Old Mutual  00:02

At Old Mutual Wealth Private Client Securities, we specialize in bespoke investment management for high net worth individuals, trusts, and companies. Our Private Client Portfolio Managers craft and manage tailored share portfolios, investing directly into high quality companies, both locally and globally. We partner with you and your financial planner to ensure that you achieve your financial goals with peace of mind. 

Ian Fraser  00:30

Semiconductor chips are the engine driving the technological transformation of the world. It's been like that for many years, and as US entrepreneur Marc Andreessen famously pointed out, software is eating the world. And evidence of this can be seen absolutely everywhere. 

However, the underlying thing: without semiconductor chips, there would be no machines to drive the information age. And nevertheless, today, we find ourselves in incredibly precarious positions of relying on just a handful of companies to meet the world's insatiable appetite and desire for faster, more powerful, smaller semiconductor chips. 

Let's welcome Andrew Dittberner, who is the Chief Investment Officer at Private Client Securities. Andrew, it's great to have you on the podcast today. Let's talk about the significance of this global semiconductor industry. Why... I mean, for obvious reasons, we know why. But why is it so big?

Andrew Dittberner  01:30

As you rightly point out, you know, semiconductors are the brains, you know, that sit behind every single electronic device that we can think of. Previously, it would have been, we would just think about our computers, for instance. But when it comes to today, and you think about your mobile phones, tablets, the Internet of Things, connectivity, you know, literally every single device, your fridge, your car. All of these devices need semiconductors. 

They are effectively, I suppose, the unsung hero, you know, that sits behind technology, and as you rightfully point out, these are the... this is the equipment that is driving the technological revolution of the world today, so they are incredibly important. They sit very much behind the scenes. 

When you talk about technology, often we talk about artificial intelligence, virtual reality, you know, autonomous driving, these sorts of things, but what sits behind all of that are these semiconductor chips. And as we've seen this year, they sit in the hands of a few very powerful companies, so the world is almost, how do I say, held ransom, but we're very reliant on a very few small number of companies that produces and designs these chips. And as such, what we see now is this very complex supply chain, that as a result of the complexity of it, and reliance on not one company fulfilling the whole supply chain, we’re ending up in this shortage, which we've seen coming through today.

Ian Fraser  02:58

That's a very interesting point, we'll get to the shortage in a second. I want to step one step back, and just talk about the demand. You've mentioned that, you know, they're underpinning all of the things, the Internet of Things, the AI, the virtual reality, or the augmented reality, etc. etc. But what about the actual things that are driving the demand? 

I have three here, maybe we can tease these out. Cloud Data Centres, obviously, they're underpinned by massive machine power. The move to mobile, of course, there is everybody with a mobile phone in their hand these days. And of course, the Internet of Things, as you mentioned, fridges, washing machines, dishwashers, light sockets, etc. etc. and so it goes. Let's just tease that out a little bit and see what the landscape looks like from that point of view.

Andrew Dittberner  03:45

Yeah, so I mean, if we can start with the first one, you touched on cloud computing. When you think about whether it's Amazon Web Services, Microsoft Azure, Google have their cloud platform as well, companies, corporations, everything, that sits on our laptop, now sits in the cloud, as we know, you know, things that sit on your phone, your music, your photos, etc. They all sit in the cloud, and we talk about the cloud, but the cloud actually needs to store the data somewhere. And that data needs to be stored in data centres. And that data needs to be processed. And in order for it to be processed, you need these, you know, as you point out, smaller, more powerful, and probably a very important point that you didn't touch on, more energy efficient semiconductor chips to power these data centres. 

