win situation for everybody.
Instead of having islands of capacity of your computer storage, digital networking all around the world where usage is very low or under-utilised, if you have it in a Cloud environment, in massive data centres, you can increase the utilisation rate while reducing the operating costs on an on-going basis.
Now digital processes, what does that mean? If you look within a company there are 30, 40, 50 processes depending on the type of the business that can be totally digitalised. Why is it important? It is important because, again, improved efficiency reduces mistakes and really increases the through put of how to do certain processes.
Let me give you one example. In US if someone were to go into a branch and to get a mortgage, home mortgage, that entire paperwork is digital. The paper is not printed all throughout the process, even for attorney to view or signing the documents. Completely digital. They use signature capability, digital signature capability from a company called Docusign. 400,000 people from J.P. Morgan working from home. You know, if I have an IT issue I can't track down the IT guy from our floor, because there are hundreds of other people calling him. So we submit a ticket in a system, one closest to provided by a company from service now. So these are digital processes. And a lot of the processes within a company will continue to move in a digital format, away from manual. And this is going to be a big area of growth and investment for companies to confer in multiple years time in future.
The last point, when you look out 3 to 5 years out, there are two very important technologies, 5G and artificial intelligence. These two technologies will be very critical in driving growth in the autonomous cars, industrial revolution 4.2, healthier services, smart cities, smart farming, a lot of multiple industries and making a profound impact, and we'll talk about this more in subsequent slides.
EFI GEORGIADOU:
Perfect Manish, thank you very much. I kept Cloud and I kept 5G, but before we move on discussing those I want to ask you a very quick question. Your [inaudible] semi-conductors has served very well. Companies like NFC microchip have done very well for the portfolio, so what's your thesis from here?
MANISH GOYAL:
So if you take a step back and look at 2019, chip companies were shipping less than the consumption. Last year, late in 2018, US imposed tariffs on China. The chip distributors in China got spooked, they were not sure what the end demand look like. Just for those not familiar with the chip supply chain, US chip companies sell semi-conductor components to Chinese distributors, these distributors sell components to tens of thousands of customers in China. They could reach from small product manufacturers like [inaudible] et cetera, to all the way to handset servers, laptops et cetera.
So these distributors who are not sure what the end demand will look like in the US they didn't want to take the inventory risk, so they depleted their inventory, they were buying only [inaudible] So the bookings and shipments at the US chip companies saw a significant slowdown. They were shipping less than the consumption. Earlier this year, due to Covid and due to work from home, a lot of people were forced to buy laptops, monitors and desktops because they had to work from home and their personal computers are not up to date. Enterprises were forced to buy machines for their employees. That created a vacuum for [inaudible] inventory. I'm trying to buy a 34 inch monitor and, believe me, a lot of those places are out of those monitors. So now when I look at where we stand the inventory levels for components are low, the inventory levels for [inaudible] is low.
So I expect as the economies open up, as the markets open up we will see a significant recovery in bookings for the semi- conductor companies. Those companies supplying to the industry have changed, those companies supplying into 5G and to computing, they all will benefit as economies grows or begins to recover and businesses begin to open up. In particular, companies exposed to 5G, companies exposed to broader industry trends they will see significant recovery in their bookings. That's why we continue to like semi-conductors. Semi-conductors are roughly 13% of the benchmark in the US, and we have a rather large position in semis, about 25.6%.
EFI GEORGIADOU:
That's great, Manish, thank you very much for that. I will go back now to Cloud. You've mentioned it before, you talked a little bit about Cloud, and it is very clear that Cloud is a winner from Covid-19. So how does the portfolio capitalise on this trend and what kind of companies benefit from Cloud beyond the usual suspects, like Microsoft, Google, Amazon?
MANISH GOYAL:
So most of the time when people think about Cloud from an enterprise perspective, they think about Google, Microsoft, Amazon. But the investment opportunity in Cloud is much bigger than that. You know, a large bank, pharmaceutical company, industrial company, they are not going of buy all of their Cloud need from those three companies. Think about it. I live in the US and if I knew that I have to spend 250 nights in London it will be much more economical for me to buy an apartment there than to stay in a hotel.
So a large company who has significant computing needs, they don't necessarily need to pay 29% operating margin to Amazon, they can build their own Cloud and data centre because they have internal scale [inaudible]. So large companies may keep 60, 70, 80% capacity in-house and they can use Cloud or public Cloud for FLAX and other applications or for needs in other countries depending on the type of the business.
So when you start building your own Cloud you are looking to buy microprocessors, graphic processors, you are looking to buy high speed memory and communication chip, infrastructure hardware, infrastructure software, a variety of applications. You want to put your HR system on the Cloud you [inaudible]. You want to put your customer management into Cloud you go to
sales force. You want to put your PBX in the Cloud you go to [inaudible]. So depending on the type of application you want to go to the Cloud, you want to move to the Cloud, you create infrastructure behind it.
Then there is security layer, then there is analytics layer. So we see significant investment opportunity in Cloud which extends well beyond Microsoft, Google and Amazon.
EFI GEORGIADOU:
That is interesting, and I think we're going to see probably a lot of other companies in the following few months on that aspect. I'll move on to 5G.
MANISH GOYAL:
Just one more quick point here.
EFI GEORGIADOU:
Sure.
MANISH GOYAL:
When consumers adopted a digital lifestyle much of the shareholder value was concentrated within 8 or 9 or 10 companies. You [inaudible] you pretty much did well, but as enterprises are moving towards Cloud, enterprises are moving towards digital processes, that's a very fragmented market. I give you examples for multiple companies, chip companies, infrastructure, hardware, software, et cetera. You don't have one or two or three names that you can own and say okay, I'm done. There is a lot of digging required to figure out which applications are more important. So the time of consumer adopting a digital lifestyle is very different from enterprises moving to Cloud and digitalised processes.
EFI GEORGIADOU:
Sure. Thank you, Manish. Heading into 2020, 5G was a big theme for everybody. I do remember that we started talking about 5G at J.P. Morgan back in 2018. It is expected to impact almost every industry. Are you still excited about 5G?
MANISH GOYAL:
Absolutely. 5G will be a very critical piece of technology that will be deployed and used into multiple new applications over the next 5 years. Consumers will be the first to adopt later this year. I expect Apple to introduce 5G phone some time during the fourth quarter of this year in US. AT&T Mobile rival they will all start marketing their 5G plans. And it will be yet another major replacement cycle. But 5G will be far more critical in non-consumer applications, just the traditional voice and data application in new applications.
So let's spend a second and understand why 5G is so important. 5G speed will be 10 to 15 times faster than LTE, the 4G that we are using today. Theoretically, it is 20 times faster, but practically it will be 10 to 15 times faster. There is virtually no latency. So when you are watching a YouTube video and you get that buffering sign, that buffering goes away. In Netflix a video that takes 7 minutes to download will take a few seconds. But there are far more critical applications that can be had with over 5G network.
