Why most things believed about investing are wrong.Read more
Exploring Sustainable Growth: A New Approach to ESG.Listen now (19 minutes)
Inflation risks: Fine-tuning multi-asset investment tactics.Read more
ESG v sustainability: are we heading in the right direction?Read more
NO SUCH THING
AS 'TECH'Allen Farrington, Investment Analyst. Third Quarter 2019.
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk.
TECHNOLOGY THEN AND NOW
After steady falls in their aggregate share, the top five stocks in the S&P 500 have surged to a combined 25 per cent of the index, leading the bull market into an historic twentieth year.
No, I’m not referring to Facebook, Amazon, Microsoft, Google, and Apple (FAMGA) which make up around 20 per cent of the S&P today. I’m not even recalling any time in the past fifty years. That opening snapshot dates from the Bryan Adams’ celebrated ‘Summer of ‘69’, when the five big beasts were AT&T, General Motors, Exxon, IBM, and Eastman Kodak.
For an illustration of the impact of technology in the mid-20th Century, consider the following: AT&T used cutting-edge telecoms to operate a public switched telephone network – then the largest network in the world – connecting every home in the US and Canada.
General Motors continuously reinvented, at scale, arguably the most important consumer product of all time – with the key ingredient, gasoline, provided by Exxon – which was instrumental to the way we travelled and lived.
IBM and Kodak were, of course, household names and for many still are.
Clearly none of these companies competed directly. Consumers didn’t have to choose between cameras and gasoline; businesses did not choose between paying the phone bill and buying a mainframe. We can tell they didn’t compete just by looking at the sectors they were in: telecommunications, consumer discretionary, energy and information technology.
Granted, these sectors were not designated as such by S&P until 1999, but it is obvious how they would have been seen if the classifications applied.
The same kind of differentiation is roughly true of the FAMGA five. Amazon primarily runs a retail service and logistics network. Apple makes consumer electronics. Facebook sells targeted advertising on a social network. Google is a reference service that sells query-based advertising, which also owns YouTube, the most popular video service in the world. Microsoft sells operational tools for businesses.
Consumers didn’t have to choose between cameras and gasoline; businesses did not choose between paying the phone bill and buying a mainframe.
It’s true that Google, Microsoft, and Amazon compete in the cloud computing business, but this is a small component of the revenue of each. Apple and Microsoft devices sell on Amazon’s marketplace. Google and Facebook both sell ‘advertising’, but their tools are about as different as any two kinds of advertising can get.
By and large, the FAMGA companies are not in competition. And yet all are ‘technology’, we are told. But weren’t the telephone, the internal combustion engine, and the film camera ‘technology’? Aren’t they still?
The point is that if everything is technology then potentially nothing is.
In a wide-ranging interview with the journal Foreign Affairs in the January/February 2015 issue, venture capitalist Michael Moritz said; “It’s very hard to detach any form of entrepreneurial activity from technology, because whatever business you start is launched on some form of technology. You may just want to start a small bakery, but you’re buying really good equipment, you’re using software to run your business, you’ve probably got a website.”
That website may well run on Wix, the Israeli company that allows users to create and host their own sites. The accounting may well be managed on Xero, a New Zealand firm offering cloud-based accounting to SMEs. Boosting capacity might involve an arrangement with Delivery Hero, a German online company, to deliver straight to customers? If the bakery is in China, it almost certainly accepts WeChat Pay and AliPay, the payment options provided by ecommerce and internet media platforms Tencent and Alibaba. If it is in Japan, GMO Payment Gateway is likely to be the connection to the payments ecosystem; in Argentina, MercadoLibre’s Mercado Pago payments solution.
SOFTWARE IS EATING THE WORLD
All these companies count as ‘technology’, but as with FAMGA, they do not compete. It is inconceivable that a company that enables food delivery could take on a company that helps you with your taxes, or with one that facilitates card payments. The idea is absurd. Nor do they compete for resources or credit, nor do they share suppliers, nor are they subject to the same regulations. By no stretch of will or imagination are they in the same ‘sector’.
