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Nov 22, 2018

Future Proofing Your Portfolio Blockchain, 3D Printing, Energy Storage And Artificial Intelligence

by Moez Mahrez

Moez MahrezBefore investing in a ‘trend’, it is crucial to know what one owns and the risks involved, especially if you are investing long-term. Unfortunately, many investors get blinded by recent trends and hot themes and invest based only on the basis that others are investing in something (some may recognize this as the fear of missing out or ‘FOMO’). While some of these spaces can surely become overhyped and outright speculative, they should not be ignored outright. We think an investor should once in a while take some time to philosophize on where the future is headed and ensure that their portfolio is protected from future developments and even stands to benefit from them. We call this future-proofing your portfolio. For investors that may have missed out on say the social media stocks over the last few years, the opportunity costs here can be real but avoided even with a small sprinkling of exposure to some of these potential high growth (but high risk) areas of the economy. Let’s take a look at some of the trends and ways an investor can gain exposure through ETFs while starting with one broad warning, most of these technologies we are looking at remain high risk and in some cases speculative for many investors, so use this as a starting point on these types of industries and if they may fit into your portfolio.

Why Invest Through An Etf?

ETFs are a great way to get your feet wet with a space that is unfamiliar. For example, if you are interested in prospects for an industrial sector in Germany but are unfamiliar with the market, it is instead wiser to lower your risk of the unknown and find an ETF with diversified exposure to industrials in Germany. Similarly, when investing in the future, the ‘unknown’ is determining which company is going to be the next super stock in these early stages of adoption, so it is often best to spread out, or diversify, your investments among various companies in these spaces. This allows an investor to have more general exposure to a developing theme or industry opposed to trying to guess which companies will be around ten years from now.

Blockchain Technology

Block chain technology and Bitcoin are words often used interchangeably. This may be due to the fact that they both arose into public awareness around the same time and that blockchain is the technology used for Bitcoin. However, investing in a blockchain technology is entirely different than investing in cryptocurrencies. Cryptocurrencies are more of an asset class (some would say a commodity) whereas blockchain is a shared ledger system that can have an array of applications for many different industries. Many large-cap companies like IBM have not only dabbled with blockchain technology but have begun significant investments related to its application and development for businesses, resulting in greater efficiencies. Blockchain has the potential to transform industries and bring huge costs savings. We are still in the early stages of blockchain development and are likely to see rapid developments in the coming years. According to Netscribes1, it is estimated that there will be a 42% expansion per year on average until the year 2022 in the blockchain space. According to Gartner group, blockchain is estimated to add $3.1 trillion in business value by 20302.

A Fund For Blockchain Exposure

Amplify Transformational Data Sharing ETF (BLOK) is actively managed which will serve it well in a rapidly changing industry compared to passive peer ETFs and for not that much more of a cost (0.7% MER). BLOK also has the highest AUM of $167M compared to peers. In general, we prefer to avoid funds under $100M in assets under management (AUM) to avoid high price fluctuations due to lack of volume and liquidity and potential closing of funds. Looking at Table 1, we can see that compared to its peers, a decent portion of BLOK is invested in small and micro-cap companies (~20%), which is desirable for investors seeking to capture potential growth of the blockchain industry through smaller companies that emerge as winners. BLOK’s large cap holdings provide some stability to the fund and are some familiar tech names such as Intel, Square, AMD, Overstock, Yahoo!, Alphabet, Microsoft and IBM. Since we are at the very early stages of blockchain technology, performance results of ETFs in the space will provide little insight. Therefore, it becomes very important to look at not only the creditability of the ETF issuer but also the methodology by which the securities in the fund are selected. What stands out with BLOK is the focus on selection of companies that will likely have the most impact to their revenue by incorporating blockchain technology. This is sound investing rationale as it will more likely reflect direct gains in the fund itself, whereas other blockchain funds tend to focus on how much blockchain integration will take place in a company.

