1

Series 1.3: DIGITAL REVOLUTION: LIKE THE INDUSTRIAL REVOLUTION, CREATING INTER-GENERATIONAL WEALTH

Over the past few weeks, as part of our Thought Leadership series, we introduced three investment elements that we believe are essential for smart investment strategies and portfolios. Last week, we covered why we believe the inevitable end to QE and rise of populist Trump-economics means inflation risk is coming back, (http://crossinvest.com.sg/crossinvest-crossinvest-thought-leadership-series/), and therefore why we believe investments in real assets should be an essential element of an investment portfolio; This week, we introduce the final two essential elements of Smart investment portfolios:

1. Digital revolution: Like the Industrial

Revolution, creating inter-generational wealth

and why investors should not miss out on this;

2. High conviction investing, a must as

equity prices remain high despite weak

economic outlook.

“Favour substance over form. It doesn’t matter if an investment is public or private, fractional or full ownership, or in debt, preferred shares, or common equity”.

Warren Buffett, 2009

“It’s obvious to me that we live in a transformational time, where emerging technologies are creating new business models and

destroying old ones” Nick Grace, Capital Group, 2016

The first two industrial revolutions inflicted considerable pain and destabilisation erasing

whole industries. The power boom in the late 18th century and then Edison’s electric light

and Benz’s horseless vehicles in the 1800s, led to significant job losses. These though

ultimately benefited everyone.

CrossInvest Asia

UNCONVENTIONAL THINKING: three essential elements

of smart portfolios in the new world economy

DIGITAL REVOLUTION & HIGH EQUITY

PRICES, AND WHY HIGH ALLOCATION

TO CONVICTION EQUITIES AND

NON-LISTED ASSETS MAKE SENSE

2

The current revolution, the digital revolution, however could be far more divisive due to

the “unpresidented” (author’s note: could not help myself) pace at which the change is

evolving.

This is, and will, create significant risks not only for investors but many livelihoods.

This is, and will, create many livelihoods as well as provide opportunities for many astute

investors.

The digital revolution is likely to create more economic change than ever before as its impact on every aspect of society, not just the working economy, is far more omnipresent. Between 1988 and 2003, computers became 43,000,000 times more effective through smaller processors and algorithms. Problems once deemed impossible, are now held in the palm of our hands. Recently, one of

Google’s AI innovations, AlphaGo, beat South Korea's Lee Se-dol, in a complex Chinese

game called Go – a feat that had not been expected to be achieved for a very long time.

The pace of change is undeniable – but the key is to understand the remarkable pace of

change, and more importantly understanding the likely impacts of this accelerated change,

and then having a strategic plan of action. For the investment world for example, it is

important to understand how companies can be very quickly disrupted, their share prices

decimated and shareholder value eroded – this is already too fast for many investors to

have time to react. The figure below shows the companies that have over the recent years

joined the S&P500 index and the ones that have exited.

FIGURE 1: PACE OF CHANGE IN THE COMPOSITION OF THE S&P500 ACCELERATES EVERY YEAR

The pace at which these companies have entered the index means there has already been a

significant growth in value while they remained unlisted. Back in the first technology

investment boom in 1998/99, companies were listing at an average age of four years. Today

the average is 11 years. Of the technology IPOs completed since 2002, 91% of the shareholder

wealth created was pre-IPO, despite the better than market returns made by these

companies post-IPO. Those that waited for the IPO simply missed out, as shown in the Figure

below.

3

FIGURE 2: VAST MAJORITY OF RETURNS ARE MADE PRIOR TO IPO NOW

RETURNS FROM THE MAJOR DISRUPTING COMPANIES OF THE PAST 20 YEARS: PRE AND POST-IPO

COMPANY

(LISTING DATE)

SERIES A TO C (RETURN %PA)

SERIES C TO IPO (RETURN %PA)

IPO TO NOW (RETURN %PA)

Amazon - 1997

15%pa

(14x in 11mths)

n/a

(series A only)

21%pa

(34x in 18 yrs)

Google - 2004

212%pa

(378x in 5yrs)

n/a

(series A only)

21%pa

(8.4x in 11 yrs)

