Megatrends reshaping our world

Back in 1982, a struggling business consultant published a book that described a series of changes taking place in the US and other areas of the world. It was an immediate hit – ‘Megatrends: Ten New Directions Transforming Our Lives’ sat on the New York Times Best Seller List for almost two years and sold more than 14 million copies in 57 countries. Its author, John Naisbitt, passed away in April this year, but the word he coined lives on.

Megatrends are often described as ‘avalanches in slow motion’ – they’re changes that unfold gradually, and yet touch every aspect of our lives. While we may not be able to predict the future, monitoring these large-scale changes across the world can give us an idea which way the wind may blow.

Digitalization, climate change or urbanization, for example, are just some of the megatrends with the power to reframe the way we live, what governments prioritize or how businesses operate and succeed. Today, many companies look at these megatrends to help them make strategic choices for tomorrow. And investors are also taking note.

Randall Dishmon, a global equity portfolio manager at Invesco, notes that looking at how the world is changing sits at the core of his investment philosophy. He focuses on these durable structural changes, rather than fleeting cyclical trends that are hard to predict.

“No one really knows what’s going to happen next year,” he says. “But what I do know is that things like e-commerce, the electrification of money or the move to cloud will continue to go ahead. None of these things will really stop or revert even if the economic backdrop changes.”

The themes mentioned by Randall form part of the world’s journey towards digitalization.

Covid-19 has accelerated many megatrends that began decades ago, but the pandemic itself is also leaving a lasting mark on the world. Let’s take a brief look at some of these long-term trends and ask our investment specialists where the opportunities lie.

A brave new world

Nearly two years have passed since Covid-19 took hold of the world, and yet an end of the global pandemic still seems like a distant possibility to many. Some countries have either tightened restrictions or reintroduced lockdowns as a response to the new Omicron variant.

Looking ahead, we do see the light at the end of the tunnel and the eventual normalization of economies from the disruption of Covid-19. However, the ‘brave new world’ that awaits us post-pandemic is probably going to be very different from the world we’ve left behind.

History shows that past pandemics have shaped the world into the one we know. The Black Death brought an end to serfdom in Western Europe; the Spanish flu sparked a wave of uprisings that changed the political, social and economic fabric of many countries. Today, many people are researching the consequences of pandemics, believing that our past can provide us with a glimpse of our future.

"Every crisis leaves an innovative legacy," says Erik Esselink, a fund manager specializing in small cap equities. "There’s greater use of technology now due to the pandemic. Many people who had to commute to work on a daily basis have now experienced ‘working from home’. Meanwhile, many companies have realized that the wheels of business can continue to turn even though there’s no one in the office. Some people may like this, others may not – but the option to work from home is now on the table, and it will be difficult to take it back."

Erik notes that the pandemic has accelerated digitalization, with people having been pushed to shop online. However, for some companies, it has also shone a light on supply chain issues. “Some of the supply chain disruption they’re facing are likely going to be transitory,” he says, “but others are longer-term issues, such as the structural lack of truck drivers in Europe. This has resulted in some companies trying to localise or nearshore supply chains.

He can see near-term opportunities in the most negatively impacted sectors, where significant supply/demand mismatches can be found. Here, a post-Covid world would offer transformational market share opportunities for the survivors.

Ido Cohen, an Invesco fund manager focusing on the consumer sector, agrees. “There’s an attractive set of recovery opportunities in cyclical businesses, and an emerging trend of ‘living our real lives again’. People want to go out and explore the world, and as an investor in the consumer sector, I believe they may favour buying experiences over things.”

His reopening plays include holdings in theme parks, leisure resorts and online travel agents. However, he also has holdings in online fashion platforms that he believes will not only benefit from pent-up demand as a result of the pandemic, but also the longer-term trend of consumers moving toward digital channels.

Digital revolution and increased connectivity

’Digital revolution’ stands for many things. It ranges from people generally using more technology, to companies undergoing transformation to future-proof their operations. Much of this, of course, is due to increased internet connectivity. Without the internet, much of the technology we use today would be unusable.

