Finding balance in the ever-growing world of technology

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  • 5 min
  • 11th September 2019

With greater enthusiasm being placed on the future of AI, it’s important for investors to maintain strong levels of both optimism and scepticism throughout these changing technological times, says Walter Scott¹, part of BNY Mellon Investment Management.

There’s a good reason for the increasing popularity of the Greek ‘philosopher of change’ Heraclitus in the business world. He seems to have been musing over the age of technology in around 500 BC. To tech evangelists disruption may be synonymous with opportunity. From an investment perspective it is, of course, also strongly intertwined with risk. Alas, it doesn’t make the job of picking long-term winners any easier; not only do we need to stress test a company’s competitive moat and cash flows for a range of future scenarios, but assumptions continually have to be updated, with few sectors immune to tech-driven change. Against this flux, it won’t come as a surprise that we encourage a healthy level of scepticism within our research team – that is, we dwell as much on what could go wrong, as what could go right. Key to this approach is regular engagement with investee companies, their competitors, customers and suppliers, as well as keeping abreast of the latest developments and debates.

With greater enthusiasm being placed on the future of AI, it’s important for investors to maintain strong levels of both optimism and scepticism throughout these changing technological times, says Walter Scott, part of BNY Mellon Investment Management.

Last year, we attended a couple of UK-based tech conferences to this end, and can confirm that the buzz is moving on. For starters, the cryptocurrency fever of yesteryear has – unsurprisingly – waned, with much greater enthusiasm displayed around areas such as Augmented Reality (AR) and Artificial Intelligence (AI). Ethical discussions around the latter are gathering momentum, in no small measure due to fears that we’re racing headlong towards the realm of unintended consequences. Meanwhile, although robotics and automation will continue to displace jobs in many parts of the economy, the converse is true in the IT sector, where a skills shortage is driving up global competition, and pay, for a shallow pool of programmers. It seems today’s young can’t start practising coding soon enough, with some of the businesses we listened to expecting to hire fully-fledged coders at the age of 20-21.

In a compelling presentation at the Leaders In Tech Summit, we heard the head of Microsoft Corporation’s UK business outline some of the darker aspects of AI, particularly the urgency of developing a code of conduct for the design of AI based products and services. Microsoft predicts 95% of customer interactions will be through channels supported by AI, including chat bots, by 2025. The software giant is embedding AI in products such as Cortana and Office, and finding ever-more creative ways to deploy its machine learning prowess. This includes a healthcare-focused initiative dubbed Project InnerEye, which is helping diagnostic radiologists, by automatically delineating tumours in the space of a few minutes, as opposed to the hours required by a human.

Another example of stunning efficiency gains was insurer Hiscox’s use of Microsoft’s Azure Cloud to predict flood risk – enabling it to conduct calculations that previously would have taken eight months in a mere 12 hours. The old cliché about running to stand still is taking on a new significance in the tech age, with today’s crop of CEOs requiring greater lateral-thinking skills, and probably higher stress tolerance, than their predecessors. In the publicly-listed space, these Darwinian forces are on full display; at the current churn rate, 75% of companies in the S&P 500 will be replaced by 2025. It is clear that tinkering around the edges – say developing an app and establishing an online presence – won’t suffice. To stand a fighting chance, companies need to ensure that they keep pace with increasing consumer expectations. This involves fundamentally changing business processes, products and services.

Businesses hoping for a breather are likely to be disappointed. Amazon pushes new live code to its servers every 11.6 seconds, and clearly sees very few areas as off-limits for its expansion, recently illustrated by its foray into healthcare. Even a seemingly low-tech area such as the distribution of construction materials, which has historically been characterised by a lack of pricing visibility, informal relationships, and cash-based transactions is being disrupted by technology. Examples include a next generation supplier that utilises Oracle’s NetSuite for mobile ordering and delivery, within specified 30-minute slots, to construction sites.

Indeed, amid the obsession with the so-called FAANGs (Facebook, Apple, Amazon, Netflix, Google), Oracle is a good example of a ‘pick and shovels’ tech company that quietly has been working away at some cutting-edge solutions, including the world’s first autonomous database. This machine learning based data management offering promises to “eliminate human labour, human error and manual tuning” and thus significantly reduce costs for users. Similarly, Cisco Systems, another ‘mature’ player, has invested heavily to facilitate the AI and machine-learning revolution, including through its recently released ‘deep-learning’ server; the first that the company has created from the ground up for these applications. What’s more, it is also pushing the envelope through its intent-based network system. Described as a ‘self-healing’ network, this is, among other things, designed to reduce the time (some 43% in Cisco’s own estimation) IT departments spend on reactive troubleshooting.

Where do emerging markets feature in all of this? No one will have failed to notice that China has become a central protagonist in the global tech race, driven by a host of factors, including the rapid adoption of mobile technology, strong government support, and a veritable explosion of STEM (science, technology, engineering and mathematics) graduates. And the attendant innovation drive is placing the country at the vanguard of new business processes. Alibaba’s push into offline, or ‘New Retail’, is a case in point. Its high-tech supermarket Hema, which doubles as a distribution centre, has grown from zero to over 60 stores in three years, and is widely thought to have put daylight between itself and ‘online-offline’ efforts elsewhere. Customers order food on Hema’s app and, if they live within a three-kilometre radius, should have their shopping bags delivered within 30 minutes. Payments are made via Alibaba’s Taobao or Alipay platforms, and at a number of its stores, customers can pay through facial-recognition technology installed at kiosks.

While Chinese tech companies appear to be stealing the march in many areas and clearly have international ambitions, they are yet to prove that they can establish a real foothold overseas. Current global trade frictions certainly do not help, but it is also the case that they face very different competitive dynamics, consumer behaviours and more mature markets. In areas like payments, developed markets don’t have a void to fill, whereas the fintech industry in China is clearly capitalising on the shortcomings of the local banking industry. When it comes to AI, which Beijing is championing effusively, Chinese firms need to build a network of international partners to sell through, which is easier said than done. That said, the country is undeniably making serious headway, with no shortage of financial backers. And, should anyone doubt the enthusiasm of the country’s young, they need only take a look at international machine-learning competitions, which Chinese teams now regularly dominate.

As bottom-up and resolutely long-term investors we view technology in a particular light. Although we too are excited by the growth opportunities here, we are wary of the lofty valuation multiples that often get assigned to tech companies and therefore tread carefully, with a focus on business models that bring strong recurring revenues and sustainable margins, at valuations that don’t beggar belief. Rather than trying to catch the next big thing, we ask questions such as: how are established businesses adapting to the seismic changes underway, and what threats and opportunities could materialise down the line?

Critically, while the market is particularly drawn to things shiny and new, some businesses that may be perceived as more pedestrian ‘legacy’ tech have actually reinvented themselves and are blazing the trail in many areas. In short, we believe it is possible to maintain a Heraclitean embrace of change, without succumbing to undue speculation.

¹Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA), BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA, BNY MFML or the BNY Mellon funds.

The value of investments can fall. Investors may not get back the amount invested. 


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