Facebook - 2012

472%pa

(8.9x in 15mths)

132%pa

(198x in 6yrs)

31%pa

(2.4x in 3.5 yrs)

Twitter (2013)

273%pa

(8.1x in 19mths)

136%pa

(36x in 4.5yrs)

1.7%pa

(1.03x in 1.8 yrs)

Alibaba (2014)

115%pa

(23x in 4yrs)

19%pa

(6.8x in 11yrs)

-7.7%pa

(-8% in 12 mths)

Who would have believed five years ago that today, Google and Apple would have a target to

become the world’s largest automotive company? Or that the taxi and car rental industries

could be so disrupted so quickly by the new “sharing economy”? While still a long way to go,

this is now a very real possibility and a threat to some of the world’s oldest companies. And

in response, these companies are investing in disrupters as witnessed in January 2016 when

GM invested $500 million into car ride sharing upstart, Lyft. GM is hoping to offset some of

the risk of disruption with this exposure to an unlisted disrupter.

The implications for today’s global corporates and therefore, for the investors, are

impossible to estimate. The portfolio manager of 1950, 1980 or even 2000 didn’t have to deal

with such risk management and allocation complexities.

But today’s portfolio manager, more than ever, does. And this is likely to get more and more

complex as the pace of change accelerates.

We have seen what disruption has done to the likes of Kodak, Borders or Blockbuster Videos –

these were specific industry innovations. What we may witness this time around is how the

digital revolution could impact every industry indiscriminately: financial services, logistics,

tourism, media and many more.

Companies facing disruption have two options for survival: compete and therefore lower

margins by either investing in technology or fighting on price; or buy the disrupter. Either

approach has more chance of lowering earnings per share than increasing them.

4

Investors have three choices:

Actively avoid industries that could be disrupted, or, actively invest in the disrupters, or

invest in the index and ignore the digital economy’s impact.

The first and third are increasingly difficult - it is already estimated that 47% of US industry

is at “severe risk” of disruption. That leaves investors with one practical option: invest in

the disrupters. Most of the disruptors are unlisted and access can be complex and somewhat

tricky.

Yale Endowment, widely recognised as the most successful portfolio manager of the past 20

years, has increased private shares exposure from 8% in 1985 (ie 92% of equities were listed);

50/50 by 2000, to 63% unlisted (just 37% listed) by 2016.

FIGURE 3: YALE ENDOWMENT FUND

ASSET ALLOCATION 1985-2016

For investors, the implication of a slower world economy over such an extended time

period combined with the digital technology revolution is that portfolio construction and

allocation to equities needs to be reconsidered. There is an increasing trend amongst the

leading US and European institutional investors to slowly reduce their exposure to listed

markets and increasing their unlisted equities exposure just in the same way as Yale

Endowment Fund above.

Both listed and unlisted equities are exposures to the ownership of the private sector of an

economy; both are valued according to expected future earnings potential; and both are

subject to the vagaries of the market’s risk appetite from time to time.

CONCLUSION:

- The digital revolution is upon us and is changing and accelerating at an unprecedented

pace leading to significant change, challenges and opportunities;

- The pace of change is leading to significant disruption – the number of new companies in

the S&P500 index (and the number of companies that exit every year) is telling;

5

96.0

98.0

100.0

102.0

104.0

106.0

108.0

80.0

90.0

100.0

110.0

120.0

130.0

140.0

20

03

-12

-01

20

04

-06

-01

20

04

-12

-01

20

05

-06

-01

20

05

-12

-01

20

06

-06

-01

20

06

-12

-01

20

07

-06

-01

20

07

-12

-01

20

08

-06

-01

20

08

-12

-01

20

09

-06

-01

20

09

-12

-01

20

10

-06

-01

20

10

-12

-01

20

11

-06

-01

20

11

-12

-01

20

12

-06

-01

20

12

-12

-01

20

13

-06

-01

20

13

-12

-01

20

14

-06

-01

20

14

-12

-01

20

15

-06

-01

Ch

ina

Exp

ort

Pri

ces

US

Exp

ort

Pri

ces

US Export Prices China Export Prices

- The key is to understand the remarkable pace of change, and more importantly

understanding the likely impacts of this accelerated change and having a strategic plan

of action;

- Significant wealth is still being created although 90 percent of the wealth is being

created before a company is listed;

- There are significant opportunities as a result of this digital revolution – an allocation to

unlisted assets is a critical element of any investors’ portfolio;

- but this needs proper investment guidance and advice.

