Investing in the Digital Revolution

The Digital Revolution – the Fourth Industrial Revolution – is by now well underway. As investors in long-term growth we have followed it through all its major themes, from 3D, through Advanced Robotics, 5G, Cyber Security, Data, AR, VR, Cloud Computing – which has proved very profitable and cash generative for more than a decade – and now, AI.

The last two technologies make up a structural trend with enormous growth potential. Most AI goes through the Cloud, which supports further growth on this theme bringing with it strong profits and cash flow generation. They are the two main reasons that we are unashamedly well invested for these technologies in the Stonehage Fleming Global Best Ideas Equity Fund (GBI) portfolio.

The top four companies in our concentrated portfolio (Microsoft, Alphabet, Cadence and Accenture) and, further down the list – Amazon, Adobe and ASML – are all well exposed to the Digital Revolution. Indeed, technology is easily the dominant sector for the fund, with the Digital Revolution theme making up a third of the portfolio.

In terms of geography, although almost three quarters of the companies held in GBI are American, they are all ‘global’ businesses, providing a good geographic and currency spread, right across the world. Almost half of that is dollar exposed, and just under a quarter in emerging markets where we know the best long-term growth potential lies. The net effect is world-class emerging market operators operating on a global basis and bringing with them the governance and entrepreneurship of a ‘best ideas’ company.

As investors, we are often asked as much what is out of the portfolio as what’s in it. Outside of tech, the rest of the market hasn't done much this year. Apple, Amazon, Nvidia, Microsoft and Alphabet — combine to make up a quarter of the S&P 500's value at the end of October (Source:Bloomberg). What that means, though, is that there are many opportunities that remain under the radar. The Fed has sent a very clear message that they are not going to drop rates any time soon. Investors can take comfort from the fact that the US Economy remains resilient, allowing other, non-tech companies to also keep growing. We continue to scour the market for growth opportunities to invest.

When it comes to Big Tech, observers may also notice some notable absences from GBI. Those of the ‘Magnificent Seven’, (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) that we don’t have in in the portfolio are incredible companies – in several cases, the jewels in the crown in their respective industries. When it comes to these, we never say never. That said, it is not practical to own all of them. By following a rigorous process, we seek out only those companies that in which we have the most conviction for sustainable growth.

We implement our philosophy in assessing all companies’ quality, strictly according to four ‘pillars’. First, we look for sustainable, organic growth. Secondly, we go out of our way to understand the business culture and to verify that the management is of the highest quality, managing the business for long-term sustainable growth. Third is efficiency, where we only invest in companies that have already proven themselves to be profitable businesses with strong balance sheets and offering a good return on capital. Finally, we seek companies generating free cash flow on a sustainable basis. Ultimately, free cash flow is all that a shareholder can claim from a company. Without it, it is very difficult to value the business.

Following the Fourth Industrial Revolution, the Digital sector is the proverbial Oil or Staples of the modern world, providing fantastic opportunities for us to earn good returns going forward. By confining ourselves to the world's best businesses –specifically identifiable by their quality, strategic competitive edge and attractive valuation – we position ourselves well to deliver good investment returns over time.

Gerrit Smit is Head of Global Equity Management at Stonehage Fleming Investment Management. He established the Global Best Ideas Equity Management division in 2009 and is Portfolio Manager of the Stonehage Fleming Global Best Ideas Equity Fund.

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Disclaimer: This article has been prepared for information only. The opinions and views expressed on any third party are for information purposes only, and are subject to change without notice. We do not intend for this information to constitute advice or investment research and it should not be relied on as such to enter into a transaction or for any investment decision.

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