And if you are riding in your brand new Tesla and going at a 100 miles per hour and you slam the brake, your Tesla will be kind of enough to communicate with my Prius in the back so that I don't come and rear end your car. Vehicle to vehicle communication will be possible because of the speed of the network and reliability of the network.
Soon New York will be able to perform surgery in Des Moines, Iowa, which is about a 1,000 miles away from here. The image will be instant, it will be more, the network is reliable and those services will be possible.
And we have given multiple examples in multiple different industries from healthcare to smart factories. Imagine precision manufacturing, entire floors which are connected by wired networks today all moving towards wireless, highly reliable, it will improve the use of the factories, it will improve the efficiencies and make a big difference in terms of creating shareholder value.
So the real value of 5G will be realised as enterprises start to deploy 5G forward for their personal networks.
EFI GEORGIADOU:
Thank you, Manish. It's truly fascinating how lives will change completely when 5G is totally implemented within our lives and different aspects.
That actually leads us to innovation, and the innovators' portfolio that you have launched more recently. Now following the portfolio over time I would say, and I would say that loud and clear, that innovation is truly not just tech, it's pretty much everywhere. So please talk us through your framework for identifying these innovative companies, and also how you look beyond tech for opportunities.
MANISH GOYAL:
So some good ideas come from within J.P. Morgan, and sometimes greater, better and great ideas come to us from clients. A couple of years after the launch of VES, one or two of the large VES clients said to me that, Manish, you're doing a good job in capturing all the innovation going on in the technology sector. But, you know what, I see innovation all around me, in every aspect of my life, at work and at home. The strategy that will capture innovation in all the sectors of the economy. I thought that was a great idea. So we came back, we
take at look at like, okay, how do we go about finding innovation, what is innovation, because innovation could be different. Something that is innovative to me may not be innovative to you. And then what is the systematic approach to management even, you are using the lens of innovation.
And most importantly, is there even empirical evidence that investing in innovative companies creates [inaudible] returns. So we looked at all of these things. We [inaudible] portfolio for about 2, 2½ years, and last year in the fourth quarter we launched the strategy called the Innovators' Strategy.
The mandate here is to invest in companies, in any sector of the economy where we see innovation, and these companies ought to produce a product or service which is truly outstanding, innovative and has moved around it. Now how do we define [inaudible]. It all starts from the leadership. There are some CEOs and their management team who are boldly committed to be the leader, to be the innovator in their respective industry. They want to come up with products and solutions which others have not really thought before. And then you see a whole bunch of companies which are fast followers. And then there are even a greater number of companies who really don't care as much about innovation, they are just [inaudible] companies. We want to focus on those leadership, those management teams who are truly, truly committed for innovation, their conversations are tied to innovation and they have demonstrated in the past that they are the true innovators.
The second thing is about investments. Innovation cannot be created in vacuum. It requires investment, it could be R&D investment, it could be capital spending, and what we'd like to do is to look at those companies who are efficiently investing in R&D. Just because you invest in R&D does not ensure success. Nokia was investing nine times more than Apple in R&D and we all know how it went down for Nokia, how it went down for Apple.
And the third piece of it is product and service. What kind of products and services have they launched in the last 3, 4, 5 years? Do these products create shareholder value? Are they able to capture transitions? We pay attention, and that requires a lot of fundamental [inaudible] equity analysis in terms of looking at that.
So that is, broadly speaking, our framework. In short, I could say we use the same lens that we have used to analyse technology companies, and we apply the same lens to all the sectors to figure out [inaudible].
EFI GEORGIADOU:
Sure. It is a very unique approach to investing, and a question that very frequently comes up in our conversations is whether there is any data, suggesting that investing in innovative companies generates excess return.
MANISH GOYAL:
So before I do that, I want to spend a couple of minutes to talk about how innovation is not limited just to technology, and then I can address that question. When I use the word innovation most of the people think about the technology sector. Rightly so, rightly so. And in the last 10 or 15 years much of the technology sector grow a lot of innovation, but innovation is not limited to technology. Again, I go back to my iPhone. This device is loaded with technology. This is a pure tech product and 6 months from now it will be a 5G phone and then it will be updated and it will have more technology. When I am talking to Alexa or something it's pure tech product. But when I want Uber and I want to go from point A to point B, that is a tech enabled device. I just want to use a car that will take me from point A to point B.
When you are doing a tele-medicine call with the physician you want to speak to the physician. Technology is only enabling that. When you're shopping on Amazon or e-commerce or omni-commerce, you want the product, tech is only enabling that. So we are interested in tech products, we are interested in tech enabled products. And more importantly, we are very much interested in innovation which has nothing to do with technology.
You've got pants coming from Lululemon, there is a tremendous amount of research that goes behind it before Lululemon figures out which fabric will perform better in dry climate, in wet climate, how can they enhance an athlete's performance, et cetera.
Cosmetics coming out of Estee Lauder, whether it is lipstick or whatever, they employ hundreds of PhDs. They want to have cosmetics for a variety of skin tone, from Caucasian skin to African skin to Chinese, and they like to use local ingredients to make the best products possible. They have done a phenomenon job in product introduction, a phenomenon job in branding and even better job in marketing those products.
You look at healthcare, significant innovation going on in healthcare which has very little to do with the [inaudible]. If you go to the next page what we have tried to do here is we have tried to put a few sectors and name some of the innovations that we are excited about in each sector, healthcare, liquid biopsy, probiotics available to our health, and there's innovation all around us. So we are using the lens of innovation, applying that lens to all the sectors to figure out which companies are truly innovative in their respective field, and maybe there is investment opportunity there.
EFI GEORGIADOU:
That's great. The takes us to the question on the data, and suggest that investing in innovative companies, do they actually generate excess cash?
MANISH GOYAL:
So this is the framework we used for the innovators' strategy. Companies invest in R&D to create a differentiated innovative product. There is only one reason why a company invests in R&D, to create a differentiated and innovative product. If we are both selling this glass we will end up competing on price. If you are investing in R&D you have a better glass that can be microwaved, that is thinner, better designed. You have innovative products, you will have higher sales, better profit and you will create more shareholder value.
Those companies who do not invest effectively in R&D it doesn't matter. Automotive companies are the largest spenders in R&D, but they don't create value because they don't invest money effectively.
So the key point here is to invest in R&D to create an innovative product. Now the question is where is the empirical data to show that. Let's go to the next slide. What we are looking at here is Russell 1000. We look at Russell 1000, within Russell 1000, roughly speaking, 40% of the companies report R&D on a quarterly basis. Those companies out-perform the rest by 340 business points annualised over the last 15 years. Massive out-performance by companies who invest in R&D.