Below, we cover the third most essential element of smart portfolios - criticality of high

conviction investing.

SERIES 1.4 HIGH CONVICTION IS A MUST AS EQUITIES PRICES REMAIN HIGH DESPITE WEAK ECONOMIC OUTLOOK World economies have fallen into a trap with some concerning parallels to Japan’s lost

decades. This gloomy opening sentence does not mean however that investors’ are best

placed to lock their money away in cash (in fact that is probably the riskiest plan of all) -

it actually means that investors have more opportunities to create wealth from what will

invariably emerge as a massive shift in economic prosperity across the world.

The global central banks’ response to the GFC was to flood the world with cheap credit in

the form of low interest rates, Quantitative Easing (QE) and easier lending standards. This

was supposed to restart economic growth, but instead has created a toxic mix of excess

industrial capacity, unsustainably high financial asset prices and record levels of debt,

replicating the Japanese economy from the 1990s.

While excess capacity is keeping inflation low, it is also keeping employment down as

demand for new investment is now even lower than in 2009 while demand for goods hasn’t

recovered to pre-GFC levels.

FIGURE 1: EXCESS CAPACITY IN THE US AND CHINA IS CREATING DEFLATIONARY PRESSURE

US and China Export Prices, 2003-2015

6

Employment is the backbone of any economy. High employment means more money spent

on goods and services in the economy leading to higher GDP growth, higher corporate

earnings, share-markets, property markets and so on. This would all be good if

employment remained high. We are seeing a global employment recession unfortunately

especially amongst the youth and in manufacturing.

The demand for labour is down, covered up by the misleading “unemployment” statistical

measure. The average person in the labour force is now working around 2% lesser hours

than pre-GFC. While that might sound immaterial, it is the equivalent of everyone in the

labour force working the same hours but unemployment being 2% higher across the world

than currently reporting. The impact on the global economy is the same.

Even the US, despite its relative health, has seen long-term unemployment jump from 11%

to 18% since 2007

In Europe, long-term unemployment is now 50% (50% of unemployed have been out of work

for more than 12 months).

Similarly youth unemployment across Europe is a dangerously high 21%, and much higher in

Italy and Spain. And even for those with jobs, underemployment (workers not able to find

as many hours as they need) is also at record levels.

So stimulus has at best been selectively successful - it has boosted investment to create

jobs in the short term and arguably pulled the US economy out of its worst recession since

the 1930s, but it created excess capacity and a more permanent and troubling employment

issue for future years to face.

7

Unprecedented levels of debt, increasing risk and reducing future

stimulus options

Worse still, not only was the stimulus relatively ineffective, it left global balance sheets

with unprecedented levels of debt. The US, Europe and Japan added US$21 trillion to their

federal liabilities since 2007. During that time, household, banking and business sectors

reduced debt, but only by around US$3 trillion.

China’s government debt officially only rose by US$2 trillion, but their total debt to GDP

ratio jumped from 120% to 250%, a total of $7 trillion, between 2007 and 2016. China

accounted for 55% of the world’s household debt increase, 65% of the world’s total banking

sector increase, and 64% for the corporate sector. As shown below, this means that 35% of

total new credit globally in the past 9 years has been to Chinese borrowers, compared to

their 15% share of world GDP.

FIGURE 2: CHINA RESPONSIBLE FOR $1 IN EVERY $3 OF NEW DEBT GLOBALLY

Increase in debt between 2007 and 2014, by country and sector

Credit rating agency Fitch estimated that China pumped around US$3 trillion a year into its

economy in the past 3 years, much of it via state-owned enterprises and local government

borrowing. Then in 2016 as private sector investment growth slumped to zero, the

government stepped in and funded a further US$0.9 trillion in public sector fixed asset

investment.

