Investors must recognise disruption risks

Not all recent UK company results have made pleasant reading for shareholders. Some highly regarded retailers – such as Next and Kingfisher – have disappointed, and not just because of the recognised headwinds of Brexit and currency. Something bigger seems to be happening. Across the whole of Europe, the retail sector has lagged the main share indices. And in the US, retail malls are noticeably quieter. The internet is rapidly eating into brick-and-mortar sales. But retail may not be the only sector being disrupted. What are the risks to investors?

The warning signs for the retail sector have been in the online growth of Amazon and Alibaba, with record sales in last November’s Black Friday and Singles Day. UK High Street activity is shrinking, with speciality shops and restaurants that depend on footfall also seeing weakness in retail parks and shopping centres. Many units in these locations depend on the major branded retailers to attract customers, and everyone loses when shopper numbers fall. The only stores that appear to be coping with this onslaught are businesses such as John Lewis that have a strong online offering.

The process of shrinking-down the retail estate could be a challenge spanning many years, with a high cost to exit units that are trading poorly. And, technological development will compound these pressures. New services such as Google Home and Amazon Dash simplify direct ordering of home supplies on an “as needed” basis. The intelligence brought in to homes and everyday objects – the Internet of Things – will see even more products circumvent bricks and mortar retailers. And the growth of mobile services on our streets – such as Deliveroo, Just Eat and Uber – should make us think how that impacts other investments.

Other sectors are being disrupted, too. For banks, branch closures are just one tangible sign of a change in customer demand. Many customers are now comfortable with handling their bank accounts entirely online, needing only ATMs on the high street. New challengers are using big data to catch up quickly with traditional banks in understanding all the nuances of consumer credit risk. Decades of experience in judging lending risks are quickly giving way to direct lending methods that target niches of profitable customers, using technology to monitor changes to risk. Credit scoring used by traditional banks has evolved little in recent years, but new entrants have found surprising indicators. For example, measures of social media influence can be effective in assessing lending risk.

Financial technology such as blockchain, best known as the infrastructure behind Bitcoin – could accelerate demonetisation and bring in competitors that are currently not even in the finance sector. The potential to use new data analysis could also disrupt insurance. Phones are not just a way of attracting customers and servicing them, but can also gather useful data on lifestyle, preferences and risks.

While western investors are focused on the disruption potential of Facebook, Amazon, Neflix and Google, in Asia there are bigger threats. Alibaba and Tencent Holdings have already moved into digital banking, scooping up financial customers with astonishing ease. Alibaba’s finance business is now worth $60bn, and has 450m active users. Once customer trust is gained, it may prove easy to move from e-commerce into consumer loans and online payments.

A combination of widening broadband availability with higher capacity, cloud and mobile computing, big data and wise use of smartphones will hit many industries. Many of the new entrants are using unconventional streams of data and applying innovative business models.

Investors should consider the risks this creates for blue-chip investments. The gaps in the high street, such as HMV and Blockbuster, are testimony to this. Annual reports should be examined closely for information on how companies are dealing with these challenges. And portfolios might also include some investments or funds that will be part of the new business landscape.

Disclosure: The opinions expressed in this article are my own, and may not represent the views of any firm or entity with which I am affiliated. The information presented in this article has been obtained from sources believed to be reliable, however, I make no representation as to their accuracy or completeness and accepts no liability for loss arising from the use of the material. Articles and information do not represent investment advice. I am a manager of actively invested equity funds. At the time of publication, clients of my employer held long and short positions in bank stocks. A client fund of my employer holds a position in Alphabet (Google).

Image credit: Some rights reserved.

A version of this article was published in The Herald on March15 2017

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