Fidelity: Why Europe could drive the next decade of innovation

Sam Morse and Marcel Stötzel, portfolio managers of the Fidelity European Fund and Fidelity European Trust PLC, outline why they believe Europe could be at the forefront of the next decade of innovation, and why this creates significant opportunities for patient, long-term investors who are will willing to back European innovation and benefit from the leaders of the next decade.

Key points

• Europe is much better placed to outperform in the coming decade than it did in the last because we see growth being driven by Business-to-Business (B2B), rather than business -to-consumer (B2C) innovation.
• Many of the biggest trends of the future decade mainly have B2B application, including Cloud, Edge, 5G, Robotics and Additive Manufacturing.
• European stock indices are still trading at a large discount to US indices mainly because there is scepticism that Europe can benefit from innovation over the next decade. This creates opportunities for long-term investors.

One of the most remarkable features of the global stock market recovery of 2010-2020 is the extent to which it was US led. The S&P 500 Index returned a 10%+ compound annual growth rate over this period, while the MSCI Europe Index remained broadly flat (in USD terms). The list of the world’s largest companies today shows clearly what led this outperformance: mega-cap tech stocks.

The world’s largest companies by market-cap Company

Source: Bloomberg, September 28, 2021

However, there’s another interesting observation we can make - many of these companies are Business-to-Consumer (B2C). This is a reflection of where the largest advances in innovation have occurred over the last decade - such as smartphones, social media and e-commerce. Unfortunately for Europe, there are few B2C tech winners of scale and the few that have succeeded, have ended up listing in the US, for instance Spotify.

Growth in Europe will be driven by B2B innovation

For investors today, the real question is: what will the next decade look like?

We believe that Europe is much better placed to outperform in the coming decade than it did in the last because we see growth being driven by Business-to-Business (B2B), rather than B2C innovation. How do we know this? The first place we can peer into the future is to look at the areas in which most global patents are being filed.

Ranking of global patents by technology

Source: WIPO, EPO, JPO, USPTO, Morgan Stanley Research, 2020.

We can see some interesting trends from this data:

• Many of the biggest trends of the future decade primarily have B2B application, including Cloud, Edge, 5G, Robotics and Additive Manufacturing. A number of these have accelerated to the top of the ‘greatest number of patents filed’ list.
• Whilst some areas, such as AI, will have a B2C impact, the scope to transform B2B is much greater given the room to catchup. We could also use this same argument for semi-conductors and their Industrial Internet of Things applications - B2C tends to be easier to disrupt than B2B, as B2B requires deep industry knowledge or at least a partner with that expertise.

Why Europe?

If we have confidence that B2B innovation will lead B2C in the coming decade, a logical question could be why US tech companies would not come to dominate versus European names.

We have confidence that Europe will not miss out for three reasons. Firstly, Europe is far more “in the mix” this time around when it comes to filing patents, ranking third overall globally behind USA and China but second according to experts when measuring “quality / high value patents” behind the USA.

Secondly, in sharp contrast to the dearth of B2C enablers in the last cycle, Europe already has a number of globally competitive B2B enablers such as ASML, SAP, Ericsson, Dassault Systemes and Capgemini.

Lastly, the B2B innovation benefits created by the B2B enablers will also spill over to industries where Europe has a highly competitive global position such as electricity, pharmaceuticals, manufacturing, banking, insurance, fintechs and telecoms.

European innovations

We have confidence that Europe will benefit from the B2B cycle much more than the B2C cycle as Europe has more B2B tech enablers than they had B2C enablers and because European strengths lie in the sweet spot of industries where these innovations will benefit the most.

Indeed, many people have already started putting serious money behind this idea. We can see this in the Venture Capital (VC) industry - our preferred place to look for when innovations are progressing from patents to actual businesses.

Outside of the VC industry European listed corporates are already bringing to life many of the practical implications of these new B2B innovations. Through our due diligence and meeting with companies we see examples in practice:

Roche’s Genentech division is focused on data-based drug discovery and leverages cloud and AI advances to deliver breakthrough and transformative medicines. Additionally, Roche has partnered with the likes of Dassault Systemes which provides the necessary digital design, simulation and clinical trial software. This innovative new approach has resulted in new Genentech product launches contributing more to the overall pharma division sales.

ASML provides chipmakers with hardware, software and services to mass produce patterns on silicon, helping to increase the value and lower the cost of a semiconductor chip. Leveraging advances in AI and semiconductors has allowed ASML to gain 90% market share of the total lithography market and 100% market share of the leading-edge technology – extreme ultraviolet lithography (EUV).

Siemens launched their Lean Digital Factory (LDF) program by connecting more than 30 plants to one Manufacturing Data Platform. On the production side, the LDF program leverages a variety of the B2B megatrends such as robotics, additive manufacturing and Industrial Internet of Things. On the digital design side, the LDF program leverages a number megatrends including cloud, edge, 5G and AI. Through these innovations Siemens has seen 50% savings in tooling and reduced project lead times for new product developments by 20% - all while maintaining production quality at the factory of 99.99%.

Long-term opportunities

We therefore believe that Europe is not behind the curve when it comes to innovation but because of their B2B focus, many of the incredible advances in technology remain under the radar. European public equity indices still trade at a large discount to US indices mainly because public markets are still much more sceptical that Europe can benefit from innovation over the next decade. We believe this will create large opportunities for patient investors willing to back European innovation and potentially benefit from the leaders of the next decade.

Important information

This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of an investment in overseas markets. The Fidelity European Fund and Fidelity European Trust PLC can use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The shares in the investment trusts are listed on the London Stock Exchange and their price is affected by supply and demand. The investment trusts can gain additional exposure to the market, known as gearing, potentially increasing volatility. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.