Digital Economy is here to stay. Here’s why we have already invested in it.

Since the dawn of time, societies have shared a symbiotic relationship with technology. As their technology improved, so do the societies that progressed alongside the novel innovations. With digital economy becoming a permanent fixture in our society, we believe it deserve a spot in our investment portfolios as well.

iFAST Research Team
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Published on 08 Jun 2020

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Digital economy, a collective of long-term growth trends, is here to stay. E-Commerce and a wide range of e-Services, are underpinned by massive multi-years growth trends that have weaved seamlessly into our daily lives.

Given its promising growth potential, as long-term investors ourselves, we decided to extend the conviction into our investment portfolios. Back last month in April, we have already allocated 10% of our core strategic allocation within MAPS portfolios towards the digital economy.

While there are plenty of options to gain exposure to the digital economy, one ETF resonated most strongly to us: O’Shares Global Internet Giants ETF (NYSE:OGIG).

Over last 10 years, internet stocks have seen a tremendous improvement in corporate fundamentals. Earnings and free cash flow have significantly outstripped other sectors as well as the broader index. The outperformance of fundamentals will likely continue for many years ahead, driven by the several mega trends.

With the world spending ever more time online, digitalisation has become a necessity for countries to remain competitive in this new global backdrop. This necessity grew more pronounced amid the Covid-19 pandemic, where social distancing measures have severely affected the traditional physical-only businesses.

We believe that digital economy is an investment theme that deserve to be in our investors’ portfolios, especially those with longer term investment horizon.

Since the dawn of time, societies have shared a symbiotic relationship with technology. As their technology improved, so do the societies that progressed alongside the novel innovations.

Just like how early 1800s is known now as the first Industrial Revolution, we too are at the precipice of a transition into a new era: the Digital Economy.

Not only has Information Technology (IT) revolutionised the way we interact with one another – to the extent that digital tools are now our preferred mediums of communication – it has evolved into an indispensable part of our lives, ushering a paradigm shift in the way we consume information, entertainment, goods, and services.

As a result, the digital economy of today has become a massive web of interconnected stakeholder and supply chains, spanning across a wide range of product and services easily accessible on the Internet.

Today, a European customer can place an order on the Amazon.com website (US company) for a product made in China, comprised of materials sourced across Asia, with just a few taps on his similarly globally produced smartphone.

The advent of such a digital economy is arguably a natural progression of globalisation, where local economies are integrated into a massive global free-market economy.

Digital economy, a collective of long-term growth trends, is here to stay

While no universally agreed definition, we believe that digital economy is made up of various fast-growing segments: E-Commerce and a wide range of e-Services (such as Travel booking, digital media, Fintech, Digital advertising, Cloud Service and Cybersecurity). They are underpinned by massive multi-years growth trends that have weaved seamlessly into our daily lives.

In fact, the current Covid-19 situation has inadvertently accelerated some of such digital shift, where traditional retailers are forced to go online or risk getting weeded out. In Singapore, wet market vendors – an unlikely group for digitalization in more normal times – have been innovating ways to acquire customers’ orders via live video streams. One doesn’t need to look far to find plenty of examples for such trends.

Collectively, these segments that make up the digital economy are worth approximately USD 9.5 trillion today (Table 1) – that’s approximately 10% of the world’s GDP. If we were to compare it on the standard geographical classification, the digital economy would be the third largest in the world, behind only the economic powers US and China.

Table 1: The eight major segments that make up the digital economy

Segment	Market Size (USD bil)	Share of Digital Economy (%)
Fintech	5,492.3	57.7
e-Commerce	2,027.9	21.3
e-Travel	944.9	9.9
Digital Advertising	331.5	3.5
Cloud Services	213.5	2.2
e-Services	190.0	2.0
Cybersecurity	167.1	1.8
Digital Media	150.0	1.6
Total	9,517.2	100
Source: Statista, iFAST Compilations. Data as of May 2020.

Among them, three trends stood out particularly to us – E-commerce, digital advertising and cybersecurity. Not only do they form the backbone of the digital economy, we believe the momentous growth in these segments will persist in the years ahead.

E-commerce: The buying and selling of goods are shifting online at a rapid pace, displacing the traditional brick and mortar business model, giving rise to a whole new genre by itself: E-commerce. This relatively new industry is no longer novel, but increasingly the mainstream way consumers purchase products.

