Webinar Replay: What’s the Next Big Theme?
Disruption is everywhere around us. Technology is advancing at a rapid pace, what consumers want and how they shop continues to evolve, and demographic shifts are remaking the complexion of regional and global populations. In this webcast, Global X ETFs will explore emerging themes in 2019 and assess their impact on the global economy, including:
- 5G and the Internet of Things
- Cloud Computing
Jay Jacobs: My Name is Jay Jacobs. I’m the Head of Research and Strategy at Global X ETFs. You can read all of our research online at globalxfunds.com/research. We will of course share some of that with you today, but there’s a lot more behind what we’ll touch on.
In this hour, we’ll touch on some of the more interesting themes we’re seeing out there. Please do check in for additional research behind that. Very briefly about Global X if you’re not familiar with us, we are an ETF issuer based out of Manhattan focused very closely on the thematic space. It is one of our largest suites both by number of funds as well as assets under management. This slide is as of 3/31, but actually, more recently we now have 14 thematic growth ETFs including a couple that we will talk about today in more detail.
In terms of how today will progress, this is the introduction. We’ll quickly move to an overview of thematic investing. We’ll chat a little bit about how we think about themes, and how we select them, and what criteria we look for long-term disruptive themes. After that, we’re going to touch on three of the most powerful themes we see today: first being 5G and the internet of things, followed by cloud computing, and lastly, genomics.
Then we’ll talk a little bit about how themes can fit in a portfolio. If we have time at the end, we will touch on some Q&A. If anything pops in your head, please do submit that into the questions box throughout today’s webinar.
As we approach the thematic investing space, I think it’s important to think about how do we contextualize this? Maybe to be a little bit provocative I think that many people are comfortable building portfolios based off the past and based off of things they’ve observed through data, through earnings, through correlations, through volatility, through price action. That data that we have that we use so oftenly in portfolio management in portfolio management tools is backward-looking.
It’s how companies have performed in their earnings reports. It’s how volatility has previously expressed itself. It’s how factors have performed over time. We think that can be nicely complemented with anticipating the future looking at what might change, how this might be different, and growth-oriented strategies for themes that we’ve never seen occur before. We think that really the ultimate approach to portfolio management incorporates both sides of the equation looking both at what we can learn from the past as well as anticipating these powerful trends into the future.
What is thematic investing? We believe it refers to the process of identifying powerful macro-level trends and the underlying investments that stand to benefit from the materialization of those trends. It truly is a top down, bottom-up process. From the top down, we’re looking at which are the most powerful trends around the world. From a bottoms-up perspective, looking to identify the companies that really are in best position to benefit from those themes.
As we’ll talk about a little bit today, those companies can span from a range of sectors and geographies. We believe that the best themes are unconstrained. We don’t care if a robotics company is Japanese robotics company, a German robotics company, an American robotics company. If that’s the theme we’re looking at, we don’t want it to be constrained by geography and we don’t want it to be constrained by sector either. We see some powerful companies in the robotics space that are coming from information technology, that are coming from health care, that are coming from consumer stocks. In any theme that we’re looking at, we don’t try to constrain them by geography or by sector.
In addition, a few other characteristics about thematic investing. We believe these truly are long-term growth-focused strategies, that they offer low correlations to other growth strategies because they tend to be pretty focused by nature, and they’re pretty relatable concepts. A lot of jargon around finance the end client might not understand what is being discussed. In thematic investing, they can be pretty intuitive. If we’re talking about lithium and battery technology, people see electric vehicles driving on the roads. If we’re talking about genomics, people maybe have already their genetic test conducted and have seen the results of that. Many of these themes are permeating our everyday lives, not just living on a spreadsheet in Excel.
When we look at the thematic opportunities said, and as I mentioned before, we now have 14 thematic ETFs, so we certainly have many in the space. We think a lot about, how do we select which themes are ultimately going to make it into an ETF. We really think about three important things: the first one is conviction. Do we believe that this is a powerful trend that is going to disrupt multiple aspects of the global economy? Again, using my example of robotics, when we look at robotics, the conviction is certainly there for us. It’s disrupting manufacturing. It’s disrupting agriculture, militaries and defense, health care. Its effects are being felt across the global economy in a very powerful way.
The second thing we look at is investability. When we’re talking about a theme in an ETF, it has to have at least 20, but really ideally 25, or 30, or more publicly traded companies that have high exposure to the theme. Not just being companies that are tangentially related to something like genomics, or cloud computing, but truly derive a meaningful amount of revenue from that theme so that it is providing access to the theme that we’re targeting.
