Pandemics have a way of speeding up change and innovation. We speak to Kunjal Gala at the international business of Federated Hermes about what this means for emerging market equities.
Many people are inherently conservative and resist change, even when all the evidence suggests that there are better ways of doing things. Innovation is, therefore, often slow and has many false starts.
The 16th-century Flemish anatomist Andreas Vesalius, often referred to as the founder of modern human anatomy, is a good case in point. The existing medical knowledge at the time was heavily influenced by the work of Roman physician and surgeon Aelius Galenus.
But when Vesalius discovered that much of Galenus’ work was based on the dissection of animals, rather than humans, he realised that many assumptions about the human body were simply wrong.
Was he celebrated for his efforts? No, Vesalius was sentenced to death for dissecting human bodies, and although the sentence was thought to have been commuted later on, he died alone and destitute on the island of Zakynthos, in the Ionian Sea.
It took centuries before the insights of Vesalius, who is also the first person to describe mechanical ventilation, were fully appreciated.
Change and Innovation
Yet, pandemics have a way of speeding up change. Yes, they are a great source of stress and despair when you are in the midst of it, but history has also shown that they are often a period that challenges existing ideas and form a catalyst for lasting change and innovation.
During pandemics, people are more likely to question the status quo, shift mindsets and, thereby, often speeding up technological innovation.
Kunjal Gala, co-portfolio manager part of the Global Emerging Markets team at the international business of Federated Hermes in London, says he expects the current coronavirus pandemic to lead to a number of important and lasting changes.
“Every time there is a crisis, there are things that change. Things don’t move back exactly to the way they were before,” Gala says. “Markets change, new themes emerge, so never let a crisis go to waste,” he says in an interview with [i3] Insights.
“If you think about all the prior crises, in the 90s we had the Asian crisis and after that the Asian countries started to think more from a macro prudential perspective, they started to accumulate FX reserves.
“Then during the dot.com crisis, a lot of money was invested in physical infrastructure, especially when it came down to fibre optics, telecommunications and all of that was then later used to create the digital economy that we know today.
“Similarly, the global financial crisis unleashed a lot of quantitative easing (QE) and the world is now accustomed to living with QE and whenever there is talk of taking QE out, the market basically starts shivering.
“So for good or bad reasons, crises always change certain perspectives, they change behaviours, but always there is something positive and something new that comes out and similarly in the current crisis that we are facing, we feel that there will be a number of changes that will happen,” he says.
For good or bad reasons, crises always change certain perspectives, they change behaviours, but always there is something positive and something new that comes out and similarly in the current crisis that we are facing, we feel that there will be a number of changes that will happen
From an investor’s perspective, some of the more interesting developments include the wider embrace of cloud technologies. And it is not just those software and services that have benefited from large amounts of people working from home, including video conferencing, online shopping and cloud storage, but also the traditionally more conservative sector of manufacturing.
IoT Innovation in Manufacturing
“Traditionally, manufacturers were not very agile because you have a lot of fixed expenditure, a lot of capex that goes into putting together an assembly line,” Gala says. “On the other hand, the preferences of consumers keep changing quite rapidly. Consumers need variety.
“So at one hand you have manufacturers who are not very flexible and on the other hand you have consumers that want flexibility. Here the role of innovation is becoming very important and there is one technology that we like here and that is called the Internet of Things, IoT.
“With industrial IoT, you can have sensors or other components that are embedded in manufacturing lines and they start collecting a lot of data and they analyse the data, so that a lot of predictive maintenance can be done.
“Even before an assembly line breaks down, data can be collected that the efficiency of the line is reducing and that something is wrong. An engineer can then check and see if some correction has to be done and prevent a breakdown, and hence prevent lost opportunity,” he says.
A glimpse of what assembly lines might look like in the future can be seen in the automobile industry, which has been many years ahead of more traditional industries, Gala says.
“The automobile industry has adopted every possible technology that we can think about. It is a cut throat industry; it is very competitive.
“If you have ever been to a car manufacturing factory, you can see that no two cars on the assembly line are the same. They are all different: one might be red in colour, one might be white, some might have a different interior. So cars are extremely dependent on consumers’ preferences. That can be a challenge for a manufacturer,” he says.
There are several large technology companies, which are internet, or e-commerce platforms, but for them to operate they need data centres, because they need to be efficient and fast. There are all sorts of switches and routers that need to be upgraded regularly so they can keep up with the amount of data which is transmitted
“Unfortunately, other sectors in manufacturing haven’t really automated in the way the automobile industry has done. There is a lot of room for innovation and catch up that other industries can do in the future. IoT can also help in making a manufacturer more agile and more flexible,” he says.
In emerging market equities, most eyes have been on the large Chinese technology companies, but Gala emphasises that companies, such as Tencent and Alibaba, don’t operate in a vacuum.