Table 13

 

Artificial Intelligence And 3D-Printing

Whether it is asking Siri what movie is playing tonight, adding a friend on social media from the “suggested friends” section or conducting a google search, you’ve encountered some form of Artificial Intelligence (AI) in your day to day life. AI has also branched out into other fields including applications of language processing, robotics in assembly lines, 3D-printing, self-driving cars and much more. AI is also helping businesses. According to Statista, 84% of enterprises believe investing in AI will lead to greater competitive advantages, and global revenues from AI for enterprise applications are projected to grow from $1.62 billion in 2018 to $31.2 billion in 2025 attaining a 52.59% Compound Annual Growth Rate (CAGR) in the forecast period4. We think both of these spaces are very interesting because on one hand it is very difficult to imagine where and how far these technologies can go but on the other hand it should be clear that they have the potential to upend current industries and create brand new ones. As noted earlier, not taking some time to think about how these areas could impact a portfolio longer-term could be a risk in itself.

Global X Robotics And Artificial Intelligence ETF (BOTZ)

If you’re looking for pure exposure to the AI industry, the Global X Robotics & Artificial Intelligence ETF (BOTZ) is probably your go-to. With Assets under Management (AUM) of $2.5 billion this fund has managed to gain significant attention in a span of just under 2 years. This fund contains industry leading and high-quality companies that are not new to the business and have either robotics or AI as a central focus of their business. The combination of robotics and artificial intelligence will likely serve investors well as these two industries go hand in hand. Companies like Nvidia, Mitsubishi Electric, and Intuitive Surgical can be found in the top ten holdings. The number of holdings is relatively low at 37 companies in total, with the top ten occupying 56% of the fund. This means less diversification and more concentration risk, but that is not a “bad” thing as a satellite holding in a portfolio. The market capitalization breakdown looks healthy with 56% in large-cap, 20% small-cap, 15% mid-cap and 9% micro-cap. Large-caps are always great for a portfolio, but small and mid-caps are important for capturing growth. The 9% in micro-caps is not surprising to see given that there has been a 14X increase in the number of start-ups developing AI systems and a 6X increase in annual venture capital investment in U.S-based AI start-ups as per Forbes5. The country breakdown of this ETF reflects the global nature of the robotics and AI industries, with Japan leading the pack at 43%, followed by the U.S. at 35%. Japan has undoubtedly shown its determination of being at the forefront of technological innovation even ahead of the U.S.

3D-Printing ETF Exposure

Global spending for 3D-printing is projected to grow at a 5-year compounded annual growth rate of 18.4% and is expected to reach $23 billion6. The 3D printing industry has exceeded $7.3 billion according to Wohlers Associates7 and is projected to reach between $180 billion to $429 billion by 20258. What makes 3D-printing a compelling investment idea is the far reach and penetration of industries. Industries that benefit from 3D-printing range from automotive, pharmaceutical, medical, industrials, electronics, to jewelry and manufacturing. Due to the technology of being able to print raw materials, tools and manufacturing components (i.e. nuts, bolts, rubber, complex parts of machines, and yes even body tissues and organs).

Currently the only ETF on the market with this type of exposure is the 3D-Printing ETF (PRNT). Although it may be too early to judge performance as inception was late 2016, the fund had a strong 2017 return of 15.96%. Investors should be aware that the fund’s small-to-medium-cap tilt means high volatility. Its AUM at $51 million is a bit low, but understandable for a relatively newer fund and volume can be low so an investor needs to be cognizant of the risks here. The MER at 0.66% is considered average. It is designed to track the Total 3D-Printing Index, which tracks companies in the 3D-printing industry. The companies found in PRNT are industry leaders like Stratasys Ltd, 3D Systems Corp, Ex One and HP. The top 10 companies in PRNT give investors good diversification in the 3D-printing industry. For example, Organovo is a medical research company which designs and develops functional, three-dimensional human tissues and Prodways provides 3D printing solutions such as printing machinery for industrial, consumer and automotive sectors.

Energy Storage And Smart Grids

Renewable energy is another, but perhaps less attention-grabbing technology of the future and there is little doubt that as innovations continue and costs gradually fall below that of fossil fuels, renewables will continue to occupy a larger share of energy consumption in the future. However, one of the concerns investors have investing with the clean energy industry is that many forms of clean energy are facing regulatory and adoption hurdles. Another concern is that traditional fossil fuels offer both energy harvesting and a way of storing that energy (such as a gas tank), whereas renewables only provide energy harvesting due to their intermittent nature (solar energy requiring the sun, wind energy requiring wind etc.) This is where energy storage like batteries and smart grids emerge as a way for renewables to be more efficient and competitive than fossil fuels. Energy storage solutions can be made compatible with any type of renewable energy whether it be solar, wind, biofuels, tidal or other forms. These factors make energy storage an integral part of the energy revolution taking place and present a robust way to invest in clean energy.

