Specialist Outlook

The web at twenty

20 February 2014

Nandu Patel discusses how the internet has developed in the last twenty years and the impact this has had on investments.

“The most profound technologies are those that disappear. They weave themselves into the fabric of everyday life until they are indistinguishable from it.” Mark Weiser, former chief scientist at Xerox PARC.

Predicting the direction of markets may be popular, but then so are horoscopes; neither are particularly good guides when making important decisions. For our part, we are more interested in dealing with uncertainty than forecasting the future. Technological change makes our task harder, by adding complexity, challenging norms, and re-defining many of the ways in which we live, work and communicate. Here, we explore these themes, considering the impact of the internet on business and outlining the implications for the way we invest.

There is a message here for charities seeking to stay ahead of the pack and achieve superior investment returns over the medium to long term. Moving away from conventional thinking in terms of manager and stock selection is worth considering. Today’s great managers and companies may not necessarily be tomorrow’s if they do not keep up with rapidly evolving and changing technologies and processes.

On 30th April 1993, the World Wide Web became free for everyone. Twenty years on, the internet and the web (which are actually different things, but synonymous in everyday use) have become like electricity: almost-invisible technologies that we now take for granted.

Yet consider how much has changed. With search, we have instant access to information that is unprecedented in its breadth, size and rate of growth. Anyone with a smartphone can broadcast to a global audience, whenever they want from wherever they are, limited only by access to mobile reception. Email and social networks are re-shaping the way we interact and communicate. In some areas, automated systems are replacing humans (how many people have you spoken to at Amazon?) while digital products and services are changing the way we read, keep records, take photos and listen to music. At a deeper level, emerging research in neuroscience suggests internet technologies are likely to alter the way we think, particularly for children growing up with touch screens.

Companies are at the forefront of these revolutionary changes. Twenty years in, we attempt to survey the landscape, identifying three major trends that have, are, and will continue to transform sectors and industries and outline the implications for our investment approach.

Three powerful trends

The first of these major trends is access to information. Transparency is a defining theme of the internet era. Product and service reviews highlight the failings of bad hotels and unreliable laptops; the internet gives consumers more power and control, and their conversations are amplified on social media.

At the same time, price transparency is powerful. Comparison sites make it easy to evaluate a range of competing services or find the best deal on a particular item. High Street chains selling non-perishable commodity products – such as books and electronics – struggle to compete against online retailers with lower overheads and more efficient supply chains. Without strong brand differentiation, traditional retailers get dragged into a race to the bottom on price, a race they are likely to lose.

Where businesses provide access to factual content, the internet has been particularly disruptive. Wikipedia destroyed the business model of the Encyclopaedia Britannica, while the New York Times fell out of the S&P 500 index of US stocks in 2010, replaced by Netflix, a company best known for internet video streaming.

Yet it would be wrong to conclude that providing access to content can no longer be profitable. After 125 years, the Financial Times is flourishing, and digital subscriptions to FT.com now exceed the newspaper’s print circulation. Under a very different model, Time Out no longer charges for its magazine in London but instead distributes it freely to commuters. This is part of a strategy to create a global digital media brand: Time Out has local websites in more than 40 cities, attracting 15 million visitors each month.

Good digital marketing allows small businesses to reach both mass and niche audiences.

The second main way in which the internet is re-shaping business is by lowering barriers to entry. A small retailer can use eBay or Groupon to compete in a specialist area or challenge established and well-recognised brands in ways that wouldn’t have been possible before the web. Lean online businesses with low distribution costs can target niche groups in the ‘long tail’ and the internet makes it possible – through blogs, online communities, display and pay-per-click advertising – to find and sell to everyone from hand-gliding fanatics to tortoise owners.

Mass marketing is also more accessible. An email marketing campaign can reach 100,000 people at a fraction of the cost, time and effort of direct mail through the post. In the 1980s, the high cost of advertising on TV, radio and in print held small new businesses back. Today, companies can create interesting, useful or amusing content on a low budget and distribute it cheaply online, boosting brand awareness and sales.