“Yes, there are several large technology companies, which are internet, or e-commerce platforms, but for them to operate they need data centres, because they need to be efficient and fast. There are all sorts of switches and routers that need to be upgraded regularly so they can keep up with the amount of data which is transmitted.
“You also need a lot of fibre optics and laser technology, so there is a lot of supply chain technology opportunity that we see and we are invested in some of those areas, where we think the upgrade cycle is very strong.
“But perhaps the most important bucket is semiconductors, because everything today is electronic, everything is digital and semiconductors are at the heart of everything that is happening in the digital world.
“Emerging market companies, especially in Taiwan, have a very strong role to play, because that is the place where most of the semiconductors that are consumed are made. Taiwanese companies are at the cutting edge; they are ahead of the Chinese. They are even ahead of Intel in terms of advanced semiconductor technologies,” he says.
Taking Advice
Gala has an extensive career on both the asset owner and asset management side of the industry and he is set to take over as Lead Portfolio Manager of Federated Hermes’ global emerging market equity funds from Gary Greenberg in September 2020.
But when he started his first gig as an intern at an asset management firm, his father gently suggested that he build up some real world experience before telling people what to do with their money.
“I started working as an intern in the late 90s with a boutique in equity research in India, doing financial analysis on companies, and I realised that this is what I wanted to do. But my dad gave me advice and said:
‘You are too young to be thinking about investing or markets. You need to first experience what the real world is. Then after 10 to 15 years, after you understand how the world really works and how businesses operate, then you can come back and think about investing your or somebody else’s money’.
“I took that advice and forgot about investing and pursued my chartered accountant accreditation,” Gala says.
After a stint with PwC, Gala was hired at Morgan Stanley, working for the sell side, covering the global consumer sector. It was during his time with Morgan Stanley that Gala moved to London.
Having now built up experience in accounting, auditing, investment banking, mergers and acquisitions, and strategy, Gala felt ready to go to the buy side and put to practice what he had learned.
“My first buyside portfolio was with the UK government, in Treasury, in a unit called: The Shareholder Executive. Now, they have renamed it and it is known as UK Government Investments, but this is the in-house corporate finance and portfolio management arm of the UK government and I joined them in 2008, which was a very interesting time, because the whole world was going through the global financial crisis.
“The role of government was important, because governments were quite interventionist at the time, especially bailing out banks and financial institutions, and also providing capital to the private sector, because capital had dried up by that time,” he says.
Gala had met Greenberg, earlier on in his career and kept in contact with him after moving to London. Eventually, Gala joined him at Federated Hermes in 2012.
Pandemic and the Fallout
Taking over the reigns of the portfolio later this year will come at an interesting time in markets, as uncertainty is high, while the outlook is almost guaranteed to be somber for most economies.
While acknowledging the difficult times ahead, Gala is also optimistic about the opportunities that lie ahead. Apart from changes in manufacturing, he sees changes in many sectors that have been impacted by the pandemic, with healthcare being the most obvious example.
“Many countries are not self-sufficient in the discovery of drugs, R&D, even in the manufacturing of basic protective equipment,” he says. “I think governments across the world will, and should, take a very hard look at their capabilities and make sure they have some sort of self-sufficiency in this area,” he says.
He also believes that many small to medium sized enterprises will accelerate their move towards online goods and services.
“Businesses have received a shock and many of them have not been able to operate during the lockdowns, primarily because they are reliant on offline, rather than online [activities]. Many businesses haven’t really progressed on the digital curve and hence they have been suffering with cash flows going to zero.
“We feel a lot of changes are likely to happen, for example in diversifying their supply chains and having some buffer in their inventories. They will focus more on digital technologies and automation, all of this will also have implications for talent. What sort of talent do they need in the future to operate in a digital world and mitigate any disruptions like the one we see right now?
We feel a lot of changes are likely to happen, for example in diversifying their supply chains and having some buffer in their inventories. They will focus more on digital technologies and automation, all of this will also have implications for talent. What sort of talent do they need in the future to operate in a digital world
“We don’t expect businesses to go back to normal or business as usual,” he says.
Finally, consumers themselves have been impacted by the pandemic as well and Gala expects this means tourism and long-haul traveling will be one of the last sectors to recover, and this might also mean the tourism industry has to think about reinventing themselves, focusing more on local travel.
While some of these trends apply to both developed and emerging markets, Gala expects households in emerging markets to make one important change that won’t be as pronounced in developed markets.
“The importance of insurance is evident, now more than ever, especially health and life insurance. In emerging markets, the protection gap is very high. People have not prioritised insurance the way insurance is very common in the Western world,” he says.
“We already had investments in insurance before the crisis, given the huge under-penetration of insurance there, but there is a huge opportunity for insurers in emerging markets as more and more households look for protection,” he says.
This article is paid for by Federated Hermes. As such, the sponsor may suggest topics for consideration, but the Investment Innovation Institute [i3] will have final control over the content.
__________
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.