So we are fishing in the right pool. We are looking at those companies who are innovating. And if we do our jobs right we should be able to create significant access returns.
EFI GEORGIADOU:
That's a great approach to that. What I'd like to do now is I would like to dig a little bit further, and in the interests of time, if you can share with us a couple of high conviction positions within the [inaudible] portfolio. You mentioned healthcare before.
MANISH GOYAL:
So if I look at healthcare one of the biggest trends today is liquid biopsy. You take a little sample of the blood and you go through a variety of analysis to figure out if a recovering cancer patient you are beginning to see cancer cells in the blood again. So instead of going through a very invasive procedure, invasive testing, you can capture that through liquid biopsy. Similarly, they can capture things like Down Syndrome in a child by taking the fluid from the mother's womb and, again, significant improvement there. We have multiple investments in that area.
If you look at robotics there is [inaudible]. And we made some changes in the portfolio due to Covid, what we saw was there was a sharp drop-off in elective procedures, so hospitals that were taking Covid patients they were not taking elective procedures. So if you had a knee replacement, hip replacement, those out-patients didn't want to go to hospitals, and now what we are going to see is a sharp recovery in elective procedures, companies like Zimmer are going to benefit from that. We have a pretty large position, we especially added to our position significantly and even the stock goes down.
Elective procedures are not perishable demand. You know, it's not a cosmetic procedure that I can change my mind. If I don't go to Starbucks today I'm not going to drink twice as much coffee tomorrow. But if I'm deferring a hip or knee replacement, although already I am in pain, I may defer it by a month, two months, three months or so, then ...[loss of sound]... So we see that more as a deferred demand as opposed to perishable demand.
I have a 13 year old who is very wearing braces to straighten his teeth. You know, they're required to go back to the orthodontist every three or four weeks to get them adjusted. We ran into this company called Align Technology which makes clear aligners that reduces your visit to an orthodontist by 50% or more, without really impacting the bottom line of the orthodontist. In a Covid environment that's a great solution where the patient doesn't want to go to the orthodontist, the orthodontist has to practice social distancing so, again, we have quite a large position there.
So healthcare is going through [inaudible] which a company who provides a platform that benefits from having like a virtual [inaudible]. So these are some of the key investment ideas that we have played with, which some of them are more secular and some of them are benefitting from Covid.
EFI GEORGIADOU:
This is fascinating what's happening within healthcare, and healthcare innovation is actually one of our mega trend discussions this year. There are hundreds of other questions we'd like to place right now, but I'm conscious of time, so I'd like to open up for questions if there are any please.
If you'd like to place a question please raise your hand on the application, on the device, or otherwise you can email the question to the email address that you see on the screen.
I think I'll give it a few more seconds just in case we have a question.
We don't have a question so far, but I'd like to place one more question, Manish, if I may. We talked a lot about technology. It's a massive beneficiary, there's no question about that. Is tech an all-win sector?
MANISH GOYAL:
Look, the technology sector - depending on the industry - if you look at semi-conductors the leader makes 85% of the profits, number two company makes 10, 15% of the profits. And C company they rarely break even. And then D, E they don't make money. So the leader clearly has a dominating position. In software that's not really the case. Usually one company brings a very large portion of the market, and then there is another company, and then there is C, D, they don't exist.
There is only one gold medal, there are no silver medals, no bronze medals. For all practical purposes there is one search company - Google. For all practical purposes there is one social media company - Facebook. For all practical purposes there is one professional network company - LinkedIn. There is a very dominant position by Amazon in the e-commerce world. The network effect tries the big to get bigger, they capture more market share, mind share and market share value.
So it depends on which piece of technology we look at but, broadly speaking, if your question is about is tech a winner, tech is a winner, because today any product differentiation or service differentiation is driven by development. If you were buying a car, the car is being differentiated by integration of technology in the car. It is [inaudible].
If you were buying a simple thermostat, the new thermostat can be operated by a mobile phone and it has a lot more technology than its preceding generation 3 or 5 years old. Again, it is the integration of technology in industry products. So it is the technology integration which is driving product differentiation, that is why the importance of tech continues to grow higher.
EFI GEORGIADOU:
Perfect. We've received a question and I'd like to very briefly ask you what is the overlap between digital evolution and the innovators' strategy, please?
MANISH GOYAL:
So innovators' strategy is a technology sector strategy. Sorry, I misspoke. Digital evolution strategy is a technology sector strategy. Innovators' strategy is an all sector strategy. The scope is much bigger than DES - digital evolution strategy. So tech sector is about 30% of [inaudible] a little less for Russell 1000. So the overlap between DES and innovators could range from 15% to 20, 25%, depending of the [inaudible]. So, you know, we like to come up with the best ideas for both those strategies. DES tends to be a little bit more tactical in approach, where we can trade around a quarter, But for innovators we are taking a little bit more longer approach, because there, you know, investments are more long term, thinking about the R&D considerations. But, you know, from a [inaudible] perspective about 15 to 20% overlap for two strategies is not much, especially when [inaudible] stocks are such high potential for the market capital.
EFI GEORGIADOU:
Which effectively means that one complements each other to cover the entire spectrum. So I will conclude with one more question, and that is the obvious question around risk. So what sort of risks do you see in the world in the market? We see a lot of developments. Do you feel that they are risks that can impact the portfolios?
MANISH GOYAL:
So clearly there are always risks when we are dealing with equities. There dual political risks, like the two largest economies, like US and China, at war with each other, a trade war with each other. That can escalate further. We just went through a massive pandemic. It's not over yet. It could re-emerge and it can have a very significant impact on global economies again. Parts of the world may have to shut down.
But for me, but from a broader perspective, you know, what I see is generally central banks have done a very good job in terms of infusing liquidity. Interest rates are very low. So there are positives to be had. On the other hand, dual political risks [inaudible] and re-emergence of Covid are probably the biggest risks in the market today.
EFI GEORGIADOU:
Agreed. And I know for a fact you keep an eye on them. So with that we passed our time in location for this webinar. We will conclude here.
Manish, thank you very, very much for your time.
MANISH GOYAL:
Efi, I want to make one concluding comment if I may.
EFI GEORGIADOU:
Yes, of course.
MANISH GOYAL:
So if you look into the history, the last 5 or 10 years, I ask myself did innovation and technology change my life? Emphatically. I couldn't walk out of the house without my phone. My entire life rotates around this phone, mobile phone device. In the process of doing that the stock market created trillions of dollars of shareholder value, and in the last five years we have done a good job in capturing more than our fair share from that shareholder value. [inaudible]
How is the innovation pipeline, how is the technology pipeline when I look in the next 5 years and 10 years? Massive innovation in the pipeline today. We discussed 5G, we didn't go deeper into artificial intelligence. Artificial intelligence is the biggest science project in the world today. A variety of industries will be backed, from autonomous cars to healthcare to you name it. I'm very excited about all this innovation. Will this innovation change our lives? I bet it will. And in the process of doing that, trillions of dollars of shareholder value is most likely to be created again. And we have two very strong solutions to take advantage of those innovations coming. Covid and other things will only accelerate such innovation and adoption.