The last thing is a long-term time frame. If we’re going to go through all of this work of creating an ETF, identifying these themes, discussing it with clients, we want to make sure that this theme truly has staying power. Really what we’re looking at is a multiyear cycle, something that is still in its early stages, and will not be ending tomorrow.
If we look at something like is trade wars a theme, well, in a way it is, but it doesn’t meet it by our standards of being a long-term theme because, in reality, a trade war could end tomorrow. However, something like robotics, or something like genomics, or cloud, that’s not going to change overnight. That’s going to be many years until we see that theme really fully adopted and fully penetrated.
This brings us to our discussion around cyclical verse structural themes because I think in the broader finance discussion, people use thematic investing, or least the term, a little bit too liberally. Meaning people talk about the theme of rising interest rates, or the theme of high valuations, low valuations, currency trends. Those are themes, but those are cyclical in nature.
There’s nothing that says that interest rates should always rise or always fall, that valuation should always rise or fall, or that currency values are going to be one directional. Oftentimes, we see those cyclical themes resemble the wave pattern that we see in the blue in the middle of this chart. You can certainly make a lot of money trading those cyclical themes, but the timing is absolutely essential to be able to capitalize on those themes because you really have to ensure that you’re buying low and selling high if it’s following the wave pattern.
Now, structural themes, the ones that we’re really trying to target with our thematic ETFs are S-shaped. They follow the orange line or resemble the orange line we’re showing in the middle there. Meaning it is longer term in nature and it’s really a one-off shift, a changing paradigm that is expected to be long-term in nature. It’s not going to mean revert back to some level.
If genomics is going to start to be incorporated more and more into the modern health care system, that won’t revert back to average or to where it is today. It’s really going to be a one-off shift. If we look at cloud computing, the movement of people taking local IT resources and management and putting it into the cloud, that resembles a one-off shift, not a cyclical pattern as we’ve seen with something like asset valuations and volatility in interest rates. While you could consider both of these types of cycles or themes to be thematic in nature, our preference is certainly for the structural themes that are one-off in nature because if you can really make sure you’re still early in the theme, the timing of the entry and exit point becomes less important. It’s really about sticking it out for the long run to watch that theme fully express itself.
This really aligns with The Diffusion of Innovation Theory from E. M Rogers who really focused on describing what this S-shaped pattern looks like and called this essentially the adoption curve of looking at how early in a new theme, or new technology, or demographic change, you have innovators, the people that are ahead of the curve who are starting to adopt that technology even if that technology is not proven, even if there’s still a lot of risk involved in that technology. It may or may not have any staying power. Think of electric vehicles in the early 1990s, or think of Google Glass, or the first iPod. The people who bought those products were buying it out of almost novelty more than functionality.
While some of those products are good, oftentimes, they don’t really have the infrastructure to support themselves yet or to really model the second model that comes out that starts to perfect a lot of the issues with the first model. The innovators play a very important role in adopting that new technology. Soon to really have staying power, it needs to make it through the early adopters bigger portion of the population that is willing to take a risk on a new technology before making it to the bulk of the population, the early and late majority who are really going to drive a technology to be nearly ubiquitous in its adoption, and then finally, the laggards coming through.
Whenever we look at a new theme or evaluating our current themes in ETFs, one of the questions we really ask ourselves is where are we in the adoption curve? How much of this technology has already been adopted into a broader population? How much more run do we have before it becomes fully penetrated?
What’s interesting is that this S-shape really does hold throughout history. We have seen this with numerous powerful innovations over time including everything from the telephone to electricity, refrigerators, stoves, clothes dryers, you name it. They really all did follow this S-shaped expression of slow, initial buildup before reaching the steep part of the S-curve where there’s nearly ubiquitous adoption before tapering off with full penetration. The difference we’ve seen over time, however, is that S-shaped is getting steeper and steeper. Meaning that the adoption periods of these new technologies is taking less and less time.
If you compare that to the S-shape that’s being drawn the refrigerator, for example, that took many decades to be fully penetrated, whereas you compare that to the internet and to cell phone, a much quicker adoption. When we look at some of the themes that we’ve highlighted in our 14 thematic ETFs, you see that a lot of these really are still earlier on in their adoption than we might assume. If you look at robot density, for all the things we talk about with robotics and how powerful robotics is going to be in the future, robot density is still less than 1%. Meaning there’s still less than one robot for every 100 manufacturing workers around the world.
For electric vehicles, penetration is a little more than 2%. For as many Teslas as you might see on the road, there’s still a huge addressable market with automobiles that hasn’t been penetrated. Even smart watches or smart home speakers in the US, we’re still in the early phases of many of these technologies which gives us a lot of excitement in thinking about these themes that we’ve already seen so much progress in these technologies already. Yet, there’s still much more runway ahead of them to be fully adopted.
