Digital Economy Anniversary Special: The online consumer trends shaping our future
On 24 October 2020, Portfolio Manager Jeremy Gleeson and his team celebrated an important milestone - three years since the launch of AXA WF Framlington Digital Economy.1 In an interview to mark the occasion, Jeremy reflects on his experience over the past three years, the recent acceleration of underlying trends during the COVID-19 crisis, and his thoughts on the future of this multi-decade theme.
1. What was the rationale behind setting up the strategy three years ago?
At Framlington Equities, we have always believed that investing in high quality, growth companies that are exposed to long-term secular trends offers the potential to outperform broader equity markets. One key trend we identified as likely to have a huge impact on society in the coming decades is that of increasing digital connectivity among consumers, especially since the proliferation of smartphones. The digital economy describes the vast universe of companies operating across all touchpoints of connected consumers’ online journey.
At the time, we felt the strategy was very relevant – and, we believe, is more relevant today as we live in an increasingly digital world. When we launched the strategy, one of the first goals was to identify a theme that had longevity and would tap into multi-decade demographic and technological changes, which we believe will shape the way companies operate in the future.
While markets such as e-commerce have been around for a long time, it’s surprising that only 13% of global retail sales are transacted online2 , and in fact, when we launched the strategy just three years ago, this figure was only 9%. We believe this should allow for significant growth in the future and presents a compelling investment opportunity.
2. How is this different to a typical technology strategy?
Firstly, the portfolio has exposure to other industries which wouldn’t usually be found in a technology index such as consumer discretionary, industrial and real estate sectors.
Secondly, looking at other tech-oriented indices such as the NASDAQ or the MSCI World IT Index, both are large-cap indices. The NASDAQ is highly concentrated, with the top 10 companies representing 48% of the index. It is therefore more sensitive to price swings in its largest constituents, which include the FAANGs (Facebook, Amazon, Apple, Netflix and Google )* – companies which have performed very well over the last five years and contributed to the NASDAQ’s positive returns. Similarly, the 10 stocks with the highest weights in the MSCI World IT Index account for 56% of the index.3
By contrast, the Digital Economy fund is more broadly diversified, global and multi-cap in nature, with a particular bias towards small- and mid-cap stocks.4 The largest holding in the Fund has less than a 4% weighting, while our top 10 holdings represent less than 30% of the entire portfolio.5
3. How has the fund performed over the period since launch?
Since its inception1 , AXA WF Framlington Digital Economy’s cumulative return stands at 94.71%, versus just 20.79% for the broader equity market, the MSCI All Country World Index (25.47% and 6.67% annualised, respectively).6 While the strong secular growth of digitalisation and e-commerce have certainly played their part, we believe that several other factors have contributed to the Fund’s outperformance7 :
As mentioned above, the multi-cap strategy within our portfolio has provided us with greater exposure to plenty of opportunities within the digital economy investment universe.
Furthermore, small- and mid-cap stocks have provided a rich source of alpha for the Fund.8 This was particularly evident when our small-cap holdings – notably Zendesk, Twilio and New Relic* – contributed to the Fund’s positive return in 2018, a year where the broader equity market was down by 10% in US dollars.
Finally, we believe that taking a carefully considered approach towards stock selection has been key in achieving positive returns. The broad scope to invest across different industries helps in being able to time our investment decisions well and reallocate capital into newly identified growth opportunities. For example, we sold our online travel exposure in early 2020, having taken the view that such businesses will be especially affected by the COVID-19 pandemic. During this time, we also decided to gradually increase the Fund’s exposure to the Data & Enablers sub-theme, whose underlying businesses have been supporting the current lockdown situation.4
4. Speaking of which, how has the COVID-19 crisis impacted the digital economy theme?
The COVID-19 crisis is a perfect example of why we think investing in companies with strong long-term prospects is important. Some of the companies in which we invest have seen disruption but still held up well; meanwhile, others have in fact experienced a growth inflection amid heightened demand for the products and services they offer. So, not only has the theme remained intact, but COVID-19 has clearly accelerated the growth of the digital economy and forced companies across the entire economy to consider how they can do business digitally.
