Practical analysis for investment professionals
05 May 2015

Is Your Portfolio Ready for an Invasion of Disruptive Technologies?

Something amazing this way comes. An invasion fleet of perennial “next big things” that have disappointed futurists (for decades in some cases) and provided ammunition for skeptics is finally set to arrive. Artificial intelligence, robots, biotech, and several other world changers are about to create entire new growth-stock ecosystems while disrupting a range of established industries — not someday, not maybe, but definitely, and starting now.

To understand this approaching wave of creative destruction, two basic concepts are helpful: exponentiality and simplification. First, on exponentiality, humans tend to think in linear terms. That is, we notice a rising trend generated by the early stages of steady growth but don’t extrapolate to the point at which progress will go parabolic (if it continues at the same rate). As Ray Kurzweil, noted inventor, author, and now Google’s director of engineering, told a Singularity University audience in August 2014, “People tend to dismiss a disruptive technology when it’s only 1% of a solution, ignoring the fact that it’s doubling every few years and will be at 100% in a very short time.”

Second, on simplification, it’s important to understand that in many cases, the real disruption will come not from bigger, “badder” machines but from simpler, smaller ones. “A typical high-end sports car like a Mercedes S550 has around 1,600 moving parts; a Tesla [electric car] drive train has 19,” says Alex Daley, editor of Casey Extraordinary Technology newsletter in Stowe, Vermont. “A Predator drone is far simpler to build and maintain than an F-35 fighter jet. Big, single-purpose manufacturing robots are being supplanted by fundamentally simpler 3D printers. At every point in the manufacturing process, the steps are being simplified and digitized, as software replaces hardware.”

Rise of the Machines

Consider two examples of what happens when exponential improvement and radical simplification intersect: artificial intelligence (AI) and robotics.

Computers are (perhaps thankfully) a long way from being conscious. But they are becoming intelligent. IBM supercomputers Deep Blue and Watson have, respectively, outplayed the reigning human champions of chess and the game show Jeopardy. And Google and Amazon certainly seem like brainy entities to their users. This kind of AI is spreading to pretty much everything, automating what can be automated and augmenting what (for now) cannot. Amazon warehouses use fleets of robots that locate items and bring them to a central packing station, cutting the time it takes to box a typical order from 1.5 hours to 15 minutes. Spanish food processor El Dulze uses robots to evaluate heads of lettuce, reject substandard specimens, and position the good ones for processing by other machines. Google’s driverless vehicles had, by the end of 2014, driven 800,000 miles without an accident. And pilotless drones are replacing everything from fighter jets to traffic helicopters to spy satellites. The list continues through burger-flipping robots and semiautomated clothing stores to encompass virtually every manufacturing and transactional service niche.

Exponential Growth Chart

In addition to AI and robotics, three other key areas figure to be the focus of intense development: 3D printing, expert systems, and “the internet of things.”

  • 3D Printing. Thirty years ago, an engineer named Charles W. Hull invented a process called “additive manufacturing,” which involved building objects layer by layer rather than through molding or cutting. It was slow and expensive and required decades of incremental improvements to escape the lab. But escape it has. Today’s 3D printers can build objects of startling complexity from a set of digital blueprints, and the price/performance ratio is falling exponentially. Entry-level versions now cost less than US$1,000, and the range of things they can produce has expanded to include electronic components and human replacement organs.
  • Expert Systems. In December 2014, internet phone company Skype debuted a feature that translates conversations between English and Spanish in near real time. Stanford University’s PaleoDeepDive “machine reading system” has equaled scientists at extracting and organizing data from scientific journals. And IBM is turning its Watson AI into a cloud-based utility that will dispense smarts the way an electric utility provides power. Oncologists at New York’s Memorial Sloan Kettering Cancer Center currently use Watson to improve diagnoses and treatment.
  • The Internet of Things. According to the 2013 McKinsey & Company report Disruptive Technologies: Advances That Will Transform Life, Business, and the Global Economy, “More than nine billion devices around the world are currently connected to the Internet, including computers and smart phones. That number is expected to increase to between 50 billion and one trillion in the coming decade.” The trend is proliferating. Take ever-smaller, more sophisticated sensors and microelectromechanical systems; embed them in appliances, buildings, and clothing; and imbue them with cloud-based artificial intelligence. “Everything will have its own IP address and will communicate with everything else,” predicts Jim Mellon, UK money manager and author of Fast Forward: The Technologies and Companies Shaping Our Future. The result is not just a world of smart devices but a smart environment that understands the spoken word and behaves in ways that simulate volition and judgment.