For no other investment team at Invesco is the digital revolution more pertinent than our Invesco Quantitative Strategy team. One of the portfolios they manage makes use of natural language processing to analyse the news. This allows them to identify stocks related to three key megatrends: technology, society and sustainability.

“This alternative data provides us with a different perspective of a company,” says Tim Herzig, a portfolio management associate for the team. “Screening over 2.5 million news items each month, while also taking into account backward-looking data, such as revenues or earnings, helps us identify and invest earlier in upcoming companies.”

Randall Dishmon is a more traditional fund manager, who uses three simple rules for investing: buy companies with an edge over competitors, pay the right price and know the people involved in the business. The promise of what IT could do for companies was something he had heard of his entire adult life. But, in his view, the simplification and automation of everything never really came to pass.

“It came with more complexity than promise,” he says. “When I think about IT, I think about increasing complexity more than anything else, and at the end of the day, companies just had no ability to keep up. When you hear the word complexity, what you should think about is cost. So, all the conveniences IT brought to companies came at an undue cost, making the promise less than it was originally intended to be.”

However, he believes that the move to the cloud changes things. “It takes the complexity out of the hands of lay people – corporate management teams are not IT experts – and puts it into the hands of those who are experts. It’s fundamentally changing network architecture, so that the cost and complexity of keeping up with the IT rat race is in appropriate hands.”

On the consumer side, the effects of digitalization are a little more tangible. “Many of the companies we invest in are being driven by one consumer decision: on how to spend their time or their money,” says Ido Cohen. “And because of technology and increased connectivity, people are choosing to spend more time and money online.”  

Household names, such as Amazon or Netflix, are obvious winners here, but other companies are benefitting from the shift to digital, too. Video game fans notoriously love buying games in the form of a disc or cartridge. But thanks to improving internet speeds, people can choose to download games online. Sales of video games software have gradually been shifting towards digital purchases for some time now, and we’ve seen this trend accelerate even further during the pandemic.

“This is a good thing for the gaming industry, as the margin on a download is higher than on a disk sale,” Ido Cohen says. “And by selling directly to a consumer and creating a digital connection, video games software companies establish an ongoing relationship with the end-user.”

Once a title has been sold, they can sell even more goods related to the game to the end-user, such as an extra character or an expansion to the game. In the current environment, Ido also sees another advantage in digital games: with consumers being able to download them, video games software companies aren’t hit as hard by current supply chain disruptions as the manufacturers of consoles.

In Asia, digitalization is becoming a larger component of GDP across many economies, as internet penetration has grown. Many investors cast their eyes on China for opportunities, but Mike Shiao, Chief Investment Officer for Invesco’s Asia (ex Japan) equity team, notes that there are other Asian countries offering investment opportunities in the age of digitalization.

“South Korea is a famously well-connected nation, with some of the world’s fastest internet speeds,” he says. “Online sales penetration is significantly higher than in China, and the average Korean spends almost three times more on online channels than the average Chinese person.”

In his view, this makes Korea a natural hotbed of innovation in the internet space with some truly standout investment opportunities.

When the world goes green

The world has always had droughts and floods, hurricanes and wildfires, but the scale of destruction we’ve seen in the past decade has been nothing short of astonishing. Climate change is no longer a disaster lurking on the horizon. It’s here now.

Governments across the globe have finally united in a race against time to fight climate change. Reducing carbon emissions is at the top of their priority list, with many countries now having committed to transitioning to a net zero economy over the coming decades.

Simply attempting to meet  this ambitious target will have an impact on many industries across the globe. Some oil giants have already rebranded themselves to prepare for a world where oil would no longer be the dominant fuel of choice; other companies dependent on the fossil fuel economy will need to set off on their own journey of reinvention to survive.

But to make fossil fuels truly a thing of the past, a fresh wave of innovation is needed. Many investors believe they have to go to the US or Asia to tap into the themes of technology and innovation, but when it comes to ‘green technology’, Europe has the potential to seize the lead. There’s certainly no lack of innovation in Europe, which is home to seven of the Top 10 countries in the Bloomberg Innovation Index.¹

Similarly, the Energy Transition Index also puts European countries ahead of many others in the energy transition race.² The European Green Deal has been viewed as a game changer by many – it seeks to turn the world’s environmental challenges into an opportunity to modernise the EU economy.

