Marshmallows and macro towers
In the late 1960s, psychologist Walter Mischel and his colleagues at Stanford University conducted a series of studies on delayed gratification, known as the ‘Marshmallow experiment’. The researchers presented 4 and 5 year old nursery school children with one marshmallow apiece and told them they had two options. They could ring a bell at any point to summon the experimenter and eat the marshmallow, or wait until the experimenter returned – typically 15 minutes later — to earn an extra marshmallow. In other words, the children had to choose between a small immediate reward and a larger later one.
This experiment subsequently became one of the most famous pieces of social science research ever undertaken. This said, what proved more interesting were the follow-up studies with the same group of children over the next several decades. When they were re-evaluated as teenagers and adults, those who had exhibited stronger self-control by waiting to eat the first marshmallow had higher academic scores, lower body mass and were less predisposed to using drugs. Their ability to forgo a short-term reward, in favour of a higher future payoff, appears to have contributed to their wellbeing in adulthood.
Several similar studies have reaffirmed thinking longer-term leads to better outcomes. However, knowing this – and behaving to take advantage of it – are two very different things; particularly in the context of investing.
Managing this bias
Adopting a long-term mindset is not easy; moreover, the dangers in failing to recognise the investor fog stemming from its alter ego – short-termism – were well illustrated by Nassim Nicholas Taleb in his second book, Fooled by Randomness. He asks the reader to imagine they have a portfolio expected to achieve 15% annual returns, with a 10% annual standard deviation. Assuming these returns are normally distributed, a widely-used statistical algorithm reveals if you check your portfolio once a year, the performance will be positive 93% of the time. However, if you check every quarter, that number shrinks to 77%, and if you follow the performance daily, it is just 54%. If you check it every minute, you will see only noise, as the odds of the return being positive or negative are roughly 50/50. Taleb’s example shows how easy it is for investors to lose sight of the big picture over the short term. When your investment objective is a number of years away, checking progress every day is not good for your (financial) wellbeing.
Of course, as investment managers, this does not mean we should check our progress as rarely as we can. Indeed, we wake up every morning with clients’ portfolios top of mind. What Taleb’s illustration does mean, is there is a link between a goal’s time frame and the frequency with which we reposition portfolios – the two need to be connected. If a young person investing for their retirement checks the results daily, they will likely start drawing inaccurate conclusions. This commonly leads to poor choices, negatively impacting their investment goals, however unintentionally.
Anchoring to long-term themes
This perspective provides an insight into the dilemma investors have faced in managing portfolios through 2022. Rising bond yields, rampant inflation, slowing growth and elevated geopolitical risks have combined to spark downward pressure on most asset prices. At times like these, it is natural behaviour to check portfolio values more regularly, adjust assumptions, re-test expectations and – by extension, for some – lose an element of investment composure. Near-term, there is no doubt we have entered a very different investment environment to that we have faced for a decade or more, and portfolio adjustments, subject to risk/return profiles, are warranted at the margin. However, notwithstanding this macroeconomic regime change, long-term super-secular trends - driven by demographics, technological advancement and the energy transition - remain firmly entrenched and, in some cases, continue to accelerate. Anchoring to these, particularly during a period when the outlook is opaque, and volatility is high, helps provide clarity of thought. One such theme, which lies at the centre of the super-secular trends described, are the investment opportunities presented by digital infrastructure.
The emergence of a fourth utility
For almost two decades, the US government has classed digital infrastructure as ‘critical infrastructure’, an integral component to the functioning of modern-day society and its economy. But for many households and businesses, though digital connectivity was considered a necessity in everyday life, its criticality was not perhaps fully appreciated until it enabled societies and economies worldwide to continue functioning by moving online during the pandemic. However, the events of the last two years have simply brought into focus a trend that was already well underway. It is clear that digital infrastructure – such as data centres, fibre optic cabling and mobile phone masts – are now essential to the global economy. What we traditionally considered infrastructure, facilitating the movement of people, goods and services, now includes assets which enable the movement of data in the form of zeros and ones. The latter has become the ‘fourth utility’ for most countries – whether developed or developing – and the investment opportunity set is extremely attractive. Comfortable with its growth trajectory, maturing business models and the stability of cash flows, investors increasingly see digital infrastructure as an important component of their real assets’ exposures – a valuable allocation, within portfolios, during periods of higher inflation. According to McKinsey, this global opportunity is one of the fastest-growing sectors – with an estimated $7.8trn capex spend, by 2035.
Demand for digital infrastructure will grow exponentially
According to Schroder’s Global Cities team, whom we know well and have invested with for many years, structural trends are driving the strong growth in demand for digital infrastructure. The use of connected devices, such as smartphones, is likely to continue expanding. Indeed, they advise in 2018, 22 billion connected devices were in use worldwide, which is predicted to grow to 50 billion by 2030. The data consumed by these devices is also ballooning. In a recent thought piece on the topic, the team highlighted that in 2010, 2 zettabytes of data were consumed. This grew to 33 zettabytes in 2018 and is predicted to reach 149 zettabytes by 2024.
Implications for portfolios
Our Responsible and Sustainable Growth mandates have had exposure to this theme for some time. However, given the current macro environment, valuations and visibility of both capex and cash flows, we intend to introduce a dedicated, Article 9 digital infrastructure fund to client portfolios in the near future.
Investing doesn’t necessarily have to be complex or cutting-edge to be rewarding. Much like the happiness-inspiring marshmallows, which are made simply from whipped sugar and egg whites, stabilized with gelatine – and despite all the talk of zettabytes – the physical assets in the digital infrastructure space are surprisingly ordinary. Think data centres and macro towers – like the one in the image – located in the middle of nowhere. Rather than own the sexy, but more easily disrupted technology – investors hold the physical tower itself (the red part of the structure) and collect an inflation-linked rental income. It’s as gratifyingly mundane as that.