The benefits of e-commerce have come into their own over the last couple of months, with companies like Amazon and online grocery retail specialist Ocado seeing a pick-up in business. Another beneficiary of increased demand for online shopping includes fintech leader, PayPal.
Meanwhile, the need to stay safely at home and switch to widespread remote working supported demand for more cloud computing, cybersecurity and collaboration tools – with companies such as ServiceNow, Zoom and Atlassian having been among some of the beneficiaries of these needs.
For example, while video communication has been around for a long time, up until relatively recently, many peoples’ experience with this hadn’t been great. Clearly, some of the technologies that have evolved, Zoom being one of those, while not perfect and a replacement of face-to-face engagements, has been a very good substitute, compared to past video communication platforms.
Crucially, we don’t think this is a transitory move but rather an expansion or acceleration of the themes we were already addressing in the strategy. For example, many of us who are comfortable buying online have increased the frequency of our purchases; at the same time, around the world, many consumers have had their first ever experience of shopping online. Online grocery shopping had previously lagged e-commerce, but consumers may prefer it having had a taste during the pandemic.
5. What about the highs and lows of the past three years - what’s been your most successful idea or holding and what do you wish you knew in hindsight?
One company that has featured among our top holdings since we launched the strategy is Zendesk. It's a software-as-a-service platform, which enables companies to engage with their customers through the variety of digital channels that exist. When we first bought into this company, its market cap was around $3bn, representing a small-cap stock. Over the last three years, the stock has grown both in terms of its revenue growth and its performance. As a result, it’s firmly in the mid-cap range with a market cap of $12bn.9
In terms of what I wish I knew, inevitably we don’t get it right every time. But our investment method helps to mitigate the impact of the calls that don’t go our way. I suppose one thing we could not have predicted is the COVID-19 crisis. As I mentioned, we are very satisfied with how well many of our holdings held up in that period; however, had we known what was to come, we may have been positioned even more strongly in favour of those companies that actually thrived in the crisis, by being providers of much of the support and tools we needed to carry on many aspects of our lives under lockdown.
6. What do you think will be the most interesting developments within the theme in the next three years?
I think people will be surprised by how much further the digital economy theme has to run. COVID-19 did not create the digital opportunity, and the push to digitalise over the past six months will certainly not exhaust the theme; however, it does highlight how quickly technological shifts can be implemented, not only in terms of the companies driving them but also the speed of adoption by consumers.
Our key convictions are spread across the entire digital economy value chain, and are based around the trends that were already in motion but have since been accelerated by the COVID-19 crisis. Areas like online grocery shopping and digital cash payments look likely to see significantly more traction. I also think that the quality of experience has gone a long way to support video communication as being a long-term platform - not to completely replace face-to-face engagements but to provide a viable alternative for business collaboration.
I anticipate that, as the pandemic begins to alleviate and the global economy reopens, these companies will build on the strength that they have seen over the past few months to grow their business further. Despite that recent acceleration, I continue to believe the digital economy revolution is still in its early phase and, over the coming years, will present an expanding universe of diverse opportunities from which to generate potential long-term growth.
*All stocks mentioned are for illustrative purposes only and should not be considered as advice or a recommendation for an investment strategy.
Key risks – AXA WF Framlington Digital Economy
The Fund is invested in financial markets and uses techniques and instruments which may be subject to sudden and significant variation, and may result in substantial gains or losses.
Counterparty Risk: Risk of bankruptcy, insolvency, or payment or delivery or failure of any of the Fund’s counterparties, leading to a payment or delivery default.
Impact of any techniques such as derivatives: Certain management strategies involve specific risks, such as liquidity risk, credit risk, counterparty risk, legal risk, valuation risk, operational risk and risks related to the underlying assets.
The use of such strategies may also involve leverage, which may increase the effect of market movements on the Fund and may result in significant risk of losses.
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