Why are we considering thematic investing now? Why do we think this is an important inflection point for a lot of these themes? Frankly, if you looked across a lot of those sectors, a lot of the traditional sectors, you realize that there’s a lot of powerful forces that are actively disrupting them.
Something as simple as looking at the consumer discretionary sector, it was really a sector built on the preferences of Baby Boomers and Gen Xers. Yet, we see a rising Millennial population that behaves very differently from those other generations in terms of how they consume and what they consume and what those consumer preferences are. Whether that’s focusing on health and wellness, whether that’s buying things online, whether that’s favoring experiences over physical goods, that can have a massive disruptive impact on the consumer discretionary sector as companies really try to figure out how do I appeal to this new consumer, this new portion of the labor market that’s going to be deriving a majority of income, and of course, then being the major consumer segment of the United States.
Or we see that in energy, for example, a sector that’s really been built off the extraction and distribution of fossil fuels now with a lot of disruptive potential with the rise of lithium-ion and the increasing performance qualities of electric vehicles. Or perhaps we look at the health care segment where a health care system that’s really been designed around treating symptoms as they occur is going through an incredible shift through the demographic trends of an aging population, through a consumer change, and being proactive about health and wellness, and through a technological change with the introduction of genomics that we’ll talk a little bit more today. Across many segments of the economy both in the US and globally, we see many disruptive forces that are challenging the status quo and introducing a new paradigm going forward.
This is why we think now is a really exciting time for thematic. It’s also why we see a lot of potential for both risk and return in people’s portfolios. The risk being that many people owning traditional sectors that are market cap weighted that have – that really tilt their exposure towards the winners of the past are introducing themselves to disruptive potential that the winners of the past will not be the winners of the future, that these themes will be the new sectors, the disruptive sectors of the future that will displace the incumbents.
With that introduction of what is thematic and how we think about selecting themes, I wanted to talk about the first of the three themes that we’ll touch on today with the next big theme for 2019. The first being really a combination of 5G and the internet of the things. This is an interesting theme where we see a massive disruptive shift happening. Yet, the winners of that theme might be different than what you would expect.
The big shift here, of course, is the introduction of the new mobile standard 5G which is replacing the old mobile standard of 4G. You pretty much can’t turn on the news these days without reading about 5G. We wanted to touch a little bit on what is this and why is it so important.
First of all, 5G is really a collection of technology and mobile standards that are still being finalized. This is still very much something in process that touches on many different aspects of our communications infrastructure. It will impact the modems that are in phones and tablets. It will impact the physical infrastructure from routers and switches that are transmitting data. It will affect the fiber optics that is moving physically data around the United States and around the globe.
The reason why this is so important is because really three different changes that are leaping from 4G to 5G. The first is basically speed. The speed of 5G is expected to be much more than 5G – sorry, than 4G. Some expectations are that it could be up to 200 times faster. Obviously, whenever you’re trying to download a video on your phone or update your social media, speed is what gets people’s attention, doing more faster.
The lesser maybe appreciated aspect of 5G, however, is the increased capacity. If you’ve ever been to a sporting event and you’re trying to use your phone in a stadium with 80,000 people, and you realize you’re having trouble connecting, that’s a capacity issue, not a speed issue. Many networks just simply aren’t designed to have that many devices connected to them at once trying to pull information. By increasing the capacity by as much as a thousand times more than 4G, what 5G is really setting up for is a future where many devices are connected to the internet; not just your phone, not just your watch, but your car, augmented and virtual reality headsets, your dishwasher, your air conditioning unit, many different devices all being connected to the internet simultaneously. That capacity, the widening of the infrastructure pipeline here is a huge aspect.
As well as latency or how quickly a network responds to a device request measured in milliseconds. We’re seeing huge improvements from 4G to 5G. This is a relative of speed, but where this becomes really important is in really life critical situations where speed is the difference between life and death. For example, in autonomous vehicles where a vehicle is trying to respond to what’s happening on the road or changing traffic conditions, milliseconds can be very impactful of the safety of the passengers.
Or also with remote surgeries where essentially a patient could go to a hospital where there’s a robotic surgeon that’s being controlled by the true surgeon many miles away. That latency can also be – can also have very profound impacts on the patient’s health. Between those three things, we see substantial improvements from 4G to 5G that is really setting up for new backbone of mobile infrastructure around the world.