The first thing that comes to mind when we think about energy storage is electric vehicles (EVs). However, EVs may only be a small portion of the massive changes we could see with the energy sector. Electric cars, of course, get more attention because of all of the hype around them, not to mention Tesla, its stock price and its CEO, of course. However, investors should not underestimate the potential for commercial applications of energy storage. We could argue that EVs that run only on batteries may have more economic barriers (i.e. replacing the standard engine combustion vehicle) than other commercial applications of energy storage such as utilities, home energy storage, and cost savings for companies.

Lithium is the primary mineral used in Li-ion batteries and is mined and refined for a variety of applications including cell phone batteries, nuclear weapons, medical uses and aircrafts. Where we will see its increased use is in lithium batteries for EVs, electronics, home energy storage, utilities and other energy storage applications. Lithium battery costs have had a close to threefold decrease in the past five years from about $400/kWh to $150/kWh.

A great ETF option for exposure to this space is the Global X Lithium & Battery Tech ETF (LIT) listed on the NYSE Arca. The strong point of LIT is that it exposes investors to the various companies involved in the mining, refining and production processes, allowing investors to reap the benefits of synergies that those companies achieve. LIT will also allow investors to benefit from increases in demand of the lithium metal itself, giving investors a unique clean energy and commodity exposure simultaneously. LIT holds 33 companies, however, the top 10 holdings occupy a whopping 80% of the fund, so there is not as much diversification and risk reduction as we would perhaps like to see. Finally, the MER is a little on the high side at 0.75%, so willing do-it-yourself investors may also consider constructing their own portfolio of these top 10 holdings to more or less replicate the performance of this fund.

Batteries are not the only thing that are essential for clean energy efficiency. Grid technology is important for establishing large spanning networks and distribution methods for electrical energy. For investors interested in grid technology, First Trust Nasdaq Clean Edge Smart GRID Infrastructure Index (GRID) is an ETF option. It tracks companies in the electric grid infrastructure sector and gives investors diversified exposure in the space. Only about one quarter of this fund is invested in smart grids, which is a newer technology designed to distribute energy where it is needed in an efficient manner. The rest is invested in traditional electrical grid companies, transmission companies and other non-grid companies. Traditional grid is a more mature industry, so it should provide more stable returns. The transmission industry is another key component to renewable energy efficiency. This fund has been around since late 2009 with a since inception return of 6.97%. Although its AUM at $35 million is low from a liquidity and volatility perspective, it is also understandable given it is a niche ETF. This fund gives good global diversification with about 57% in the U.S. (a vital market) about 38% in Europe and the rest (5%) in Japan. Overall this ETF is worth its relatively high MER of 0.7% mostly for its diversified exposure to the grid space and relatively stable returns for a niche fund.

ETFs provide a great way for investors to venture into the unknown and the new without taking over-concentrated risks. In our fast-paced world, new technologies and investment opportunities arise a lot more frequently than they did in the past. If you told someone ten years ago that a social media company would be one of the largest and arguably most influential companies in the world, they would have called you crazy. Blockchain, AI, 3D-Printing and energy storage are all trendy topics with many risks and uncertainties but ignoring them outright could be just as dangerous to a portfolio. It may be too early for many investors to dip a toe in these sectors but building up familiarity with these world changing technologies can make an investors job that much easier when these emerging spaces start to become more mainstream.

 

Moez Mahrez, CFA , Investment Analyst at 5i Research Inc., Waterloo

 

  1. https://www.netscribes.com/about-us/media/press-releases/global-blockchain-technology-market-worth-usd-13-96-billion-2022/
  2. https://www.gartner.com/doc/3627117/forecast-blockchain-business-value-worldwide
  3. https://www.etf.com/BLOK#fit
  4. https://www.statista.com/statistics/607612/worldwide-artificial-intelligence-for-enterprise-applications/).
  5. http://cdn.aiindex.org/2017-report.pdf
  6. https://www.idc.com/getdoc.jsp?containerId=prUS44194418
  7. http://wohlersassociates.com/2018report.htm
  8. http://www.mckinsey.com/insights/business_technology/disruptive_technologies