The move to mobile, as you talk about, everyone's got at least one mobile phone that's sitting in their pocket. You've got your tablets, your laptops, think about your watches, 10 years ago, your watch had some cogs in it that drove the hands around the face of the watch. Today, you sit probably with a smartwatch, or some sort of sports watch, and all of those need semiconductors. So, let's move to mobile, and then obviously, the last thing you touched on, the Internet of Things, you know, everything today is connected, your fridges, your cars, as you point out. There's this new word around, the "metaverse", which I'm still trying to get my head around, towards the Internet of Things. But virtual reality, artificial intelligence, augmented reality, as I mentioned earlier. 

So, all of these things require semiconductors, and it's not, you don't just have one type of semiconductor, you've obviously got many different types, whether it's a CPU, you know, a GPU, an integrated circuit, etc. etc.

Ian Fraser  05:35

Okay, let's address the elephant in the room. Covid happens, the supply chain gets broken, things shut down, transports around the world slows, people are sick, people are locked down, the world economy just slows down. 

And all of a sudden, we find ourselves with everybody working from home, reliance on those chips that we're talking about, much more than they were, let's say, five years ago. Everybody needs a piece of equipment to communicate with somebody else. And now all of a sudden, we're faced with a chip shortage, let's unpack that. How did that all happen?

Andrew Dittberner  06:11

Yes, so I think to understand the shortage that we currently seeing, we probably need to take a step back and actually understand the structure of the industry. There are short-term impacts and there are long-term impacts that have caused this. You've touched on the short term, which is obviously the pandemic. But there's also a long-term issue at play here, and that's coming to the structure of the industry, which I alluded to earlier on in our conversation. 

But we can go back probably to, you know, there's not enough time to tell the whole story here. But you can go back probably to about the 80s, when there was a guy by the name of Morris Chang, who worked for Texas Instruments, which was a US semiconductor, still is a semiconductor business. And at that time, these businesses were vertically integrated. And by that we mean they designed their own chips, they had their own equipment manufacturers, they fabricated or manufactured their own chips, they sold their own chips in it, you know, even sold, you know, some of the end products that the chips went into. 

And Morris Chang in the mid 80s, cut a long story short, he left, he came from Taiwan, and he left the business, and he went back to Taiwan, took some time out, and the government, there approached him and said, he needs to get Taiwan into the semiconductor game. And he thought about this for a while, and he actually then came up with the idea of actually breaking up this vertical integration and building the industry out in a horizontal manner. And by that, I mean, you break up the different processes. 

So, you've got your design process, which are called fabulous companies, you've then got your companies that just manufacture chips, these are called foundries, Taiwan Semiconductor is the world's biggest foundry. Effectively, I think about 50% of all third party manufactured chips go through Taiwan, you know, chips around the world go through Taiwan, so very much reliant on that. And as a result, this has allowed innovation at the design process to really accelerate, because obviously, making chips is incredibly expensive. You need to build these fabrication plants that are hugely expensive, obviously to design the chips are a hell of a lot cheaper. So, as a result, you've got specialization across the supply chain at various parts. 

At the same time, you've got a very complex supply chain, and designs need to move from, you know, take it Apple or Tesla. And they need to move all the way across to Taiwan, where it's manufactured. And then the chip needs to travel back across to America. And I think you can start to see my point, that the supply chain is quite complex. And that's the long-term issue when we talk about the shortage today. 

So, we get the pandemic that happens, obviously on the supply side, factories are shut down, which obviously slows down manufacturing. On the demand side, as we all move to online, people suddenly want more phones, more tablets, more gaming consoles, etc. etc. So, the demand picks up. Given the complexity and the fact that these chips now have to also move across the world, given that there's no one company or no one region in the world that produces chip end to end, you know, so from the equipment, the material, the design, the manufacturer, the cell, there's not one region in the world that can actually do that. So, you've got this logistics issue that sits there, which is a long-term factor. So, those two effects results in us being in the position that we found ourselves today.

Ian Fraser  09:21

I'm just listening to you talk and thinking about the vertical integration versus the horizontal integration and how it's sped everything up, the pros and cons of each. I'm thinking about Apple, and what's happened with their M1 chip. I'm going to geek out for a second here, but they were on Intel chips beforehand, which very much relied on somebody else to make those chips for them. They've now vertically integrated by making the chips themselves. Has that got anything to do with the fact that that process was out of their control?