So those interested in purely technology sector orientated we have a solution - DES, and those looking for a [product] market, like a solution which is representing [inaudible].
So we will be there to capture that innovation through that advancement through those two strategies. With that, thank you.
EFI GEORGIADOU:
Thank you, Manish. Actually, these are very valuable insights to finish off this webinar. And there's a lot of change for us all to experience and also the portfolios to [inaudible].
Thank you so much for your time. Thank you for taking good care of our client assets and all the thoughts that you shared with us today. To all participants, on behalf of all of us here at J.P. Morgan, thank you for joining. We would be delighted to discuss further with each one of you individually. So keep well and safe. Thank you very much.
MANISH GOYAL:
Thank you.
END
"INNOVATION IS NOT JUST TECH"
EFI GEORGIADOU:
Hello everybody. I'm Efi Georgiadou, senior investor at J.P. Morgan. On behalf of all us here I thank you so much for joining us today to discuss 'Innovation is Not Just Tech'.
I will be the moderator for you today. We have the pleasure to have with us Manish Goyal, who many of you know. A lot of you have the opportunity to meet, and most of you are invested his performance. For those who would welcome a brief introduction, Manish is a portfolio manager for the digital evolution, and the innovative strategy here at J.P. Morgan. He has 20 years experience researching and investing in technology and innovating companies.
And we thought actually that it is a timely call to listen to his views while he takes us through all the work that he has been doing tirelessly to actively manage both portfolios.
You should have a raised hand icon in your devices, possibly in the bottom of the screen. Press click on the icon if you want to play the question, and also on the slide right now in front of you, if you don't want to raise a question you can also email it to us in the email you see right now in front of the screen.
So good morning, Manish. It is an early morning for you in New York. Thank you very much for joining us.
MANISH GOYAL:
Good morning, good afternoon everyone. It's my pleasure to be here.
EFI GEORGIADOU:
Thank you. Now before I start this interesting conversation, please allow me to take 30 seconds to share with our participants today three striking numbers. Now, first of all, in 2020, healthcare data used in research and development clinical trials, precision medicine is estimated to double every 73 days. Number 2, artificial intelligence valued at by 2030 is expected to be more than the size of China's GDP. And number 3, for those looking for a new trend that is conversational commerce, what we call c-commerce. 25% of companies will be using virtual customer assistance this year. This number was 2% in 2017.
So Manish, I will pass it on to you as you know better than anybody to put context in these numbers. And I will start the conversation with all this question on and around Covid-19. Covid has accelerated the change in technology and innovation to a more sort of, say, digital world. Entire industries have been transformed, and are transforming right now. So the key question to everybody is asking how will Covid change our lives, and more specifically what are the big trends that you are seeing in the consumer and the enterprise base?
MANISH GOYAL:
A good point to start with. What we have learned from history is crisis always force people to do things differently, and initially there is a lot of resistance when people have to change the ways how they do things. And a lot of times, you know, later people rely on the new way of doing things is a better way of doing things. So if you look at the history, women joined the workforce after World War II, and the global productivity increased significantly, that was a new way of doing things back then. There was big social change, but it turned out to be for the better.
If you look at SARS, post-SARS, e-commerce took off in Asia, that was a better way of shopping. And similarly, you know, it became kind of socially acceptable to wear face masks. Now investment world we don't see people walking around wearing masks, I go to Asia four times, five times a year to visit companies. It is common to see people wearing masks on the train, in the office and when they are walking. And, you know, so Covid forced companies to let people work from home. No company had contingency plan where they thought 98% of the workforce will be working from home at a two week notice. But now 110 days into it most companies are operating well. I mean especially banks like ours, we have done a phenomenal job in terms of while people are working from home.
So this will have significant implications as we look forward. What I see is over the next 2 to 5 years there will be significant productivity that we have not seen in the last 5 years, and that productivity will result in shareholder value creation. The service technician from ASML doesn't have to fly to Korea to provide that service, he can do a lot of things online or over the video.
A lot of internal corporate trainings will move towards online and video, people don't have to fly from one continent or one coast to the other. I don't have to spend 2½ hours everyday commuting to work. These things will collectively translate into significant productivity gains.
Much of the selling in the US, in Europe or in Asia, most of the selling requires meeting the client or the customer in person. I believe that we are moving towards an area which I have coined the term digital trust, where the customer or the client will be willing to buy things or sign for product or service after a virtual conversation. So the trust could move towards a virtual setting. Now not all products and services, you know, there are software products, medical device products, there are financial services products, and there will be some line where you can draw on, but a lot of selling could move towards virtual selling.
Again, a significant improvement in sales for productivity. If you look at the consumer from my perspective, cash is dead. I am not comfortable handing out dollars to my kids, 9 years, 13 years, or even my son, who knows who was touching it, who was sneezing on it, and I'm just not comfortable. That will accelerate the transition towards non-cash payment solutions, and we will talk more about this. If you look at the consumer today much of the video interactions are like casual conversations, like the Snapchat or WhatsApp conversation with friends and family living abroad, but high value interactions will move towards video. Having a tele-medicine session with your doctor, kids taking online learning school in a virtual setting on video.
Yoga class, maths class or, you know piano lessons, they all are moving towards online. In all of these examples cash exchanges hands, there is a financial transaction happening that is high value. Again, a shift in mindset in accepting that as a okay way or a new way of doing things.
Now what does this all mean? This all means that the building block of technology, like 5G, Cloud, artificial intelligence, augmented reality, the adoption of these technologies will accelerate significantly because we are starting to do things differently. There will come a time when, depending on the type of the business, 30, 40, 50% of people will start working from home a lot more than what they were doing before Covid, and that may reduce the need for commercial risk.
So I think we have just seen how Covid further highlighted the importance of technology in our lives. We are all connected today in this setting with clients from various continents, and usually I have to fly obviously to meet the clients, but we are doing this on a virtual setting.
EFI GEORGIADOU:
Thank you, Manish, that's quite interesting. Now I'd like to move on to two topics actually, dislocation and valuations. We have seen in massive dislocations in the market as a result of Covid with the SMP showing the highest in its concentration in nearly 40 years. So what opportunities are you looking at and also how are you thinking about valuations?