But they do have one thing in common: software. In fact, ‘technology’ in finance seems only to refer to software – very different to what might have been said of AT&T, GM, and Kodak in the ‘60s. ‘Technology’ is both everything and one very specific thing. Why is this?
Venture capitalist and Netscape founder Marc Andreessen famously declared in a Wall Street Journal op-ed in 2011, “software is eating the world.” He wrote: “my own theory is that we are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swathes of the economy.”
Andreessen cited one industry after another that is being ‘eaten’ by software. Indeed, it is hard now to argue that FAMGA, Baidu, Alibaba, Tencent, and the like are not, in some sense, ‘software’ companies. Their products are impossible to conceive of without highly advanced proprietary software. Are they in the same sector after all?
Venture capitalist and Netscape founder Marc Andreessen famously declared in a Wall Street Journal op-ed in 2011, “software is eating the world.”
The answer is no.
Software is not like the internal combustion engine or the telephone. For any given technology, it is necessary to think of all its potential productive uses, or its ‘application space’. The application space of the internal combustion engine is instantly-adjustable acceleration. The application space of the telephone is instant transmission of sound. The applications that followed from each of these inventions clearly transformed economic and social behaviour, but they have nothing on software.
The application space of software is nothing less than any coherent human thought. It is a far vaster area than any covered by any prior technology. Any information can be software and any process can be software – from what ‘sector’ the information and processes originate is almost irrelevant.
If this seems suspiciously universal, that is precisely the point. Consider, for example, that voice-over-internet-protocol, or VOIP, provided by Japanese telecoms and internet conglomerate SoftBank, amongst others, has all but made public switched telephone networks obsolete. Software is eating communications.
Baillie Gifford’s electric vehicles holdings Tesla and NIO are rapidly making obsolete the most important use of the internal combustion engine, using an engineering framework to which software is indispensable. Software is eating transportation.
The demise of film cameras, and Eastman Kodak along with them, is now a classic business school case study. Kodak is said to have invented the digital camera in 1975 but to have failed to pursue it, to protect its highly profitable razor-and-razor-blade film model.
Meanwhile, the Dutch holding ASML and SoftBank subsidiary ARM Holdings are crucial to producing the smartphones that have become the cameras of the 21st Century. ASML has a near-monopoly on a key piece of machinery used in the global semiconductor supply chain, and ARM Holdings licenses the chip architecture used in almost every smartphone, plus a decent portion of tablets and digital televisions.
When we visited ASML headquarters outside Eindhoven in March 2019, head of investor relations in Europe, Marcel Kemp, told us that the machine testing previously done by hand is now carried out almost entirely by software. Software is eating our cameras, our phones, our televisions, industrial testing and much else.
SOFTWARE IS A TOOL
Software is eating the world because software applies to everything, but it is not itself everything.
To tease out a more useful definition of ‘technology’ than any touched on so far; software is mostly a tool for multiplying the productivity of labour. It is mostly productive capital. Companies which make better use of software than their competitors are investing their capital in better tools. They are not in a different industry, but rather are far more likely to win in their own industry in the long run.
We are often asked about our exposure to ‘technology’. It is a perfectly reasonable concern and we wouldn’t want to add unnecessary risk to your portfolio by investing in companies that are all exposed to many of the same financial, legal, and operational risks. But in the case of many of our supposed ‘technology’ investments, these precise risks do not apply. Arguably, the only reason this confusion arises is the dubious sector classifications that pervade the finance industry.
While MSCI was sharing all this with the media, nothing in the real world had changed. As we wrote some clients at the time, “the new sector classifications do not reflect a change in the underlying risk profile or level of diversification in your portfolio.”
We think carefully about where real competition and interdependencies exist between holdings, and are happy to invest in payment platforms, logistics networks, music libraries, fashion outlets, and just about anything else – provided our bottom-up research suggests a reasonable likelihood of an exceptional long-term return, regardless of how MSCI classifies such opportunities at any given moment.
MSCI may deem ‘software’ to be a ‘sub-industry’, but we do not believe that being ‘overweight’ this sector adds any relative risk to your portfolio, all else being equal.