The Disrupters and the Disrupted

3D printing is being pioneered by a range of companies, from tech giants such as Hewlett-Packard and Autodesk to newcomers Stratasys, 3D Systems, and MakerBot. But most other AI and robotics breakthroughs are either emanating from or being snapped up by established players. “The best virtual reality company is owned by Facebook,” says Mellon. “Google recently bought Boston Dynamics, probably the best robot company in the world apart from FANUC in Japan. Now they’re a leader in robotics as well as drones, bioinformatics, and wearable devices.” In effect, he contends, one could think of Google as a very long-term robotics/AI fund.

“Automation is going to take over every single repetitive task,” predicts Louis Gave, co-founder of Hong Kong–based research firm Gavekal. The factories, hospitals, and restaurants that make the transition most smoothly will tend to survive and thrive. Those that don’t will be stranded on the wrong side of history.

An automated future poses particular problems for emerging market economies that now enjoy a cheap labor advantage. With 3D printing, Mellon points out, “Manufacturing is going to be localized. Proximity to the customer will become more important than hourly wages.” The implication is that emerging market bonds and equities, big winners in the previous decade, may struggle to hold their gains.

Another at-risk sector is financial services. Peer-to-peer lending and various forms of crowdfunding are encroaching on the business/consumer loan industry. Bitcoin, a digital currency that operates outside the traditional banking system, is seeing transaction levels double every eight months. Apple’s new iPhone-based payment system, Apple Pay, accounted for 1% of grocery chain Whole Foods Market’s transactions in only its first 17 days of existence.

“The financial industry’s safe and steady margins will come under heavy pressure, rendering a lot of capital (both human and monetary) deployed in the current infrastructure obsolete,” predicts Gave. [For more on trends shaping the future of the financial services industry, see the “A View to the Future” interview with Tom Brown, global head of investment management at KPMG.]

Digital and Regenerative Medicine

For most people, the doctor visit hasn’t changed in decades, with the same physical waiting rooms; same paper forms to fill out; similar slow, expensive tests; and only marginally effective treatments. But a transformation is coming from multiple directions.

  • Digitized Research. “Instead of going out in nature and finding a tree frog that has a cure for some disease, [today’s scientists] design 100,000 chemicals and test them in the lab to find one that works,” says Daley. The combined result could be a tidal wave of powerful new treatments, which are in various stages of development.
  • Cheap, Fast Tests. “Many of today’s medical tests involve culturing cells in a lab for two or three days to get enough genetic material to analyze,” says Daley. Next-generation tests will happen in real time. “Right now, testing for sepsis [a common, extremely dangerous blood infection] takes two days and costs $2,000. But Nanosphere [a startup in Northbrook, Illinois] — one of 20 publicly traded companies focused on advanced molecular diagnostics — can test for sepsis in 2.5 hours for $70.”
  • Synthetic Biology. The emerging ability to mix and match genetic material (or build it from scratch) to create new life forms is allowing researchers to attempt such things as harnessing specially designed bacteria to mass-produce next-generation antibiotics, vaccines, and cancer drugs.
  • Genomics for the Masses. Sequencing the first human genome required $3 billion and 13 years. A decade later, the $1,000, 24-hour genome is in sight. The possibilities opened up by widely available genomics include the ability to determine which cancer drug will work on which type of cancer, something today’s oncologists can only guess at.
  • Stem Cells. Undifferentiated cells that can become anything from neurons to entire new organs were discovered more than three decades ago. But only in the past couple of years has it become possible to make them follow instructions. Scientists at Columbia University are now growing cartilage to repair damaged joints that currently require surgery, and the Harvard Stem Cell Institute is growing pancreatic beta cells, the insulin-secreting cells that are not functioning in Type 1 diabetics. Injected into diabetic mice, the cells cure the disease in fewer than 10 days.

The Business Impact

“Hundreds of biotech companies are now chasing cures for diseases that 10 years ago, we couldn’t even treat,” says Daley. And faster, cheaper tests are announced on a weekly basis. This is great news for humanity but challenging for investors trying to identify eventual winners.