Digital advertising: As E-Commerce proliferates, marketing efforts are rapidly expanding online as well. With majority of people now glued to their electronic devices all day long, advertisers are creating more innovative ways online to grasp the attention of these prospective customers. Video ads in Youtube videos, banner ads on mobile games and product placements in Instagram posts are among the various tools marketers use to maintain a strong online presence today.

Cybersecurity: With growing amounts of data transmitted through the Internet, there is also an increasing demand for cybersecurity solutions to protect networks, computers and data from unauthorised access. Data breaches are ever more common in the digital space and can be extremely costly for the affected companies.

These are just three of the eight segment which we have detailed in our previous article Invest in the world's fastest-growing Internet companies with this one ETF. With the digital economy still largely in its nascent stage, we expect even more segments to emerge with time.

Digital economy is now part of our core equity allocation in MAPS portfolios

Given the promising growth potential of the digital economy, as long-term investors ourselves, we felt strongly that digital economy is deserving of an allocation in our own MAPS portfolios.

With that in mind, back last month in April, we have already allocated 10% of the equity allocation within MAPS portfolios towards the digital economy, as part of our core strategic allocation. Since Digital economy accounts for approximately 10% of global GDP, a 10% weightage to Digital economy in our MAPS portfolios was chosen to be in-line with our GDP-guided methodology.

This weightage to digital economy will also be adjusted accordingly in the years ahead, especially as the segment continues to account for greater proportion of global GDP.

We believe that such an allocation also displayed our conviction in the robust long-term growth potential of the digital economy, which we are positive will play a major role in contributing to the outperformance of our MAPS portfolios against their respective benchmark.

Chart 1: Digital economy is now part of the core equity allocation in our MAPS portfolios

OGIG – Our ETF of choice for exposure to global Digital economy

While there are plenty of options to gain exposure to the digital economy, one ETF resonated strongly to us. Our ETF of choice for an exposure to the global digital economy is the O’Shares Global Internet Giants ETF (NYSE:OGIG).

OGIG is a US-listed ETF that holds some of the largest and most competitive global Internet companies, all of which derive much of their revenue from the digital economy.

The ETF currently has about 70 holdings in its portfolio, with 65.6% exposure to US companies and 22.6% exposure to Chinese companies. The top holdings in the ETF (Table 2) include the likes of Amazon (NASDAQ:AMZN), Alibaba (NYSE:BABA), Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), Tencent (HKEX:700), and Microsoft (NASDAQ:MSFT).

Table 2: Top holdings in OGIG ETF

Company	Country	Sector	Weight (%)
Amazon.com Inc	US	Consumer Discretionary	5.8
Alphabet Inc	US	Communication Services	5.2
Microsoft Corp	US	Information Technology	4.7
Alibaba Group	China	Consumer Discretionary	4.5
Tencent Holdings	China	Communication Services	4.5
Facebook Inc	US	Communication Services	4.3
Wayfair	US	Consumer Discretionary	2.6
Pinduoduo Inc	China	Consumer Discretionary	2.5
Shopify Inc	Canada	Information Technology	2.4
Meituan	China	Consumer Discretionary	2.2
Top 10 Holdings			38.7
Source: O’Shares ETF Investments, Bloomberg Financials. Data as of 29 May 2020

Chart 2: OGIG has exposure to Internet giants across the world

Technology stocks flourished alongside the digitalisation of global economy

As the global economy become progressively digitalised, companies in the IT and Telecommunication service (Telecom) sectors rose in prominence. These companies, like Microsoft and Facebook, have developed many of the digital goods and services integral in our daily lives.

Just as these essential product and services have provided consumers with much conveniences, they have also enabled the companies to generate vast amount of revenue and profits annually.

Over the past decade, these digital economy stocks (comprising largely of IT stocks) have seen a tremendous improvement in their corporate fundamentals. The growing prominence in the three mega trends, discussed above, were pivotal drivers of the accelerating profitability. Cash flow and cash balance also improved for internet stocks over the same period as the rise in earnings translated to greater cash for many of these companies. We see this as both a buffer for tough times and catalyst for future growth through CAPEX.