This combination of low employment and high government and private sector indebtedness

means that government and corporate balance sheets are now too stretched to provide

further stimulus should it be needed. But without further stimulus of sorts, excess capacity

will mean employment remains weak, and economic growth could be stuck in a pattern of

low economic growth for years to come.

8

Conclusion is undeniable: The future belongs to high conviction investors

One could take a position from the above forecasts of economic mediocrity that the best

place to put their money is in property and other real assets. And for some more

conservative investors, that is probably true. But for those looking to continue to grow

their wealth rather than purely defend it, there are some niches of the global economy

that will create significant wealth in the coming years. These periods of inflection in the

global economy have created history’s most wealthy family dynasties, and this time will be

no different.

The key areas of opportunity are:

1. Digital business models that transform (link)

2. Agricultural assets from AgTech to farmland itself

3. Healthcare, particularly Aged Care solutions to capitalise on the western world’s

baby boomer retirement and then shortly afterwards, China’s retirement bubble

4. Clean energy: now past the point of no return which will mean that oil producers

will not constrain production but instead create a race to produce and sell as much

as they can while oil is still relevant. Clean energy will rise to be the majority of

global energy production shortly after the launch of electric cars, and oil’s demise

will come shortly thereafter with the combined hit from autonomous vehicles and

the sudden drop in passenger vehicle demand globally.

5. Chinese exporters (excluding the overleveraged over capacity steel and coal

sectors). Years of a shift to globalisation have at the very least slowed

dramatically, but there is a significant risk of a reversal of many of the trade

agreements struck in recent decades. This isn’t just about Trump; it is also about

the protectionist politics becoming very popular in Europe. Emerging Markets

overall will be the loser from this move, but ironically China could benefit from

these changes. Trump’s plan to kill off the TPP (Trans Pacific Partnership trade

agreement) for example means that China is the largest player in the agreement,

and as such gets to call the shots on issues such as tariffs and IP protection. The US

has enjoyed leadership in every trade agreement since WWII but that might change

now with much of the western world choosing to exit agreements or at least

diminish their role.

We at Crossinvest, take a medium to long term view with respect to investments on

behalf of our family of clients. While 2016 has invariably been a difficult year for many

and is likely seen as the year that largely brought about the new “protectionist” order,

we have adopted and adapted. Our smart portfolios are established for the medium to

long term outlook and designed to withstand multiple shocks and tremors.

2017 will no doubt throw further challenges at multiple levels. We will continue to

focus on ensuring our client portfolios have the right mix of allocation in these three

essential elements of tomorrow’s smart investment portfolios:

1. Non-listed Real assets – infrastructure, agriculture, property and like;

2. Thematic based non-listed assets – PE, trade finance and like, and

3. High conviction traditional assets.

We will continue with our thought leadership series in January.

We wish you all a very happy, joyous and safe season and wish everyone an amazing 2017.

Till then………

9

CROSS-OPINION Every advisor is equal, but some are more equal than others.

You don’t think twice about seeking a HEALTH related second opinion, why then should

your WEALTH not get the same due care?

Crossinvest presents Cross-Opinion, an opportunity to have our team of investment

professionals review your investment portfolio to provide you with a second opinion, at

no obligation or cost.

Allow our expert team of investment professionals to provide you with a second opinion

on your financial health, at no cost and no obligation.

for accredited investors only

OUR REVIEW PROCESS

Once we have consolidated all investment holdings from various sources and classified

them under their respective asset classes, we will review it against underlying portfolio

theories to ensure that the portfolio:

is appropriately diversified;

asset allocation methodologies are appropriate and in line with expected market

movements;

is in line with your investment objectives and your risk appetite, and

management and transaction fees you are paying is reasonable.

FOR MORE INFORMATION CONTACT US AT

http://crossinvest.com.sg/cross-opinion/ OR CALL US ON +65 6220 9339

10

DISCLAIMER

Certain statements contained within the information in this Crossinvest Thought Leadership white paper, may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of Crossinvest (Asia) Pte Ltd, which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. Opinions expressed are present opinions only and are subject to change without further notice. No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. Crossinvest (Asia) Pte Ltd shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information.

11