Now, the question we often get is really, how close are we to 5G actually being rolled out. The reality is they’re still finalizing some aspects of the standard today, so it’s still very early on in 5G networks. In fact, if you actually look at 4G, only recently did we approach 50% penetration of 4G around the world. There’s still many places where only 3G technology is available. 5G is going to take many years to deploy.
One of the reasons why, yes, the standards are still being developed, yes, the technology is still being developed, but a critical difference in 5G versus 4G is where it operates in the radio spectrum which is at a very high gigahertz part of the spectrum which has its benefits and drawbacks. One of the benefits is it can carry a lot of data very quickly. One of the drawbacks, however, is that it can’t travel very far.
When you’re operating in the six gigahertz end of the spectrum, you can’t simply go to a cell phone tower that’s outfitted for 4G radio frequencies and simply switch out a router and a modem and call it 5G. You actually have to build out a much denser network to support 5G. Just simply the area of coverage is much narrower when you’re operating in this area of the spectrum.
What this means in cities like New York, Chicago, San Francisco, individual buildings might have to have their own 5G transponders. That’s going to take a while to build out and of course be very expensive. Also, communications is a two-way street. Just building 5G in New York for anyone trying to call a more rural area, they really have to build out the fiber networks with rural or broadband as well or else you’re limited by your weakest link there. A very big buildout of 5G is certainly going to take a very long time probably concentrated first in dense areas but then rolled out to a broader swath of the population.
Now, where we do see 5G probably having more success early on is actually in more commercial capacities. If you are in a warehouse that has robots that are picking things off of shelves and bringing them to different distribution locations and those robots are constantly processing information whether it’s downloading information from the internet about fulfilling an order, whether it’s interacting with other robots on the floor, reacting to a dynamic environment alongside people, alongside continuously changing inventory, you can make a local 5G network fairly reliably with current technology. We are seeing applications in more specific commercial capacities today.
Actually, one of the more interesting applications more recently was in a PGA golf tournament last year. If you think about what it takes to put on a golf tournament from a video perspective, 18 holes, each hole has multiple cameras trying to stream 4K video requires laying a lot of cable across – miles and miles of cable across the golf course. What people found is that it actually might be cheaper to do so wirelessly rather than laying all of that cable. What they did is they built a local 5G network surrounding the golf course to be able to handle huge amounts of data being transmitted from each of those individual 4K cameras. That’s just one example where that kind of capacity and speed is really coming into play. It actually reduced costs, but in a very limited area.
Outside of that, you are seeing certainly many countries on continents aggressively trying to expand their 5G footprint. South Korea is trying to be a leader in this space, trying to roll out 5G services this year. In Europe, Swisscom is also trying to be a leader with 5G networks. In the United States, it’s certainly top of mind most recently with the Sprint and T-Mobile merger.
The FCC is recommending that as a condition of approving that merger that they dedicate a certain amount of money towards building out their own 5G networks, so trying to leverage M&A stipulations on furthering the buildout of US 5G resources. Like we said, this is still very early on in this theme. It is going to take many years before we really build the 5G density required for nationwide 5G coverage.
The other aspect that we touched on is really how does 5G – what is the impact of 5G on other technologies? This is where we start to transition into our discussion on the internet of things which we really see as the biggest beneficiary of 5G. As we mentioned, faster speeds, higher capacity; this means that many things can be connected to the internet that have not previously been connected whether that’s all the various smart home appliances, autonomous vehicles, drones, wearables, smart factories, many devices looking to be connected to the internet because the infrastructure will finally exist. We see 5G as a foundational technology on which many other technologies will be built.
One of the things we did is, and we actually just added this to the download section of this webinar so if you’re curious in reading our research, is we looked at 4G, the previous mobile standards, and looked at what segments did it enable. 4G itself was a foundational technology that really started to roll out around 2010 through 2012 through today. If we go back to the birth of 4G, before that, we essentially did not have streaming video.
Social media networks were almost exclusively conducted on desktop computers rather than on phones because they couldn’t handle downloading that much information, videos, photos all at once. E-commerce was primarily done on desktops rather than mobile phones. You see many different segments of technology, of consumption being built on top of 4G technology that simply wasn’t possible before; basically, all different types of mobile consumption. We think 5G will have a similar impact that not necessarily the builders of 5G are going to benefit from, but those that can connect to the 5G networks and build entirely new business and technologies on top of it just like we saw with the birth of 4G almost 10 years ago.
What is this internet of things that we think is going to benefit so much from the rollout of 5G? It really is connecting devices to the internet. That can be any – virtually any device. We see it, of course, as sophisticated as smartphones and tablets that we’ve been – the original internet of things to completely new applications of the internet of things.