From a bottom up basis, the largest internet stocks (gauged from OGIG ETF) have demonstrated accelerated profitability of the past 4-5 years. Earnings for these giants have grown exponentially, in line with chart 3 which strongly points to the secular trend taking off.

Looking ahead, we expect the continue outperformance of the internet stocks in terms of profitability and cash flow, and this reinforces our decision for an allocation to the digital economy (Table 3 & 4).

Take the US S&P 500 Index for example, earnings of IT sector have easily outstripped those of other sector. As a result of the strong earnings growth and corporate fundamentals, these tech companies were able to produce stellar performances in the stock prices, similarly outpacing those of other sectors in the S&P 500.

With their earnings growth trend showing no signs of dying out, we can expect asset prices of these tech companies will continue to expand in the years ahead (Chart 4).

Chart 3: Earnings of global tech companies outstrip the broader index

Source: Goldman Sachs Global Investment Research. Data as of Sep 2019

Chart 4: With strong earnings growth and corporate fundamentals, these tech companies had produced stellar performances in the stock prices

Table 3: Top constituents of OGIG ETF have grown in market cap and cash levels…

Companies in the Digital Economy	Size		Cash Balance				Cash Flow
	Market Cap (Bn)		Cash & ST investment (bn)		Cash/ EV		TTM FCF Margin		FCF Yield
	FY 2015	FY 2019	FY 2015	FY 2019	FY 2015	FY 2019	FY 2015	FY 2019	FY 2015	FY 2019
Amazon	316.8	916.2	19.8	55.0	5.0%	3.8%	6.2%	7.7%	2.1%	2.4%
Alphabet	528.0	922.9	73.1	119.7	3.6%	2.3%	22.2%	19.1%	3.1%	3.3%
Microsoft	443.2	1203.1	113.2	133.8	1.9%	1.2%	27.4%	30.4%	5.7%	3.2%
Tencent	185.0	460.6	12.6	26.9	3.7%	4.0%	38.6%	32.4%	3.3%	3.8%
Facebook	296.0	585.3	18.4	54.9	1.8%	3.5%	33.9%	30.0%	2.1%	3.6%
Alibaba Group	201.2	569.0	17.9	51.3	8.8%	9.6%	45.5%	26.5%	3.5%	3.5%
Shopify	2.0	46.1	0.2	2.5	5.9%	1.5%	-0.4%	0.9%	0.0%	0.0%
Wayfair	4.0	8.4	0.4	1.0	9.2%	5.9%	3.2%	-6.5%	1.8%	-7.2%
Total	1976.2	4711.6	255.7	445.0	-	-	-	-	-	-
Source: Bloomberg Financials, iFAST compilations. Data as of May 2020.

Table 4: …Profitability has also broadly risen over recent years for these companies

Companies in the Digital Economy	Profitability								Weight (OGIG ETF)
	ROE		ROIC		TTM EPS		Revenue (Bn)
	FY 2015	FY 2019	FY 2015	FY 2019	FY 2015	FY 2019	FY 2015	FY 2019
Amazon	4.9%	21.9%	7.7%	13.0%	1.3	23.0	107.0	280.5	5.8%
Alphabet	14.1%	18.1%	16.4%	17.2%	23.2	48.4	75.0	161.9	5.2%
Microsoft	25.2%	42.4%	19.7%	24.0%	2.6	4.7	91.2	125.8	4.7%
Tencent	28.8%	24.7%	24.3%	17.6%	0.5	1.4	16.4	54.6	4.5%
Facebook	9.1%	20.0%	15.3%	24.5%	1.3	8.2	17.9	70.7	4.3%
Alibaba Group	39.4%	23.9%	10.9%	10.0%	1.9	6.4	15.9	73.2	4.5%
Shopify	-	-4.9%	-13.5%	-5.0%	-0.3	-1.1	0.2	1.6	2.4%
Wayfair	-28.3%	-120.8%	-29.5%	-84.8%	-0.9	-10.7	2.2	9.1	2.6%
Total	-	-	-	-	-	-	325.8	777.4	33.9%
Source: Bloomberg Financials, iFAST compilations. Data as of May 2020.

Digital economy a major beneficiary of indexation

Digital economy stocks have benefitted immensely from the meteoric rise of passive investing, executed through indexing vehicles such as ETF and indexed equity funds.