MANISH GOYAL:
So the current crisis has created significant dislocation in the market. You look at the top five, six tech companies, [inaudible], plus Apple, plus Microsoft. All these companies are up for the year, and they're up like 10, 11% collectively speaking. But when you look at Russell 1000, Russell 1000 is pretty much flat, down for the year, modestly down for the year. 1200 basis points of data. When you look at Russell 2000 the data is closer to 18%, 1800 basis points.
Maybe the market was right in terms of gravitating towards companies who are very dominant in their position, like Apple, Google, Facebook, Amazon or Centra, maybe even benefitting from Covid, and they have very strong balance sheets. But the question we should ask is are these going to be best investments over the next 3 to 5 years? And especially with dislocation in the market where we have seen other stocks, especially on the mid caps side, maybe there is better opportunity there.
So if I look at VES for a second, our allocation to fan stocks used to be close to 25%, and today we are down to like 11, 12%. our allocation has come down because we are finding opportunities outside, more compelling opportunities outside.
Now on valuation, look, generally I talk about valuation on a forward [inaudible] basis. Today I will take a slightly different route. In 2008, the prior recession, that 10 year bond was about 3%, today the 10 year bond is less than 80 basis points. In other words, the 10 year bond is trading over 100 times earnings. Let's take a second to think this information. The 10 year bond is trading over 100 times earnings. So what should be the market multiple when 10 year bonds is trading over 100 times earnings? I don't have an answer. 15 times, 20 times, 25 times? It is not 15, that much I can tell. Now is it 20, 25, 100, I don't know the answer. So the point I'm trying to drill here is when we are looking at equity valuation, generally we take price divided by earnings. I'm just saying that we need to consider the interest rate environment where we are today.
In this interest rate environment I would say equity valuation ought to move up, just because our discount factor is lower, and on top of that we have to think about - especially when you're thinking about tech - that we have just seen the importance of tech go up. So these assets probably are likely to be built up because the business is running because of tech. So we have to think a little bit in terms of how the equity value should not be changed during this low interest rate environment.
EFI GEORGIADOU:
Great, Manish. That is a very interesting introduction, and also a very interesting approach to valuations. That will lead us to discuss both portfolios. And before I do that, and knowing you and knowing that you will take a humble approach in terms of performance, I would like to take the liberty to share year to date numbers for both digital evolution and the innovators' portfolios. So the digital evolution strategy is 18% up year to date. It's beating its benchmark by 600 basis points, and the innovators' portfolio is up 11½% year to date, beating its benchmark by 1,100 basis points.
So great results. Let's first discuss technology and digital evolution. There is a massive digital transformation taking place. Now more than any other time the consumer seems to be moving entirely online. So can you bring us up to speed with what is happening with digital payment? Are you seeing the end of cash?
So as I said, first of all, thank you for bringing up the performance, this year has been kind to us. We are very excited about it. We navigated through this reshape recovery without many scars on our backs so I'm happy about that. Talking about digital transformation in payments it is going to accelerate the way we have never seen before. People will not be comfortable handing out coins or cash to their kids, to their family members, and we will move towards non-cash payments.
Now companies who benefit from non-cash payments are the credit card companies, like Visa, Mastercard and other issuers. Then there are digital payment companies, like Paypal, Square, et cetera. And there is a whole eco chain, eco system, companies who uphold the supply chain who work within this payment system, like European companies like [inaudible] or US companies, like FIS, who are merchant acquirers, et cetera. They always benefit as the market moves away from cash to non-cash payment solutions. And this is an area where we have significant exposure. And if you look at e-commerce companies, of course, like Amazon or [inaudible] et cetera, they all will have the onward benefit, because they don't really take cash, they will all move towards non-cash payment solutions.
EFI GEORGIADOU:
That's a very interesting development really, and it's great we have these type of companies in the portfolio. So all of that is very interesting. So we have Cloud computing, data analytics, 5G, artificial intelligence, cyber security, all big enablers of the digital transformation. What are the key trends in the technology sector for you.
MANISH GOYAL:
So let's take a look into what happened in the last 5, 10 years. We believe that during the last 5, 10 years consumers who are driving a massive amount of technology adoption they were driving a digital lifestyle, they were adopting a digital lifestyle. I talk about this mobile phone. I have an iPhone in my hand, it was introduced 10, 11 years ago, and since then what we have seen is more and more things have gone digital in our life. Music, media, they all come from companies like Apple Music or Spotify or Netflix or Hula. And we don't buy DVDs, we don't buy CDs anymore. We search for things online, pay online, review them online, deal with customer service online. And in the process of doing all of that a massive amount of shareholder value was created in the stock market. Apple, Google, Facebook, Amazon, Alibaba, Netflix, TENCENT, I am close to $5 trillion. Massive shareholder value. This is while consumers were adopting a digital lifestyle. And it is not over yet. You know, only 20% of US retail is online. And I don't know the point of equilibrium, whether it is 30/70, 60/40, there is a lot more room for innovation, there is more room for growth. But the bigger opportunity, in my view, is on the enterprise side.
Today enterprises are adopting a digital process. Today, enterprises are moving towards Cloud. Enterprises are moving applications towards Cloud. Covid only accelerated that. There is a very important call for [inaudible] It's not verbatim, but something along the lines that we have seen more digital transformation in the last two months than we expected over the next 3 years. I mean this guy is serious guy, very measured with his words. And companies have to now really think hard in terms of how many applications they had that were not accessible by people while they were working from home? How many applications clients are not able to access. And they may have to move a lot of these applications into the Cloud. So this will accelerate the transition towards Cloud. The simple reason why enterprises want to move to Cloud is because it is a more elegant solution which improves employee and customer satisfaction and reduces cost. It is virtually a win/win situation for everybody.
Instead of having islands of capacity of your computer storage, digital networking all around the world where usage is very low or under-utilised, if you have it in a Cloud environment, in massive data centres, you can increase the utilisation rate while reducing the operating costs on an on-going basis.
Now digital processes, what does that mean? If you look within a company there are 30, 40, 50 processes depending on the type of the business that can be totally digitalised. Why is it important? It is important because, again, improved efficiency reduces mistakes and really increases the through put of how to do certain processes.
Let me give you one example. In US if someone were to go into a branch and to get a mortgage, home mortgage, that entire paperwork is digital. The paper is not printed all throughout the process, even for attorney to view or signing the documents. Completely digital. They use signature capability, digital signature capability from a company called Docusign. 400,000 people from J.P. Morgan working from home. You know, if I have an IT issue I can't track down the IT guy from our floor, because there are hundreds of other people calling him. So we submit a ticket in a system, one closest to provided by a company from service now. So these are digital processes. And a lot of the processes within a company will continue to move in a digital format, away from manual. And this is going to be a big area of growth and investment for companies to confer in multiple years time in future.