In my own apartment, I have a Wi-Fi enabled camera. I have smart air conditioning. Those are the types of devices that previously have never been connected to the internet, but because of improved speed and coverage, because of falling chip costs that make it just frankly very cheap to connect things to the internet going forward, because of consumer demand where people want things that are connected to the internet that they can control remotely or monitor, as well as additional commercial adoption of the internet of things, we’re seeing tremendous demand and growth potential for connecting things to the internet.
We already touched on a couple of these items before, but where we see the IoT’s role really playing a huge difference, first in driverless cars. Cars will essentially have to be connected to the internet to be autonomous because they’re going to have to both interact with networking software, with mappings, with mapping technology, with other cars on the road. Increasingly cars are going to be essentially mobile TV screens where people are going to consume tons of content while traveling because they’re not going to be driving anymore. The car will be one of the ultimate internet of things with many different connections to the internet requiring vast amount of speeds and data.
The second aspect in a much lower level in terms of just low energy usage devices that will be connected to the internet are smart cities. Infrastructure, for example, where lights can be connected to the internet to monitor traffic, to respond to real-time traffic conditions. In Grand Central or in Times Square in New York City, you see trash cans that are connected to the internet alerting the garbage collectors when they’re full and where they’re empty for much efficient collection.
Many applications within smart cities to make them smarter, to reduce costs, and to operate more efficiently. In smart homes, many appliances and devices being connected to the internet such as refrigerators, and lighting, and climate control. Of course, in robotics connecting robots to the internet so that when one robot on a network learns something, every robot on the network can learn that same thing.
Wrapping up this section all together, when we think about 5G, and the new capacity, and the new speed that’s coming online, and the internet of things, these devices that are going to take advantage of these – of this new infrastructure highway that are going to be connected to the internet using tons of speed and data, we thought to ourselves, who are really the winners in this situation? We think it comes down to three potential segments. The first being the connected device manufacturers. This is really the downstream builders of consumer and commercial devices that will be connected to the internet.
The second segment: network providers of services. Basically, the IoT is going to depend on reliable networks to transmit information, so the builders of those customer networks. Third, the semiconductor manufacturers, the companies that are actually building the chips that are connecting things to the internet. Because ultimately, we believe so many different things are going to be connected to the internet, this is really the upstream play, the people that can develop those chips that connect to 5G, that connect to Wi-Fi and build those chips most efficiently. These are the three segments that we see as really one of the most – we see these as the most important segments benefiting from the rollout of 5G and thus the growth of the internet of things.
This takes us to the second theme that we’re highlighting today: cloud computing. Cloud computing is the industry involved in delivering computing services, providing servers, storage, databases, networking, software, and analytics over the internet. Many of you might be asking why is this new? Why is this the next big theme? Cloud computing, frankly, has really been around for almost 20 years. Again, it’s one of the big beneficiaries of increased speed and capacity because it’s really about taking stuff off-premise and moving it into the cloud where it can be managed more efficiently often by a third-party.
To set this up, if you think about how many enterprises have worked in the past, a standard company, everyone would have their own computer. They would install a computer on – they would install software on their computer via CD-ROM. They would have specialized software on the computer that could only be accessed on that computer; it cannot be accessed remotely. Anything that was stored, any files, any data would be stored locally and basically entirely depended on that one machine on-premises.
Behind that, many companies had to build their own IT functions that serviced those computers, that built their own servers on-premises and had to manage this entire IT ecosystem. Company by company, each single one had to build out their own infrastructure. If you think about it, a law firm, or an asset manager, or a company doing supply and logistics, you name it, their core competency isn’t as an IT company; their core competency is in being in the legal profession, or in being in asset management; not in building and servicing computers in their office.
The biggest shift that’s really happened with cloud computing is the ability to basically hire another company to take over IT services for you. No longer do you need to build your own servers, customize for your business. You don’t need to service those servers.
You don’t need to upgrade them when the software gets obsolete or the hardware gets obsolete. You don’t need to expand your server presents every time you need more memory. All of this is being channeled towards public and private clouds where third-party companies are creating large server farms that have incredible economies of scale that are very efficient, that have the ability to be flexible with storage and with compute power so that companies can get back to doing what they do best which is managing assets or providing services, legal services; not dealing with IT themselves.
Within this cloud computing ecosystem, there are many different segments. The first being software as a service. Instead of buying a one-shot version of software, this is the transition to licensed software which often has a recurring fee associated with it. That software lives on the cloud, can be accessed anywhere around the world, and is constantly being updated so that your local computer does not need to download new updates or really adapt to anything. You simply log into your account and get the latest and greatest version of that software.
