Innovation funds are battling against a combination of the absence of an industry-wide definition of innovation and their own reluctance to be typecast as merely investing in financial technology.
There is clearly investor appetite for funds that invest in companies developing solutions to various societal and industrial challenges, even if in some cases this demand is driven by governments rather than investors themselves.
For example, France has emerged as a global leader in encouraging investment in companies with disruptive potential. Mutual funds in innovation (FCPIs) and local investment funds (FIPs) raised €967m in 2016, the fourth year in which the amount raised increased and the highest level recorded since 2008.
In 2016, 114,000 individuals subscribed to FCPIs and FIPs, up from 99,000 in the previous 12 months. The vast majority (87%) of FCPI investments are concentrated on companies in the digital, biotechnology, telecoms and energy transition sectors.
Innovation as an investment theme has not yet been fully defined, however, suggests Christian Magoon, CEO of Amplify Investments.
“Another challenge is how this type of portfolio would fit into an overall asset allocation,” he says.
“Additional factors besides innovation – such as sector or market cap focus, for example – could create implementation challenges including unintended concentration risk in certain securities, industries or sectors.”
The MSCI ACWI is sometimes referred to as a barometer of the performance of innovation funds. Last year it recorded growth of 8.48%, compared with 8.15% for the MSCI World index – the first time it had outperformed the World index since 2012.
Just over 16% of the weighting of the MSCI ACWI is in information technology, with more than 11% in healthcare.
Highly disruptive companies or themes generate volatile returns. Biotech companies for whom each stage of research into a new product is an all-or-nothing game with either high rewards or complete wipeout are an example, as are application developers.
When investors believe in the innovation they tend to make high estimations of future returns and give high valuations to these companies – and when they lose that belief the decline can be equally dramatic.
Fear of being pigeonholed as financial technology investors might explain why so many managers are reluctant to talk about how their funds exploit the new economy or global megatrends.
PLAYING THE LONG GAME
One exception to this is KBC Asset Management, which confirmed earlier this year that it would merge four innovation equity funds into its KBC Equity Fund Trends following a decline in net assets to a point at which it was difficult to manage the individual funds efficiently.
The KBC Equity Fund Trends invests primarily in the shares of companies involved in “the challenges and opportunities that lie ahead in this decade and the decades ahead”.
According to KBC Asset Management, there are a number of long-term innovation themes that only temporarily fall out of favour: online services and e-commerce; media, retailing, consumer and commercial services; energy efficiency and storage (a long-term play, given the cost of the technology relative to conventional energy sources); and the internet of things, which connects devices from smartphones to simple sensors and wearables.
Only a few fintech companies are listed in KBC Equity Fund Trends; a spokesperson notes that many are overvalued and that when markets normalise the objective is to invest more substantially in this sector.
In the wider technology sector cloud computing, e-commerce, artificial intelligence and security are identified as sectors with potential.
In healthcare, while there is an appetite for all disease areas there is particular interest from specialist rather than generalist investors, which is attributed to healthcare pricing pressure and lack of clarity on future policy.
There has also been heightened demand for less mainstream domains such as probiotics, white biotech and animal health.
Innovation ETFs are an alternative means of accessing megatrends, although to-date strategic beta or smart beta funds (of which innovation ETFs are a subset) account for a small percentage of assets under management in European ETFs.
Monika Dutt, a passive strategies research analyst at Morningstar suggests that although the bulk of assets currently sit in market-cap weighted products, as European investors become more comfortable with the basic concept of passive investing they can be expected to go beyond market-cap and start adopting more complex solutions.
Last year BlackRock launched a number of innovation ETFs, which follow four investment themes including the ageing population, healthcare innovation, automation and robotics, and digitalisation.
The iShares Automation and Robotics ETF has gathered the most assets with just over $695m.
“As an investment theme, innovation is nothing new,” says Dutt. “But exposure to megatrends was previously only accessible via more expensive actively managed funds.”
As a comparison, the Lombard Odier Golden Age Fund charges 1.87% while the iShares Ageing Population ETF – offering exposure to the same demographics theme – charges 0.4%.
Dutt adds that since fees have such a significant impact on performance it is not surprising that the Ageing Population ETF has outpaced the Golden Age Fund by 4.77% since its inception.
“Innovation ETFs allow investors to capitalise on the same megatrends as before but for a much cheaper price, which should translate into better future performance,” she adds.