The last point, when you look out 3 to 5 years out, there are two very important technologies, 5G and artificial intelligence. These two technologies will be very critical in driving growth in the autonomous cars, industrial revolution 4.2, healthier services, smart cities, smart farming, a lot of multiple industries and making a profound impact, and we'll talk about this more in subsequent slides.
EFI GEORGIADOU:
Perfect Manish, thank you very much. I kept Cloud and I kept 5G, but before we move on discussing those I want to ask you a very quick question. Your [inaudible] semi-conductors has served very well. Companies like NFC microchip have done very well for the portfolio, so what's your thesis from here?
MANISH GOYAL:
So if you take a step back and look at 2019, chip companies were shipping less than the consumption. Last year, late in 2018, US imposed tariffs on China. The chip distributors in China got spooked, they were not sure what the end demand look like. Just for those not familiar with the chip supply chain, US chip companies sell semi-conductor components to Chinese distributors, these distributors sell components to tens of thousands of customers in China. They could reach from small product manufacturers like [inaudible] et cetera, to all the way to handset servers, laptops et cetera.
So these distributors who are not sure what the end demand will look like in the US they didn't want to take the inventory risk, so they depleted their inventory, they were buying only [inaudible] So the bookings and shipments at the US chip companies saw a significant slowdown. They were shipping less than the consumption. Earlier this year, due to Covid and due to work from home, a lot of people were forced to buy laptops, monitors and desktops because they had to work from home and their personal computers are not up to date. Enterprises were forced to buy machines for their employees. That created a vacuum for [inaudible] inventory. I'm trying to buy a 34 inch monitor and, believe me, a lot of those places are out of those monitors. So now when I look at where we stand the inventory levels for components are low, the inventory levels for [inaudible] is low.
So I expect as the economies open up, as the markets open up we will see a significant recovery in bookings for the semi- conductor companies. Those companies supplying to the industry have changed, those companies supplying into 5G and to computing, they all will benefit as economies grows or begins to recover and businesses begin to open up. In particular, companies exposed to 5G, companies exposed to broader industry trends they will see significant recovery in their bookings. That's why we continue to like semi-conductors. Semi-conductors are roughly 13% of the benchmark in the US, and we have a rather large position in semis, about 25.6%.
EFI GEORGIADOU:
That's great, Manish, thank you very much for that. I will go back now to Cloud. You've mentioned it before, you talked a little bit about Cloud, and it is very clear that Cloud is a winner from Covid-19. So how does the portfolio capitalise on this trend and what kind of companies benefit from Cloud beyond the usual suspects, like Microsoft, Google, Amazon?
MANISH GOYAL:
So most of the time when people think about Cloud from an enterprise perspective, they think about Google, Microsoft, Amazon. But the investment opportunity in Cloud is much bigger than that. You know, a large bank, pharmaceutical company, industrial company, they are not going of buy all of their Cloud need from those three companies. Think about it. I live in the US and if I knew that I have to spend 250 nights in London it will be much more economical for me to buy an apartment there than to stay in a hotel.
So a large company who has significant computing needs, they don't necessarily need to pay 29% operating margin to Amazon, they can build their own Cloud and data centre because they have internal scale [inaudible]. So large companies may keep 60, 70, 80% capacity in-house and they can use Cloud or public Cloud for FLAX and other applications or for needs in other countries depending on the type of the business.
So when you start building your own Cloud you are looking to buy microprocessors, graphic processors, you are looking to buy high speed memory and communication chip, infrastructure hardware, infrastructure software, a variety of applications. You want to put your HR system on the Cloud you [inaudible]. You want to put your customer management into Cloud you go to
sales force. You want to put your PBX in the Cloud you go to [inaudible]. So depending on the type of application you want to go to the Cloud, you want to move to the Cloud, you create infrastructure behind it.
Then there is security layer, then there is analytics layer. So we see significant investment opportunity in Cloud which extends well beyond Microsoft, Google and Amazon.
EFI GEORGIADOU:
That is interesting, and I think we're going to see probably a lot of other companies in the following few months on that aspect. I'll move on to 5G.
MANISH GOYAL:
Just one more quick point here.
EFI GEORGIADOU:
Sure.
MANISH GOYAL:
When consumers adopted a digital lifestyle much of the shareholder value was concentrated within 8 or 9 or 10 companies. You [inaudible] you pretty much did well, but as enterprises are moving towards Cloud, enterprises are moving towards digital processes, that's a very fragmented market. I give you examples for multiple companies, chip companies, infrastructure, hardware, software, et cetera. You don't have one or two or three names that you can own and say okay, I'm done. There is a lot of digging required to figure out which applications are more important. So the time of consumer adopting a digital lifestyle is very different from enterprises moving to Cloud and digitalised processes.
EFI GEORGIADOU:
Sure. Thank you, Manish. Heading into 2020, 5G was a big theme for everybody. I do remember that we started talking about 5G at J.P. Morgan back in 2018. It is expected to impact almost every industry. Are you still excited about 5G?
MANISH GOYAL:
Absolutely. 5G will be a very critical piece of technology that will be deployed and used into multiple new applications over the next 5 years. Consumers will be the first to adopt later this year. I expect Apple to introduce 5G phone some time during the fourth quarter of this year in US. AT&T Mobile rival they will all start marketing their 5G plans. And it will be yet another major replacement cycle. But 5G will be far more critical in non-consumer applications, just the traditional voice and data application in new applications.
So let's spend a second and understand why 5G is so important. 5G speed will be 10 to 15 times faster than LTE, the 4G that we are using today. Theoretically, it is 20 times faster, but practically it will be 10 to 15 times faster. There is virtually no latency. So when you are watching a YouTube video and you get that buffering sign, that buffering goes away. In Netflix a video that takes 7 minutes to download will take a few seconds. But there are far more critical applications that can be had with over 5G network.
And if you are riding in your brand new Tesla and going at a 100 miles per hour and you slam the brake, your Tesla will be kind of enough to communicate with my Prius in the back so that I don't come and rear end your car. Vehicle to vehicle communication will be possible because of the speed of the network and reliability of the network.
Soon New York will be able to perform surgery in Des Moines, Iowa, which is about a 1,000 miles away from here. The image will be instant, it will be more, the network is reliable and those services will be possible.
And we have given multiple examples in multiple different industries from healthcare to smart factories. Imagine precision manufacturing, entire floors which are connected by wired networks today all moving towards wireless, highly reliable, it will improve the use of the factories, it will improve the efficiencies and make a big difference in terms of creating shareholder value.
So the real value of 5G will be realised as enterprises start to deploy 5G forward for their personal networks.
EFI GEORGIADOU:
Thank you, Manish. It's truly fascinating how lives will change completely when 5G is totally implemented within our lives and different aspects.