A second segment is platform as a service. This is really allowing people to build new applications on the cloud in a very efficient way rather than programming in your own local environment and programming from scratch. The third which I think is probably the most well-known is infrastructure as a service. These are the companies that are really providing the storage and compute power that anyone can rent. Think about Amazon Web Services or Google Cloud.
The fourth segment is data center REITs, the physical properties that are owning and managing the facilities where these server farms are. Then the fifth segment being cloud and edge computing infrastructure and components: the chips, the network switches, the routers that are being used in cloud and edge computing technologies. All of these we see as still being very early on in their adoption as cloud continues to grow. The 2018 market sizes were seeing around $190 billion; looking to grow to over $320 billion in just about five years or so, four to five years. Very large growth still remaining in many of these segments as people continue to transition to the cloud.
We talked a lot about the enterprise issues related to the cloud and why people see it as really a fundamental technology. In some recent statistics, they showed that still over half of the average IT environment is not in the cloud yet. Most systems if you think about maybe your own or other businesses are still very localized. People are still saving files on their desktop, are still installing their own software. There’s still a long way to go with adopting the cloud.
The other segment that we’re seeing though is the growth of the consumer segment in cloud technologies as well. Anyone using streaming services, Spotify for music, Netflix for videos, new services are being introduced for streaming video games, all of this is the cloud being delivered to the consumer where you don’t need to own nearly as much physical hardware. You don’t need to buy DVDs anymore, don’t necessarily need to buy video games anymore; it can all be delivered over the internet. This theme, of course, is related back to 4G and 5G technology, as well as increased data speeds really enables cloud computing to further penetrate both the enterprise capacity and the consumer capacity as well.
I just like this chart a lot because this shows really some of the differences between on-premises computing which was really the way of the past versus cloud computing which we see as really the future where so much has to back up having your own IT system, your own computers, your own software, installing that, the IT personnel, and maintenance, and training, and depreciation versus moving to a cloud solution where all you do is pay a monthly fee and virtually everything is taken care of from the storage and the compute power, the upgrades, the maintenance, the personnel. This is why we see such a massive shift in the business community going from having on-premises IT environments to into the cloud. From a business model, that’s just very attractive to many companies where it’s much more predictable to pay a monthly fee.
They don’t have to have a lot of headcount in the IT Department to support this. There’s less downtime because cloud providers are just simply very efficient and know how to upgrade at the right times and can scale these upgrades efficiently rather than dealing with this locally. From an enterprise model, it’s very efficient. Then from the cloud computing technologies angle, it’s also a very attractive business model because they focus on doing what they do best which is building these very large powerful server farms that they can scale that have monthly recurring cash flows from the subscription model and which have very wide moots around these businesses because it’s very difficult for small companies to compete in providing cloud services.
This brings us to our third and final theme for today, which is genomics. If the first few themes were very focused on computing and the internet, there’s still some relationship here, but genomics is really a health care related theme related to the study of the human genome. The most important thing that has happened in this space first and foremost is the rapidly declining cost of sequencing the human genome.
It went from roughly $100 million back in 2001 to roughly $100 today. A cost decline that has basically shattered Moore’s Law and made services for genomic sequencing virtually available to everyone. What this introduces is so much more understanding of people’s own genomics and what that can do to the medical community in terms of detecting predispositions for certain diseases or anomalies, as well as collecting data on different populations groups such as their susceptibility to different disease, as well as treatments and how people respond to different treatments after they fall ill from a certain disease.
The first and foremost most important thing is the falling cost of genetic testing. What this enables, to be able to cure incurable diseases because now we have such a good understanding of the human genome. These new gene editing tools are being introduced that can target diseases that have never been curable before. It also introduces the concept of precision medicine or personalized medicine where drugs and treatments are designed really around individuals rather than the masses.
We also create this positive feedback mechanism where the more genomic sequencing that happens, the more information that is collected, the more that information can be analyzed to create better treatments for diseases and better-personalized medicine. This is essentially the collection of human data, the processing of human data, and the application of new medicines with the empowerment of this data.
What’s probably the most interesting aspect of genomics beyond getting your genomes tested and learning some things about your history and where you’re from of course is going to be the treatment of diseases that have previously been uncurable. The most ripe for being treated right now are single gene diseases where there’s a single mutation where if you could just change that one mutation you might be able to either eliminate the disease or limit the expression of that disease in the human body. Diseases like cystic fibrosis, hemophilia A, sickle-cell anemia, many of these diseases have been around forever with very little advancement in the cure or treatment of those diseases. With genomic sequencing and all of the data that we are now collecting on these diseases, the exciting aspect is to someday have a cure for them by treating those individual genes that are expressing that mutation. That’s really the most – what I think is the most exciting aspect of genomics right now.