The biggest risk of all would be in investing in companies – in any industries – that are not embracing software to the best of their abilities and hoping to preserve this invested capital over the long term. The revenues of any such holding represent low-hanging fruit for the kinds of companies in which we want to invest.
THE MAP IS NOT THE TERRITORY
The philosopher Alfred Korzybski is best known for his dictum “the map is not the territory”. He was warning of the dangers of taking abstractions too seriously. In particular, that we shouldn’t trick ourselves into thinking that an abstraction is literally what it is supposed to represent.
One of the many dangers of this seductive practice is the temptation to believe that changing a representation of reality will change reality itself. Korzybski offered another formulation in that ‘the word is not the thing’. The word ‘technology’ – or worse, ‘tech’ – is most certainly not the thing. It isn’t clear to us that it is anything. We should stop trying to fit reality to labels and wonder instead whether we should change the labels to reflect reality.
The reality is that Amazon, Facebook, and Apple do not compete. Neither did AT&T, IBM, and GM, and neither do GMO Payment Gateway, Tesla, NIO, ASML, Alibaba, SoftBank, Baidu, Spotify, Tencent, MercadoLibre, Delivery Hero, Meituan Dianping, and Zalando.
In all cases, these companies both use and manufacture technology. For the contemporary examples, much of that technology is software. If we understand the qualities of software as a technology, there will be no great mystery as to why this is the case, but it does not imbue these companies with extra characteristics. How the world of finance categorises these companies does not change how they operate, or how they relate to one another, no matter how much we might enjoy scribbling on the map.
To repeat: The map is not the territory. There are exceptional businesses,
but there is no such thing as ‘tech’.
Risk Factors and Important Information
The views expressed in this article are those of Allen Farrington and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved in the third quarter of 2019 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
Baillie Gifford has holdings in all the companies mentioned within this article, except for: General Motors, Exxon Mobil, Eastman Kodak and Netscape.
Potential for Profit and Loss
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.
This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used in this article are for illustrative purposes only.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.
Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.
Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018 and is authorised by the Central Bank of Ireland. Through its MiFID passport, it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Baillie Gifford Investment Management (Europe) Limited is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co.
Persons resident or domiciled outwith the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.
The S&P 500 (“Index”) is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”). Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.
Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.
Important Information Hong Kong
Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 licence from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of UCITS funds to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 can be contacted at 30/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong. Telephone +852 3756 5700.
Important Information South Korea
Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.
Important Information Japan
Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.
Important Information Australia
This material is provided on the basis that you are a wholesale client as defined within s761G of the Corporations Act 2001 (Cth). Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth). It is exempt from the requirement to hold an Australian Financial Services License under the Corporations Act 2001 (Cth) in respect of these financial services provided to Australian wholesale clients. Baillie Gifford Overseas Limited is authorised and regulated by the Financial Conduct Authority under UK laws which differ from those applicable in Australia.
Important Information South Africa
Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.
Important Information North America
Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in America as well as some marketing functions in Canada. Baillie Gifford Overseas Limited is registered as an Investment Adviser with the Securities & Exchange Commission in the United States of America.
Ref: 42674 PRO WE 0072
Allen Farrington Investment Analyst
Allen joined Baillie Gifford in 2015 and is an Investment Analyst in the International Growth Team. He graduated MA (Hons) in joint Mathematics and Philosophy from the University of St Andrews in 2015.
YOU MAY ALSO LIKEInsights.Visit Baillie Gifford's Insights page.Exploring Sustainable Growth: A New Approach to ESG.Are your investments as good for the environment and society as you think they are? Stuart Dunbar, partner at Baillie Gifford, explains why too many people have been lulled into a false sense of security by metrics-based approaches to ESG that don’t support the transition to a more sustainable society.The Truth Will Out: Dispelling the Myths of Emerging Market Investing.The golden age for EM economic growth is over, but for some EM companies, the opportunity set may be far larger than anything EM investors have seen to date. Will Sutcliffe dispels some common misconceptions surrounding EM investing.Digital payment platforms pave way to a cashless future.Disruptive fintechs are paving the way to a world without physical money.