Income streams from treatments that manage but don’t cure diseases will evaporate as true fixes emerge. Today’s high-margin tests will be supplanted by cheap, mass-market versions. Medical devices like artificial joints and insulin pumps will be replaced by regenerated tissue. Repetitive hospital tasks and basic diagnosis will be automated. “Medicine is going to be fundamentally disrupted,” predicts Daley.

Investors and Disruption

For investors thinking about the implications of the coming wave of creative disruption, the future can seem a daunting prospect. But some general guiding principles may be helpful.

  • Assume a Few More Doublings. “[Some exponentially improving technologies] will be a thousand times more powerful in a decade, a million times more powerful in 20 years,” says Ray Kurzweil. The biggest opportunities and threats will come from those future capabilities rather than from today’s emerging ones.
  • Assume Automation. As venture capitalist Mark Andreessen famously noted, “Software is eating the world.” Virtually every field will be automated to some extent in the coming decade. The winners will be the companies that facilitate the process and/or successfully embrace it.
  • Avoid (or Short) Static Industries. “The less a business has changed over the last 30 years, the more it’s about to change,” says Daley. “Publishing, for instance, didn’t change for decades, and in a single decade has been completely transformed.” Now it’s the turn of manufacturing, health care, and most service industries.
  • Or Play Both Sides of the Process. “Existing markets don’t disappear overnight,” says Daley. “So, one strategy is to invest in the growing threat and the potential victim and let the market sort it out. Had you owned both Netflix and Comcast at the time of Netflix’s IPO, you’d be doing just fine today.”
  • Be a Little Paranoid. “Know where a company’s margins are made, and assess every potential threat,” says Daley. “Regularly survey the landscape of new innovations, even some of the goofy-sounding ones, and ask yourself whether or not it could disrupt your model.” To take just one of myriad possible examples, the recent quantum leap in connectivity allows the customers of Boston car-sharing firm Zipcar to use their phones to find, reserve, and unlock the company’s cars and then pay based on miles driven and time spent in the car. Right now, this is just a tiny blip on the car rental industry’s radar screen, but five years from now, who knows?
  • Understand What Is Not Disruptive. Electric vehicles, for instance, “are additive, not a substitute for internal combustion engines,” says James Albertine, energy analyst with investment firm Stifel Nicolaus in St. Louis, Missouri. And there are no more Teslas in the pipeline because a big part of the company’s advantage is derived from the low price it paid General Motors for its main production plant. “They had a very attractive entry point, just as GM was restructuring. That’s not going to be easy to replicate,” says Albertine.
  • Notice Old Firms with New Tech. “Some of the old dinosaurs might have things that completely transform their growth prospects,” says Mellon. Hewlett-Packard’s memristor, for instance, “can compress vast amounts of data in portable format, 100 terabytes on a phone. It will be enormous.” Combine memristors with 3D printing, and HP might look shiny and new a decade hence.
  • Watch Those Network Effects. Also known as the law of increasing returns, network effects are caused by the tendency of a network to become more valuable and powerful as it gains users. In an interconnected world, predicts McKinsey & Company in its previously cited report, cloud-based AI services will be subject to this law: “The more people who use an AI, the smarter it gets. The smarter it gets, the more people use it. . . . Once a company enters this virtuous cycle, it tends to grow so big, so fast, that it overwhelms any upstart competitors.” For an idea of the investment implications, think Google versus the other search engines.

Nowhere to Hide

The technologies highlighted in this article are just a sample of what’s coming. The McKinsey report lists a dozen disruptive technologies and business models that it estimates will have a cumulative impact — wealth created and destroyed — of tens of trillions of dollars. In other words, every corner of the global economy is getting an upgrade, and no place is safe.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Illustration credit: Timothy Cook

About the Author(s)
John Rubino

John Rubino, a former financial analyst, manages and is a freelance writer and author of several books on investment topics.

3 thoughts on “Is Your Portfolio Ready for an Invasion of Disruptive Technologies?”

  1. Colin McLean says:

    Good article – thanks for sharing. Not sure about the graph though. I think the exponential curve might look the same all the way along. All that has happened is the application of hindsight and shrinking the scale for the first part of the graph. I agree that absolute volume can look insignificant early on, but even at the time can look exponential.

  2. Patrick Mutimba says:

    I found this article very insightful.

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