The other aspect that’s very exciting is the rise of precision medicine. When you look at various studies of different treatments, oftentimes you see that a new wonder drug has come out and 40% of people that take the wonder drug are suddenly cured of their ailments. What happened to the other 60%? Why were they not cured of that by that wonder drug? What happened?
Oftentimes, it’s a difference in genomics. If you can understand which types of population groups or what types of similarities in genomics respond well to a certain treatment versus those that respond less well, you can create more personalized treatments. One size will no longer fit all with medicine, but instead, you can either be put into a group of people who respond well to a certain treatment versus others or truly having a completely personalized treatment for certain dosages and treatments to give you the best chance to eradicate that ailment. This is where we see a ton of excitement as well. It would be a huge advancement forward for medicine from really a cure the masses approach to the cure the individual approach.
In terms of market sizing, again, we see this as a very fast-growing space. In 2017, $6 million in the genomic sequencing bucket expected to rise to over $25 million. Computation biology which is really the data science being applied to this could triple by 2024. Gene therapies and gene editing also experiencing rapid growth. This is an area where we see incredible advancements in technology as we collect more genomic data and start to develop new technologies for now treating diseases that are afflicted by mutations.
Before we get into the questions or the Q&A at the end of today’s call, I’d just like to wrap up with sharing our overall thoughts. Many of these themes, many of the themes we talk about and some of the new ones that we’re introducing today, we see these being intrinsically related. On here we show some of the other themes we’ve talked about over the years, but there’s common denominators amongst many of these themes: 5G, creating the infrastructure for data to be transferred extremely quickly, and how that makes the internet of thing much more able to proliferate as there’s more data, more capacity that can be connected to the internet, how that affects cloud computing where the data needs to be stored and processed very efficiently, or in genomics which is really about the collection of human data.
We see a lot of similarity with these themes being connected to each other which we think makes them all the more powerful that there’s these unifying forces. The growth in data, the growth in the processing of data, the application of artificial intelligence to that data is likely to benefit all the themes that are related and can benefit from data. We just like to leave on that note as we see the emergence of these themes not happening in isolation, but often happening in a coordinated effort.
Also, maybe preempting a question we often get in the Q&A: how do people think about introducing themes into a portfolio? By nature, these do not fit into specific sector classifications or geographic classifications; actually, by design, that’s the case. We think first off, themes make the most sense by looking at growth-oriented portfolios where they can really live in the portfolio for the long-term, not a highly tactical or in more conservative portfolios that are looking for lower volatility because themes will certainly move in the near term. We think it’s best suited in growth portfolios really as a carve-out of a core equity portion looking more like a satellite where investors are looking for long-term growth and can tolerate that volatility and also not benchmark it as closely to the S&P 500 or in the MSCI County World where it’s really going to be – it’s really going to have tracking error to whatever you try to benchmark it to. With that, I think we have a couple more poll questions before we turn it over to Q&A.
Natalie: With that, I would like to start our Q&A portion of the webcast. Jay, the first question that came in reads: how should investors think about including these themes in a portfolio?
Jay Jacobs: Yep, that’s a question we get often. Of course, we did touch on this a little bit before. Yes, it’s part of an equity carve-out. Yes, it’s going to have more volatility and tracking error. One of the things we like to do when we think about thematic investing is to consider how does it compliment or challenge some of the risks in your portfolio as well?
I see there’s another question that’s can these themes play along with each other or play along with other themes like robotics. When we look at these themes, one of the ways we like to look at the risk is, what sector is it disrupting? Yes, there’s going to be overlap from a sector perspective between FinTech, and robotics, and cloud computing which are going to have a lot of companies classified as information technology. When you look at what are they actually disrupting, you see that FinTech is really a theme that disrupts the financials. Cloud computing really disrupts more like the software industry and other aspects of IT. If you look at robotics, it’s primarily disrupting the industrial sector.
We do see these themes can very much play along with each other and next to each other even if it looks like they are owning a lot of companies from the same sector because they’re disrupting different sectors in a portfolio. One way we think about constructing that is, if you do have a lot of financial exposures, maybe pairing that with a FinTech fund that’s disrupting financials to play the traditional sector, as well as the emerging sectors side by side. Or if we’re looking at genomics, pairing that with someone’s health care exposure where they might already own a lot of health care services companies, insurance companies, and pairing that with the technology of the future that’s going to be applied to the health care sector. The internet of things and 5G, a great compliment to someone’s existing communication exposure, especially if they have a lot of exposure into telecoms already. This is going to be the disruptive aspect.
