How to invest in disruption: 3 trends you can invest in, and 3 you can’t | Alex Pollak writes in Smart Investor

First published in BRW and Smart Investor by Loftus Peak’s CEO Alex Pollak.  Australian investors, especially self managed super funds, should consider diversifying their portfolios to include blue chip global disrupters like Alibaba and Apple. 

With the Chinese government all but decreeing his success, Jack Ma’s Alibaba group makes for a good ‘disruption’ investment.

The trouble with investing in disruption is that it’s not just about the business model, but the pricing risk. What this means is that investors shouldn’t just look at the change to the way industries operate, but focus also on the price – lots of stuff works, but is hard to make money on. Will the real winner of the electric car space be Volkswagen AG, which is priced at less than one times sales, or Tesla, at 14x. With this in mind, here is the “Things you can do, and things you probably shouldn’t” investment list.

THE ‘CANS’

1. MOBILE IN CHINA – BAIDU, ALIBABA AND TENCENT

Baidu, Alibaba and Tencent (colloquially known as BAT) provide mobile commerce, gaming and social media to the burgeoning Chinese middle class. This is a lock because the Chinese government has more or less decreed it, meaning it has checked the progress in China of Google, Facebook and Amazon, for which BAT are analogues, so that China can grow its own versions. The effect of this is that the BAT triumvirate will continue to grow quite strongly, with each selloff providing a base for investors to reload. I highly doubt it will all come unstuck any time soon – the Chinese politburo is keen, even desperate, to have a place in the new world order and these companies are its best shot.

2. THE ENTERPRISE MARKET (players include SAP, Microsoft, Amazon through its cloud business, Google, Apple, IBM, Amazon Google).

This one is interesting, because the cloud is disrupting the disrupters. But the issue is that the enterprise market (meaning pretty much every business) will ultimately move to a cloud-based architecture because it’s cheaper to have your data storage managed by experts rather than on-site through your IT department. Unsurprisingly, Microsoft is fielding its Azure product in this mix, IBM has just bought SoftLayer, Amazon has Amazon Worldwide Services. The point is that because the market is so large, there is room for many of these players. Further, big companies (like banks and airlines) are not going to take risks with small or even medium-sized ones in mission-critical infrastructure, meaning that businesses like Salesforce etc have much to guard against.

3. BANKING PRODUCTS

Tricky, this. Going long bank disrupters should not be interpreted as “Sell your banks today.” Let’s be clear – the Aussie banks (which may be overvalued) are still massive cash cows with a regulated oligopoly, but they still care about PayPal, since it chops Visa and Mastercard out of the picture and they make serious money from these products. But just because the banks are not immediately under threat doesn’t mean you can’t make money out of disrupters like PayPal or some of the as-yet-unlisted micro-finance players that doing the rounds. It could be that many of these alternative banking products have serious upside for investors (like Paypal, owned by eBay).

And don’t forget that another way to play it is through the big guys. For example, Apple stock is climbing in part because it will likely debut its iPhone 6 with a fingerprint-enabled payment mechanism. Google has a different version of the same thing through Google Glass – ie, you are looking at those sneakers, which are being scanned through the Google Glasses on your nose. Say the word and Google Glass will do the transaction (through the Android phone).

Just one further point re the payments space and start-ups – exercise care. While Lending Club in the US is about to be listed, and Zopa in the UK is going well with 500,000 customers, Quakle in the US closed down in 2011 with a 100 per cent default rate.

THOSE YOU PROBABLY SHOULDN’T

1. SOCIAL NETWORKS

Everybody uses them. That doesn’t mean they are great investments. I haven’t found anyone who said it as neatly as Ethan Zuckerman, the inventor of the pop-up ad, so I won’t try to paraphrase. “As a rule, the ads that are worth the most money are those that appear when you’re ready to make a purchase – the ads that appear on Google when you’re searching for a new car or for someone to repair your roof can be sold for dollars per click because advertisers know you’re already interested in the services they are offering and that you’re likely to make an expensive purchase. But most online advertising doesn’t follow your interest; it competes for your attention. It’s a barrier you have to overcome (minimising windows, clicking it out of the way, ignoring it) to get to the article or interaction you want. Targeting to intent (as Google’s search ads do) works well, while targeting to demographics, psychographics or stated interests (as Facebook does) works marginally better than not targeting at all.” Zuckerman is also a director of the MIT Centre for Civic Media.

The bottom line on this is that 10 years after inception, Facebook revenue is still just one fifth of Google, but it has half the capitalisation ($US194 billion – $207 billion – versus $US400 billion). And Facebook is an important benchmark in valuation for other social media companies, like Twitter.

2. START-UPS

This is controversial. It is still possible to make a lot of money in start-ups – almost more than you could ever make in any listed security. But there are a few conditions that the average self-managed super fund investor would need to take into consideration. First is liquidity – owning a start-up in your super fund could be a great idea, but the nature of start-ups is: money in . . . wait . . . wait . . . money out (maybe). Trying to get money out any time in the gestation process is likely to be very difficult – the investor would have to arrange a buyer through their own connections. This could be a problem if you are paying pensions out of your super fund. The second point is: how likely is it that you are being offered an opportunity that the big guys have missed. Meaning that many of the big private investors have comprehensive networks involved in funnelling the best start-ups to them, so it is unlikely that anything half-decent will get missed.

3. RESOURCES PLAYS FOR RARE EARTHS, BATTERY MANUFACTURERS ETC

Many of these have already had a massive run, for example in graphite (Lamboo) and lithium (Orocobre) so a lot of blue sky is already priced in. To put it in context, let’s talk about lithium, one of the key components in the lithium-ion battery that powers almost all small devices. There is a lake of the stuff in Bolivia, in vast salt flats one of which is called the Salar de Uyuni. Bolivians have begun to speak of their country becoming “the Saudi Arabia of lithium”. It is also one of the poorest places on earth. Governments, local tribes and a host of middlemen including financiers all take their cut along the way, making it very hard for investors. Still it can happen – but it’s a little high on our risk curve.

However, overall, there is cause to be very bullish on the whole solar/electric vehicle/battery technology story. The issue is the pricing all around – investors have to make decisions about Tesla, Volkswagen, BYD (in China) to name just a few.

Well, that’s the list. Clearly, there will be some winners or losers that come out of left field, and that’s fine. But for most investors in disruption, it’s ultimately a matter of the risk profile that must be one of the key determinants of buying or selling.

First published in BRW and Smart Investor by Loftus Peak’s CEO Alex Pollak.  Australian investors, especially self managed super funds, should consider diversifying their portfolios to include blue chip global disrupters like Alibaba and Apple.