At the same time, the cost of much IT and communication infrastructure has also fallen sharply, removing this as another barrier to entry. A start-up in San Francisco can run on inexpensive but powerful laptops, access servers and software in the cloud, and collaborate over Skype with developers in Pakistan or designers in Russia.

This lowering of barriers helps facilitate disruptive innovation which, online, can lead to spectacular growth. As an example, consider photo-sharing app Instagram. In the nine months from December 2010 to September 2011 it grew from 1 million to 10 million users. By April 2012, that figure had trebled to more than 30 million users. Facebook then bought the company for $1 billion– at the time, it had just 13 employees, no revenues, and was less than two years old.

Disappearing middlemen

Easier access to information and lower barriers to entry have both contributed to our third internet trend: disintermediation, or cutting out the middleman.

This speaks for itself. In some sectors – including travel, general insurance and classified advertising – the process is already advanced. In others, disintermediation is only just beginning. Emerging areas include lending and access to capital (with the rise of peer-to-peer networks), real estate (where property websites are dominant, but estate agents haven’t yet been cut out of the loop), recruitment (where LinkedIn challenges traditional agencies), publishing (everything from open-access academic journals to thrillers self-published as ebooks), education (where ‘massive open online courses’ may re-shape the role of traditional universities) and television (online video is already supplanting free-to-air and subscription TV in China, a trend that may follow in the US and Europe).


Yet not everything changes

What does all this mean for the way we invest?

The internet is important, but it doesn’t change the fundamental disciplines of our investment approach. We are not technology zealots, nor are we luddites. In practice, the trends we have identified are simply an addition to our existing research process. They provide another lens through which we can view opportunities and risks and assess the prospects of businesses that we invest in.

Given the perennial danger of internet hype, it is also worth making an obvious point: the impact of the internet isn’t uniform across sectors. Demand for chocolate, medicine, beer and shampoo won’t disappear in a digital world. Firms such as Nestlé, Unilever, GlaxoSmithKline and AB InBev will continue to adapt their marketing to changes in consumer behaviour, but their actual products are unlikely to change very much. These firms own strong brands in generally-stable industries. This helps make them resilient businesses and, in our view, attractive investments for the long term.

Put another way, our goal is to preserve and grow the real value of our clients’ wealth. Technology doesn’t change that. Every investment – old economy or new – still has to earn its place in a client’s portfolio.

It is also worth stressing that the internet is an extremely complex system where innovation and progress are not steady or linear but volatile, rapid and unpredictable. In this context, extrapolating current trends is naïve. Placing too high a degree of certainty on any assumption about the future is dangerous. In our view, it is no basis for prudent investment decisions.

Conclusion

In its first twenty years, the web has re-shaped many industries, created new business models and unleashed bouts of rapid growth. When thinking about the internet and investing, we avoid the extremes of hype and complacency, instead sticking to what we do best: portfolio management focused on wealth preservation.

Over the next twenty years - the internet trends we have identified – access to information, lower barriers to entry and disintermediation – will continue to create many challenges to manage and opportunities to grasp. In a world of rapid change, we have developed an innovative investment approach that is well suited to charities.

We aim to protect capital during difficult markets, smooth returns and dampen risk across the market cycle. At the same time, we seek to meet income needs without taking excessive risks in the investment portfolio or compromising long-term capital growth.

By Nandu Patel, Head of Charities, Rothschild

If you would like the full article and impact on some specific stocks then please contact the Rothschild charities team - nandu.patel@rothschild.com
 

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Nandu Patel

Nandu has long standing expertise both in advising charities, foundations and educational endowments and managing their assets. Nandu joined Rothschild in 2010 to develop the charity business and has built a dedicated charities team of five people. Charity assets under management have since increased by 65%, representing 11% of Rothschild’s assets in the UK.

Nandu has more than 27 years’ experience in the financial services industry and, prior to joining Rothschild, spent 20 years in wealth management at Morgan Stanley. He read Economics at Cambridge University and has been a member of his Cambridge College’s Alumni Campaign Board for over 10 years. Nandu founded and remains a trustee of a grant making UK registered charity focused on education, health, and relief of poverty in the UK, East Africa and the Indian sub continent.

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