That actually leads us to innovation, and the innovators' portfolio that you have launched more recently. Now following the portfolio over time I would say, and I would say that loud and clear, that innovation is truly not just tech, it's pretty much everywhere. So please talk us through your framework for identifying these innovative companies, and also how you look beyond tech for opportunities.
MANISH GOYAL:
So some good ideas come from within J.P. Morgan, and sometimes greater, better and great ideas come to us from clients. A couple of years after the launch of VES, one or two of the large VES clients said to me that, Manish, you're doing a good job in capturing all the innovation going on in the technology sector. But, you know what, I see innovation all around me, in every aspect of my life, at work and at home. The strategy that will capture innovation in all the sectors of the economy. I thought that was a great idea. So we came back, we
take at look at like, okay, how do we go about finding innovation, what is innovation, because innovation could be different. Something that is innovative to me may not be innovative to you. And then what is the systematic approach to management even, you are using the lens of innovation.
And most importantly, is there even empirical evidence that investing in innovative companies creates [inaudible] returns. So we looked at all of these things. We [inaudible] portfolio for about 2, 2½ years, and last year in the fourth quarter we launched the strategy called the Innovators' Strategy.
The mandate here is to invest in companies, in any sector of the economy where we see innovation, and these companies ought to produce a product or service which is truly outstanding, innovative and has moved around it. Now how do we define [inaudible]. It all starts from the leadership. There are some CEOs and their management team who are boldly committed to be the leader, to be the innovator in their respective industry. They want to come up with products and solutions which others have not really thought before. And then you see a whole bunch of companies which are fast followers. And then there are even a greater number of companies who really don't care as much about innovation, they are just [inaudible] companies. We want to focus on those leadership, those management teams who are truly, truly committed for innovation, their conversations are tied to innovation and they have demonstrated in the past that they are the true innovators.
The second thing is about investments. Innovation cannot be created in vacuum. It requires investment, it could be R&D investment, it could be capital spending, and what we'd like to do is to look at those companies who are efficiently investing in R&D. Just because you invest in R&D does not ensure success. Nokia was investing nine times more than Apple in R&D and we all know how it went down for Nokia, how it went down for Apple.
And the third piece of it is product and service. What kind of products and services have they launched in the last 3, 4, 5 years? Do these products create shareholder value? Are they able to capture transitions? We pay attention, and that requires a lot of fundamental [inaudible] equity analysis in terms of looking at that.
So that is, broadly speaking, our framework. In short, I could say we use the same lens that we have used to analyse technology companies, and we apply the same lens to all the sectors to figure out [inaudible].
EFI GEORGIADOU:
Sure. It is a very unique approach to investing, and a question that very frequently comes up in our conversations is whether there is any data, suggesting that investing in innovative companies generates excess return.
MANISH GOYAL:
So before I do that, I want to spend a couple of minutes to talk about how innovation is not limited just to technology, and then I can address that question. When I use the word innovation most of the people think about the technology sector. Rightly so, rightly so. And in the last 10 or 15 years much of the technology sector grow a lot of innovation, but innovation is not limited to technology. Again, I go back to my iPhone. This device is loaded with technology. This is a pure tech product and 6 months from now it will be a 5G phone and then it will be updated and it will have more technology. When I am talking to Alexa or something it's pure tech product. But when I want Uber and I want to go from point A to point B, that is a tech enabled device. I just want to use a car that will take me from point A to point B.
When you are doing a tele-medicine call with the physician you want to speak to the physician. Technology is only enabling that. When you're shopping on Amazon or e-commerce or omni-commerce, you want the product, tech is only enabling that. So we are interested in tech products, we are interested in tech enabled products. And more importantly, we are very much interested in innovation which has nothing to do with technology.
You've got pants coming from Lululemon, there is a tremendous amount of research that goes behind it before Lululemon figures out which fabric will perform better in dry climate, in wet climate, how can they enhance an athlete's performance, et cetera.
Cosmetics coming out of Estee Lauder, whether it is lipstick or whatever, they employ hundreds of PhDs. They want to have cosmetics for a variety of skin tone, from Caucasian skin to African skin to Chinese, and they like to use local ingredients to make the best products possible. They have done a phenomenon job in product introduction, a phenomenon job in branding and even better job in marketing those products.
You look at healthcare, significant innovation going on in healthcare which has very little to do with the [inaudible]. If you go to the next page what we have tried to do here is we have tried to put a few sectors and name some of the innovations that we are excited about in each sector, healthcare, liquid biopsy, probiotics available to our health, and there's innovation all around us. So we are using the lens of innovation, applying that lens to all the sectors to figure out which companies are truly innovative in their respective field, and maybe there is investment opportunity there.
EFI GEORGIADOU:
That's great. The takes us to the question on the data, and suggest that investing in innovative companies, do they actually generate excess cash?
MANISH GOYAL:
So this is the framework we used for the innovators' strategy. Companies invest in R&D to create a differentiated innovative product. There is only one reason why a company invests in R&D, to create a differentiated and innovative product. If we are both selling this glass we will end up competing on price. If you are investing in R&D you have a better glass that can be microwaved, that is thinner, better designed. You have innovative products, you will have higher sales, better profit and you will create more shareholder value.
Those companies who do not invest effectively in R&D it doesn't matter. Automotive companies are the largest spenders in R&D, but they don't create value because they don't invest money effectively.
So the key point here is to invest in R&D to create an innovative product. Now the question is where is the empirical data to show that. Let's go to the next slide. What we are looking at here is Russell 1000. We look at Russell 1000, within Russell 1000, roughly speaking, 40% of the companies report R&D on a quarterly basis. Those companies out-perform the rest by 340 business points annualised over the last 15 years. Massive out-performance by companies who invest in R&D.
So we are fishing in the right pool. We are looking at those companies who are innovating. And if we do our jobs right we should be able to create significant access returns.
EFI GEORGIADOU:
That's a great approach to that. What I'd like to do now is I would like to dig a little bit further, and in the interests of time, if you can share with us a couple of high conviction positions within the [inaudible] portfolio. You mentioned healthcare before.
MANISH GOYAL:
So if I look at healthcare one of the biggest trends today is liquid biopsy. You take a little sample of the blood and you go through a variety of analysis to figure out if a recovering cancer patient you are beginning to see cancer cells in the blood again. So instead of going through a very invasive procedure, invasive testing, you can capture that through liquid biopsy. Similarly, they can capture things like Down Syndrome in a child by taking the fluid from the mother's womb and, again, significant improvement there. We have multiple investments in that area.
If you look at robotics there is [inaudible]. And we made some changes in the portfolio due to Covid, what we saw was there was a sharp drop-off in elective procedures, so hospitals that were taking Covid patients they were not taking elective procedures. So if you had a knee replacement, hip replacement, those out-patients didn't want to go to hospitals, and now what we are going to see is a sharp recovery in elective procedures, companies like Zimmer are going to benefit from that. We have a pretty large position, we especially added to our position significantly and even the stock goes down.
