In a nutshell, the Digital Opportunities fund is a concentrated single-theme equity fund that invests in the most interesting opportunities within our digitalisation theme.
Can you tell us more about digitalisation?
Digitalisation is one of our five themes and represents the rapid acceleration in the adoption of digital products and services, enabled by our increasingly interconnected economy. The cost of bandwidth, computing and storage has been falling for decades. Subsequently, the barriers to digital innovation have collapsed. One obvious side-effect is that more people, devices, cars, houses, household appliances and objects are connected than at any time in history. With an array of digital tools and services at their disposal, entrepreneurs are embarking on a frenzy of creative destruction that is challenging the old industrial economic order in almost every sector. Consumer products, real estate, IT, comms services, financials, healthcare and construction are all set to be transformed by digitalisation – if they aren’t already in the middle of this transformation.
Digitalisation is really an umbrella term for six interrelated trends. The two foundational trends are connectivity and processing power. Connectivity and processing power are what’s behind the explosion in computing power, the ecosystem of companies that enable it, and the ubiquity of connected devices and ecosystems that in turn make that ecosystem possible.
Connectivity and processing power made the cloud (our third sub-trend), one of the most important paradigm shifts in IT, possible. Being able to harness the cloud means that software can be accessed by huge numbers of users simultaneously, and it also means that the specification of individual computers becomes less important. The final three trends – digital commerce, digital media and analytics – are now industries in their own right, and were facilitated by the first three trends.
What does the fund aim to do?
Instead of investing in the FAANGs of today, the fund is explicitly trying to find the FAANGs of tomorrow. While an investor could potentially make a decent return investing in Google today, they are unlikely to see the same growth they would have seen if they had invested before Google was a household name. Plus, focusing on the winners of the past can mean you miss out on the winners of the future. Our world is being transformed by digitalisation. It is almost impossible to underestimate the extent to which (digitalisation) has the potential to disrupt existing structures and businesses. This means there are a huge number of opportunities to find the big winners of tomorrow.
While we don’t pursue the winners of today, neither do we take an overly risky approach in finding the winners of tomorrow. Between high-risk stocks with a greater loss potential and the maturing FAANGs with a lower return potential is a sweet spot, where we can find established companies with a high-return potential.
How is the Digital Opportunities fund different to competitors?
Many technology funds base their investment strategy on a benchmark. We believe that clients are most likely to see strong, long-term returns when a fund focuses on companies with the most attractive investment features – whether they are in the benchmark or not. A company with a robust competitive position, secular tailwinds and an appealing valuation may not be a benchmark constituent; some managers may be reluctant to deviate from the benchmark and risk underperforming. We adopt an unconstrained approach for the Digital Opportunities Fund, meaning we can pursue the most exciting opportunities.
We’ve noticed a lot of technology funds on the market have upwards of 60 stocks in their portfolios. This has become something of an informal convention, most likely because this is the point where the diversification benefits of additional holdings in a portfolio will plateau. However we have observed interesting phenomena when you move in the other direction and *increase* the fund’s concentration (i.e. reduce the number of stocks). As you move below 60 holdings, the level of risk does not increase commensurately. For example if you remove 6 stocks, the level of riskiness only increases slightly. It does not increase in direct proportion to the change in holdings. In fact a 25 stock portfolio is only slightly riskier than a 60 stock portfolio. For that reason we aim to manage the fund around 20-25 holdings, and never go above 25 stocks in the fund. Managing fewer stocks gives us the ability to build deep expertise on every stock we own and the focus to increase our chances of discovering long-term outperformers.
What opportunities are you particularly excited about?
The digitalisation theme has over 300 potential investment opportunities. These can be found in several areas, such as the foundational areas of semiconductors, towers, data centres and computing hardware (mainly the areas of connectivity and processing). But digital transformation is forcing enterprise to completely re-invent the way they do business, which means the business world is having to modernise every one of its divisions. Subsequently, we see opportunities emerging within IT, operations, HR, data analytics, sales, supply chain management, communications and more. And lastly there are companies that are using all of these tools to completely re-define industries. Several of these companies are household names, such as Uber, JustEat and Tesla but there are many companies that few people have heard of, such as Pluralsight, which provides cloud-based corporate technology education, Zendesk, which is an online helpdesk service and Five9, which sells cloud-based software for call centres.
What does COVID-19 mean for digitalisation and the Digital Opportunities Fund?
COVID has forced great numbers of people to contain themselves within their homes, leading to transformation in how we work, entertain ourselves, shop and socialise. As the world moved to work from home, demand for software designed for these new working practices (such as video calling, messaging and collaboration) has exploded. Even the most luddite of workers are now familiar with applications such as Zoom and Teams.
To facilitate the use of these applications, demand for software that enables these working practices, such as IT security, identity management and network management, has also vastly increased. A similar picture has emerged when we look at consumer applications such as social media, streaming and gaming.
Ultimately COVID simply underscores the importance of this long-term trend. When we think about what normal will look like post-crisis, it’s worth remembering that large swathes of the workforce are now comfortable working from home as they’ve been forced to adopt it.
COVID provided a wake-up call to IT departments everywhere. It seems likely that corporations will learn that using on-premise IT is costly, slow and a clear business risk. No one will want to be caught out again, and this could accelerate the shift to cloud.