By Christopher Dhanraj
- Investors should consider allocating to longer-term tech and healthcare exposures specifically focusing on forward-looking megatrend areas of innovation versus traditional sector approaches.
- We believe that the current COVID-19 pandemic has the potential to accelerate tech and health megatrends, driving growth in exponential technologies from networks, cybersecurity and AI to genomics and immunology.
- In our view megatrends can offer long-term investors a potential opportunity to realize outsized performance results. We see tech and healthcare innovation at the forefront of future growth and believe investors should consider long-term allocations to related megatrends, which take a view on the powerful, long-term economic and societal changes that are shaping our world.
COVID-19 uncertainty accelerates megatrends in healthcare and technology
Concerns surrounding the near-term economic impact of the COVID-19 pandemic have created a sense of uncertainty among investors looking to allocate capital. As a result, we believe investors should consider allocating exposure to longer-term megatrends — the structural shifts behind some of the key forces transforming our world.
A look inside the S&P 500’s traditional sector weighting allocations shows that the two areas with the largest market caps are information technology and healthcare — with these two sectors alone comprising 41% of the broader index. Investors holding core S&P 500 holdings already have a significant allocation in these two sectors. However, for those interested in exposure to tech and healthcare innovation, we think investment vehicles focused on these megatrends offer a potential alternative versus traditional sector benchmarks.
Specifically, the COVID-19 pandemic is accelerating the focus on longer-term innovations in technology and healthcare. As companies navigate the new work-from-home reality, cloud computing and cybersecurity have become a critical part of corporate infrastructure — with companies who are unable to deliver a robust experience to their employees and clients at risk. With respect to healthcare, attempts to find a cure or improved treatments are bringing renewed attention on some of the latest breakthroughs in genomics and immunology. Importantly, innovations that come about from the immediate pandemic crisis are not temporary; we believe investors should consider shifting their perspective to recognize the long-term impacts of themes playing out today.
Potential megatrend tech growth drivers: Helping the world stay connected in the new (ab)normal
As investors look to access technology exposure within their equity allocation, it is important to look for areas that will benefit from high growth and secular behavior changes. Remote working is likely to be a new normal and a heightened consideration in future corporate spending. According to Gartner, 74% of CFOs envision more of their workforce at home after COVID-19. Furthermore, the demands for cybersecurity are increasing as 84% of U.S. risk executives say their firms are underprepared for cyber-risks. This becomes even more critical as increasing amounts of remote work, remote learning, and remote entertainment and the like make cybersecurity even more paramount.
Potential megatrend health growth drivers: genomics and immunology
In less than ten years, the U.S. will have more people over 65 than under 18. To address this demographic shift, the U.S. government is spending more on healthcare than ever. Based on the Congressional Budget office (CBO), major federal health spending levels are set to rise dramatically from 5.4% of GDP in 2017 to 6.8% in 2028 to 8.4% by 2040. Corporations are also seizing the opportunity to devote Research and Development (R&D) resources to areas such as genomics and immunology. Indeed, the Brookings Institute estimated global Pharmaceutical R&D spending of $156.7bn as of 2016.
As with technology, COVID-19 has increased investor attention in next generation healthcare treatments. For immunology, progress is being made on employing the body’s own defenses with antibody treatments to battle incoming attacks rather than previous approaches such as blood transfusions. For disease treatment, genomic breakthroughs are allowing scientists to decode the disease and develop genomic-driven RNA vaccines that are radically advanced versus traditional vaccines (e.g., the type used for flu).
AI: cutting across both tech and healthcare
Artificial intelligence (AI) is another area of strong potential growth. Before today’s crisis, only 15% of firms had deployed AI. Research by Accenture suggests that AI could double annual economic growth rates by 2035 in developed economies by changing the nature of work while the impact of AI technologies on business is projected to boost labor productivity by up to 40 percent. COVID-19 is also spurring the adoption of AI tools, with medical professionals using it to project COVID-19’s course, enabling contact-tracing apps and the potential for medical breakthroughs.
Traditional sectors: Too blunt an instrument to capture megatrend opportunities
Implementation is a key consideration for investors looking to allocate to megatrend tech and healthcare exposures that may drive the growth of tomorrow. Adopting a traditional tech or healthcare sector approach may have limitations, which are important for investors to understand. Indeed, we see three potential pitfalls of traditional technology and healthcare classifications:
- Too broad… Traditional GICS technology sectors have a wide range of exposures that may not contain the innovation areas that investors are seeking. For example, S&P Select Technology holds 21% in old-line computer hardware and 9% in credit cards while S&P Select Health care holds 11% in HMOs and 6% across pharmacies, generics and wholesale drugs.
- …yet too narrow. New innovation is happening across multiple sectors and geographies. Yet traditional indices may not capture the full breadth of advancements underway. For example, the S&P 500 Select Technology and Health care Indexes are predominantly focused on exposure to U.S.-only firms. However, the megatrend indexes surrounding both tech and healthcare are geographically diversified and/or cross sector.
- …and highly concentrated. Traditional tech and healthcare sectors contain many of the large-cap exposures that are popular concentrated holdings for many investors. In particular, the top three names in the S&P 500 Select IT Index represent 47% of total holdings and in S&P 500 Select Health Care Index the top 3 names represent 23% of total holdings.
Source: State Street as of May 11, 2020. Allocations are subject to change.
In contrast, megatrend tech and healthcare indexes seek to target innovation, with exposure across geographies, sectors and market caps, beyond large-caps. As an example, Morningstar’s Exponential Tech Index features companies targeting potential next-generation growth areas such as driverless cars and artificial intelligence, has international exposure of 41%, cuts across eight sectors and includes large, mid and small-cap names. As investors consider how to differentiate their technology and health exposures within their portfolios we believe it is important to consider where innovation and growth will come from as these could drive outperformance.
Year-to-date the NYSE Factset Global Cyber Security Index and the NYSE FactSet Global Genomics and Immunology Biopharma Index have both outperformed the S&P Technology Select Sector Total Return Index, the S&P Health Care Select Total Return Index, the S&P 500 Index, and the MSCI ACWI Index.
Source: Bloomberg as of May 13, 2020; Indexes reflected in order: NYSE Factset Global Cyber Security Index, S&P Technology Select Sector Total Return Index, NYSE FactSet Global Genomics and Immunology Biopharma Index, S&P Health Care Select Total Return Index, S&P 500 Index, MSCI ACWI Index . Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Technology and healthcare are currently the two largest sectors by market cap within the S&P 500; in other words, investors may already have significant exposure to them in their core U.S. equity holdings. Investors seeking access to potential growth opportunities presented by innovations in the tech and healthcare fields may want to consider megatrend vehicles. They are focused on the firms driving future innovation and subsequent growth, rather than what drove growth in the past. More specifically, megatrends indexes, through their constituents, seek to capture growth drivers across sectors, regions and market caps. The current COVID-19 pandemic certainly highlights the importance of innovation such as cybersecurity, cloud computing, AI, genomics and immunology. Nonetheless, even after the current health crisis has passed, we believe tech and health megatrends should still be long-term positions in portfolios.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.