These themes can definitely play neatly alongside each other when you think about it from the lens of what exposure am I – what themes am I really going to benefit from as they are expressed? Which aspects of my portfolio are frankly going to lag if these themes really take off. Considering that balance between both the themes and the traditional sectors side by side.
Natalie: Great, thank you. The next question reads: is 5G overhyped?
Jay Jacobs: We’ve gotten this question a few times before. I think part of it is that people, they didn’t hear anything about 5G until three months ago. Now, it seems to be everywhere. It’s in the news. It’s a geopolitical bargaining chip now. It’s showing up on people’s phones even though that’s not really 5G, but if you’re in New York City, you might see 5GE on your AT&T phone. It’s suddenly popping up everywhere and people are asking is this really something new or is this just a marketing term?
In some respects, it is a marketing term. The fact that 5GE is showing up on people’s phones is completely marketing because that’s not even 5G. It’s trying to create the sense of something new that really isn’t there. In an actual sense, in the new technology that is being rolled out, I think this is a transformation technology for so many different aspects of the economy just like we saw with the rollout of 4G, which really resulted in the birth of social media as we know it today and E-commerce as we know it today.
We think on top of 5G, so many new technologies are going to be built like autonomous vehicles, like augmented and virtual reality, like telemedicine. I really don’t think you can actually overhype 5G because of what it’s going to enable going forward. It’s still very early in the transitions, so I think that it could be overhyped in the sense that it hasn’t happened yet and people are acting liking it’s happening right now when really it’s in progress, but it’s still going to take some time. The disruptive impact of 5G and what that’s going to enable for the internet of things, everything that’s connected to 5G, I think is truly transformational. I would not say that it is overhyped from a thematic perspective.
Natalie: Great, thank you. The next question reads: how does valuation fit into your portfolios?
Jay Jacobs: Yeah, this is a great question. When we think about valuation for themes, it is a challenge because the most famous valuation metric, price-to-earnings, often makes no sense in a thematic context because some of these companies are so new. They’re growing so quickly that they’re reinvesting every dollar back into their business. They have no interest in having earnings because they see so much opportunity ahead of them to develop new software, to develop new devices, and to really push the theme forward.
What we recommend is one, really don’t look at thematic investing from a price-to-earnings perspective because these companies by design are not generating earnings. If you have to look it from a valuation perspective, we think looking at a price-to-sales basis makes a lot more sense because these companies are selling into the market and are rapidly trying to grow the adoption. Frankly, what you see is that from a valuation perspective, it’s not – that’s not the most powerful driver of these companies. Often what we look at more closely is the growth rate of these companies. Is the growth rate accelerating? Is the growth rate going from a low base to a higher base?
Ultimately, what that will show us is where is it in the adoption curve and how much penetration is there left? If you’ve seen a company that’s existed for many years and its experienced high growth that’s starting to taper, that would show us it’s probably in the later stages of the S-curve and possibly fully adopted. Whereas if you look at other technologies that are very early on and they actually have low growth just because it’s early on, but it’s starting to accelerate and ramp up to be much higher on an absolute basis, that gives us a sense that this is a theme that is really starting to take off, that the growth is really starting to be realized. We look very closely at those sales metrics as a proxy for the adoption of an overall theme.
When we look within our ETFs, that’s just how we think about themes within a portfolio context. Within our ETFs, we do not consider valuation in terms of the companies that are selected or how they’re weighted. Really by design, we’re trying to find which are the companies that are generating a majority of their revenues from this theme or are critical to the theme itself?
Then we weight it in a modified market cap way so that we’re – we have improved liquidity characteristics, reduced turnover, and most importantly, really reflecting the state of the industry. That the biggest companies get the biggest weight; that the smallest companies get the smallest weight so that as this theme evolves, we continue to evolve with it to look as close to the industry as we can. Then, of course, capping some of those weights so that it doesn’t get overly concentrated. Valuation is not an input into our ETFs.
I’m seeing that it’s now past 3:00. I apologize that I haven’t been able to get to all of the questions today. We will do our best to get back to anyone that has an unanswered question. I just wanted to thank everyone for their time today.
Just a friendly reminder, if you’re interested in the topics we were talking about today, please do visit globalxfunds.com/research where we’re publishing on all these themes. Just today, we posted something on the lithium battery space as well as our analysis of what happened in the growth of 4G and what that might mean for our 5G future. Thank you, everyone, for listening and looking forward to staying in touch.