Andrew Dittberner  09:50

Yes, I think they, you know when you look now what's happening, it's not just Apple. The concern is that's given the supply chain as it is at the moment is that you're losing intellectual property. And I think that's ultimately what it comes down to. So, we see how they're rectifying this issue at the moment is that these companies are spending huge amount of capex in bringing that manufacturing, you can call it home. 

But yeah, it's not home for Taiwan Semiconductor, for instance, they're spending a large amount of money putting up a fabrication plant in Texas, I believe, I stand to be corrected, but it's in the US. They're spending 10 billion US dollars there, I think it is, you know, so that's just to, I suppose, stop intellectual property. These companies like Apple, that are now designing, Tesla is a similar one, designing their own chips. They don't want to be sending their designs across the world to what they might see as competitors, I suppose, and losing that IP in the process. So, it's, yeah, it's a very political, I suppose, issue as well.

Ian Fraser  10:54

Yeah, it is, I think the nuances and the avenues that we can go down, we could be here for days talking about this, because it is, it's a very complex setup. What is very clear, though, and let's bring it back into the context of this podcast, is that exposure to the sector, regardless of how it's gonna play out, regardless of shortage, the appetite for this sector, in terms of using electronics, is massive. It's not going anywhere. 

How is an investor, maybe, can I get exposure to this sector? What should I be looking for? What should I be doing?

Andrew Dittberner  11:26

Yeah, so it's incredibly, I suppose, complicated when thinking about investing in the sector, because you can, you know, as I've already touched on the supply chain, there's so many different parts to this supply chain. You can start right at the beginning for companies that actually manufacture equipment that goes into fabrication plants. There are companies that supply materials, that are obviously used to produce. There are companies that design software that companies use to design semiconductors. And then you've obviously got your designers, which are your fabulous companies, and you've got your fabricators or your foundries as they're known.

 So, there's so many different areas of the supply chain that you can invest in. And as a result, to then try and pick a specific winner in each one of those areas is incredibly difficult. And obviously, look, margins are fairly flat right across the supply chain in this space. But to try and pick a winner within different areas of the supply chain is incredibly difficult, you know, trying to pick the long-term winner. 

So, the approach that we've taken, is that we've got broad exposure to the sector, which includes right from the equipment manufacturers to the fabricators, and that's through the iShares semiconductor ETF, or exchange traded fund, and that gives you a very, very broad exposure. There obviously companies that dominate that, companies like the name of NVIDIA, they produce GPUs, graphic processing units, and those go into gaming consoles, etc. A company like that does dominate. Taiwan Semiconductor as well, you get quite a big exposure to that business. But at the same time, as I say, you get a broad exposure to all the companies.

Ian Fraser  13:15

Alright, there you go, good advice. So, ETF is the way to go, certainly from your point of view. If we want to get a hold of you guys and find out more, where do we go?

Andrew Dittberner  13:24

You can jump onto our website, oldmutualwealth.co.za, and we sit under Private Cloud Securities, you'll find research and relevant information.

Ian Fraser  13:33

Fantastic, Andrew Dittberner, Chief Investment Officer at Private Clients Securities. Thanks for your time, nice chat. 

Andrew Dittberner  13:39

Great, thank you. 

Old Mutual  13:42

At Old Mutual Wealth Private Client Securities, we craft portfolios using a global and unbiased investment approach, allowing us to seek investment opportunities across asset classes, sectors, and geographies. We believe that quality, valuation, diversification, and time are the key drivers of superior long-term returns. As such, we invest in quality companies with a long-term track record of delivering sustainable earnings growth. Our investment philosophy is supported by a disciplined and robust investment process and is backed by a highly experienced and talented team.