Electrification is key to decarbonization, and James Rutland, a fund manager within our European equities team based at our Henley Investment Centre, believes that the utility sector will be a beneficiary of the electrification of everything.

“They’ve long been perceived as slow-growing, defensive stocks within a portfolio,” he says. “But we believe we’re on the cusp of a change here.”

Most utility companies across Europe have joined the race to net zero and are moving beyond coal to focus on renewables. James admits that the transition is a tough balancing act, and key issues still need to be addressed, such as: who will pay for it all?

“Early signs are encouraging, with most governments shouldering the burden,” he notes. “This is a short-term solution, and the situation will continue to evolve. However, for investors with a medium-term horizon, we believe the opportunity is substantial.”

Increasing focus on health and wellbeing

There’s nothing like a pandemic to make people re-evaluate the importance of health, but Covid-19 merely accelerated an existing trend. Some of Ido Cohen’s investments, for example, are allocated to companies that could benefit from people adopting healthier lifestyles, such as producers of athletic apparel and footwear.

Meanwhile, Randall Dishmon believes that diagnostics and genetic-based testing will continue to evolve and see increasing growth. In his outlook for 2022, he talks about the genomic sequencer that used by researchers to analyse and better understand the Covid-19 virus, which eventually helped them develop a vaccine in seemingly record time.

“Different people took different approaches,” Randall adds, “but they were all based on the sequencing that provided them with the information of what the virus actually was.”

Needless to say, the company that developed the machine is a key holding in his portfolio.

Based in our Hong Kong office, fund manager Chris Liu invests in China’s healthcare sector. The country is already home to the second largest healthcare market in the world, but it’s expected to take the crown from the US over the coming years.

“The growth we see in China’s healthcare market is underpinned by a few long-term trends,” he says. “In particular, China’s ageing population, its rising middle class, as well as advances in and the adoption of technology.”

He has identified opportunities in medical devices, innovative drug makers, vaccine makers and medical services, but he also holds positions in Contract Research Organizations (CROs) or Contract Development and Manufacturing Organizations (CDMOs). They serve other companies in the healthcare industry on a contract basis, providing services ranging from drug development to manufacturing. Being able to draw on a huge pool of graduates with a biology or chemistry background helps, but so does having a vast patient base for clinical trials.

Combined with the government’s aim of encouraging innovation and improving healthcare outcomes for its citizens, this represents a vast opportunity for Chinese healthcare companies. Recent years have seen them move up the value chain, with China’s pharma industry having begun to switch away from producing generic drugs to creating more innovative medicines.

Investing for tomorrow

The themes we have highlighted are just some of the megatrends our investment experts consider in order to ensure their portfolios are fit for tomorrow. More detailed pieces providing more insight into their thinking will follow in the new year.

However, it’s important to note that investing in a company solely because it appears to align with a theme isn’t wise. Many people have made that mistake two decades ago, prior to being caught up in the Dot-com bubble – partly because they put money into companies they didn’t know or understand.

All the investment managers mentioned in this article look at long-term themes to help them pinpoint potential investment opportunities. But for the majority of them, their bread and butter still lies in rigorous fundamental research. For Ido Cohen, for example, analysing financial statements or talking to the management team alone isn’t enough. He talks to suppliers, distributors, competitors, customers, middle managers and Wall Street analysts to get a rounded view of the investments he’s making.

And while our Invesco Quantitative Strategies team may use modern technology to help them identify companies to invest in, this doesn’t mean that human insight is completely removed from investment decisions.

“At the end of the day, our algorithms aren’t created by machines,” says Tim Herzig, “they’re created by humans and hence represent their thinking. Only those companies with significant matches against theme-specific keyword dictionaries are highlighted for investment. There can also be an element of human oversight involved to ensure all those stocks truly fit into the relevant themes.”