The popularity of passive investing embodied by the trend of indexation sees growing number of investors buying increasing amounts of stocks already on the rise. This means whether a stock is in an index and/or in an industry that is popular is significant, and digital economy stocks tick all these checkboxes.

With the FAANGS leading the train, the increased buying (exacerbated by passive investing) has ballooned their market capitalization as a result. This then reinforces more buying as proportionately more passive fund flows into these stocks, extending their ‘winning streak’ (Chart 5).

Regardless of the debate between active versus passive investing, we expect the latter to gain strength looking ahead. The surge in retail investors flows through vehicles such as ETFs during the Covid crisis is microcosm of the grander picture. One where passive investing is synonymous with low-cost, simplicity and ease of access (i.e. apps that have gamified investing).

In the future, it is hard to see the digital economy theme losing its place. The constituent companies may fall from grace but the industry itself remains very central for reasons discussed in above sections. Thus, digital economy stocks will likely remain a major beneficiary of indexing, backed by the roaring trend of passive investing.

Chart 5: Net asset of ETF have skyrocketed over the last 10 years

Gone with the old, in with the new

The global market has evolved unceasingly across history. One might remember the old economy stocks - Ford, 3M, Procter & Gamble and Caterpillar – which dominated the S&P 500 in the late 1990’s. These companies were soon replaced by Microsoft, GE, Cisco, Intel and Walmart, the top five largest companies in 2000.

Fast forward 20 years, we are seeing a ‘new economy’ take form, the digital economy. Digital economy stocks have skyrocketed since 2008’s GFC largely as a function of fundamental strength, growth potential and indexation, as discussed above.

The result is an overwhelming presence of the internet sector in global indices (i.e. US, China, EMs). None better to reflect this paradigm shift to a new economy than the S&P 500, as Microsoft, Alphabet, Apple, Amazon and Facebook (five largest companies) comprised more than 21% of the entire index. (Chart 6)

While the digital economy companies have grown at break-neck speed in recent years, we believe its growth is still in its infancy with innumerate emerging economies yet to come close to the rate of adoption displayed in developed markets. Hence, as we look ahead, it is reasonable to assume greater representation of digital economy stocks in global indices.

Also, this bifurcation of tech and the other sectors, in terms of performance and representation, will continue as the digital economy expands. And as this narrative plays out, the internet companies should extend its lead within the tech sector.

Chart 6: Info Tech’s composition of risen significantly in recent years

Source: Goldman Sachs Global Investment Research. Data as of April 2020.

Chart 7: Internet stocks (incl Tech and Con disc) make up the lion share of profit in S&P 500

Digital economy deserves a space in investors’ portfolios

With the world spending ever more time online, digitalisation has become a necessity for countries to remain competitive in this new global backdrop. This necessity grew more pronounced amid the Covid-19 pandemic, where social distancing measures have severely affected the traditional physical-only businesses.

On the other hand, business rivals with an established online presence within the same industries had been more resilient in sales. For many IT and Telecom companies, business has never been better.

As the Covid-19 crisis is shaping up to be a watershed moment for companies worldwide, we expect more companies and industries will focus their efforts in establishing online presence, thereby accelerating the growth of the digital economy.

Over the long run, digital economy is here to stay. We believe that as industries transform and new business models get innovated, there will be more emerging segments, which subsequently formed essential components within the digital economy.

In a nutshell, we believe that digital economy is an investment theme that deserve to be in our investors’ portfolios, especially those with longer term investment horizon. As part of our conviction, we have already dedicated a portion of our MAPS portfolios towards the digital economy.

With the digital economy slated to accelerate in growth ahead, so will the performances of the investment portfolios that held stocks of companies that benefit from this secular trend.

For investors who wish to incorporate some exposure to the digital economy in their portfolios, just as we did, should definitely consider the O’Shares Global Internet Giants ETF (NYSE:OGIG).

The Research Team is part of iFAST Financial Pte Ltd.

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Digital Economy is here to stay. Here’s why we have already invested in it.

iFAST Research Team

Published on 08 Jun 2020

Digital economy, a collective of long-term growth trends, is here to stay

Table 1: The eight major segments that make up the digital economy

Digital economy is now part of our core equity allocation in MAPS portfolios

Chart 1: Digital economy is now part of the core equity allocation in our MAPS portfolios