Elective procedures are not perishable demand. You know, it's not a cosmetic procedure that I can change my mind. If I don't go to Starbucks today I'm not going to drink twice as much coffee tomorrow. But if I'm deferring a hip or knee replacement, although already I am in pain, I may defer it by a month, two months, three months or so, then ...[loss of sound]... So we see that more as a deferred demand as opposed to perishable demand.
I have a 13 year old who is very wearing braces to straighten his teeth. You know, they're required to go back to the orthodontist every three or four weeks to get them adjusted. We ran into this company called Align Technology which makes clear aligners that reduces your visit to an orthodontist by 50% or more, without really impacting the bottom line of the orthodontist. In a Covid environment that's a great solution where the patient doesn't want to go to the orthodontist, the orthodontist has to practice social distancing so, again, we have quite a large position there.
So healthcare is going through [inaudible] which a company who provides a platform that benefits from having like a virtual [inaudible]. So these are some of the key investment ideas that we have played with, which some of them are more secular and some of them are benefitting from Covid.
EFI GEORGIADOU:
This is fascinating what's happening within healthcare, and healthcare innovation is actually one of our mega trend discussions this year. There are hundreds of other questions we'd like to place right now, but I'm conscious of time, so I'd like to open up for questions if there are any please.
If you'd like to place a question please raise your hand on the application, on the device, or otherwise you can email the question to the email address that you see on the screen.
I think I'll give it a few more seconds just in case we have a question.
We don't have a question so far, but I'd like to place one more question, Manish, if I may. We talked a lot about technology. It's a massive beneficiary, there's no question about that. Is tech an all-win sector?
MANISH GOYAL:
Look, the technology sector - depending on the industry - if you look at semi-conductors the leader makes 85% of the profits, number two company makes 10, 15% of the profits. And C company they rarely break even. And then D, E they don't make money. So the leader clearly has a dominating position. In software that's not really the case. Usually one company brings a very large portion of the market, and then there is another company, and then there is C, D, they don't exist.
There is only one gold medal, there are no silver medals, no bronze medals. For all practical purposes there is one search company - Google. For all practical purposes there is one social media company - Facebook. For all practical purposes there is one professional network company - LinkedIn. There is a very dominant position by Amazon in the e-commerce world. The network effect tries the big to get bigger, they capture more market share, mind share and market share value.
So it depends on which piece of technology we look at but, broadly speaking, if your question is about is tech a winner, tech is a winner, because today any product differentiation or service differentiation is driven by development. If you were buying a car, the car is being differentiated by integration of technology in the car. It is [inaudible].
If you were buying a simple thermostat, the new thermostat can be operated by a mobile phone and it has a lot more technology than its preceding generation 3 or 5 years old. Again, it is the integration of technology in industry products. So it is the technology integration which is driving product differentiation, that is why the importance of tech continues to grow higher.
EFI GEORGIADOU:
Perfect. We've received a question and I'd like to very briefly ask you what is the overlap between digital evolution and the innovators' strategy, please?
MANISH GOYAL:
So innovators' strategy is a technology sector strategy. Sorry, I misspoke. Digital evolution strategy is a technology sector strategy. Innovators' strategy is an all sector strategy. The scope is much bigger than DES - digital evolution strategy. So tech sector is about 30% of [inaudible] a little less for Russell 1000. So the overlap between DES and innovators could range from 15% to 20, 25%, depending of the [inaudible]. So, you know, we like to come up with the best ideas for both those strategies. DES tends to be a little bit more tactical in approach, where we can trade around a quarter, But for innovators we are taking a little bit more longer approach, because there, you know, investments are more long term, thinking about the R&D considerations. But, you know, from a [inaudible] perspective about 15 to 20% overlap for two strategies is not much, especially when [inaudible] stocks are such high potential for the market capital.
EFI GEORGIADOU:
Which effectively means that one complements each other to cover the entire spectrum. So I will conclude with one more question, and that is the obvious question around risk. So what sort of risks do you see in the world in the market? We see a lot of developments. Do you feel that they are risks that can impact the portfolios?
MANISH GOYAL:
So clearly there are always risks when we are dealing with equities. There dual political risks, like the two largest economies, like US and China, at war with each other, a trade war with each other. That can escalate further. We just went through a massive pandemic. It's not over yet. It could re-emerge and it can have a very significant impact on global economies again. Parts of the world may have to shut down.
But for me, but from a broader perspective, you know, what I see is generally central banks have done a very good job in terms of infusing liquidity. Interest rates are very low. So there are positives to be had. On the other hand, dual political risks [inaudible] and re-emergence of Covid are probably the biggest risks in the market today.
EFI GEORGIADOU:
Agreed. And I know for a fact you keep an eye on them. So with that we passed our time in location for this webinar. We will conclude here.
Manish, thank you very, very much for your time.
MANISH GOYAL:
Efi, I want to make one concluding comment if I may.
EFI GEORGIADOU:
Yes, of course.
MANISH GOYAL:
So if you look into the history, the last 5 or 10 years, I ask myself did innovation and technology change my life? Emphatically. I couldn't walk out of the house without my phone. My entire life rotates around this phone, mobile phone device. In the process of doing that the stock market created trillions of dollars of shareholder value, and in the last five years we have done a good job in capturing more than our fair share from that shareholder value. [inaudible]
How is the innovation pipeline, how is the technology pipeline when I look in the next 5 years and 10 years? Massive innovation in the pipeline today. We discussed 5G, we didn't go deeper into artificial intelligence. Artificial intelligence is the biggest science project in the world today. A variety of industries will be backed, from autonomous cars to healthcare to you name it. I'm very excited about all this innovation. Will this innovation change our lives? I bet it will. And in the process of doing that, trillions of dollars of shareholder value is most likely to be created again. And we have two very strong solutions to take advantage of those innovations coming. Covid and other things will only accelerate such innovation and adoption.
So those interested in purely technology sector orientated we have a solution - DES, and those looking for a [product] market, like a solution which is representing [inaudible].
So we will be there to capture that innovation through that advancement through those two strategies. With that, thank you.
EFI GEORGIADOU:
Thank you, Manish. Actually, these are very valuable insights to finish off this webinar. And there's a lot of change for us all to experience and also the portfolios to [inaudible].
Thank you so much for your time. Thank you for taking good care of our client assets and all the thoughts that you shared with us today. To all participants, on behalf of all of us here at J.P. Morgan, thank you for joining. We would be delighted to discuss further with each one of you individually. So keep well and safe. Thank you very much.
MANISH GOYAL:
Thank you.
END
