Automation and reshoring – key investment themes

The twin themes of automation and reshoring will bring opportunities for investors for years to come. We look at the reasons behind their rise and their ESG implications.

Among the many trends accelerated by the pandemic are automation and reshoring, which is when a company brings production closer to its home market.

However, this is no short-term boost; these are trends that are set to prevail and grow for many years to come and provide rich opportunities for investors.

Dan McFetrich, fund manager:

Last year saw massive disruption to global supply chains amid Covid lockdowns, worker shortages, and even a container ship stuck in the Suez canal. Freight and logistics costs skyrocketed to all-time highs as booming demand for goods met tight supply conditions.

These events highlighted a need for greater resilience in supply chains. Given that imperative, the next decade looks set to herald a new cycle of capital expenditure (capex, or spending on buying, upgrading or improving physical assets).

Companies will lift long-term spending, with investment in automation spearheading this as it addresses both capacity and resilience concerns at the same time.

Automation to be adopted by more industries

The adoption of automation has already broadened out from the car manufacturing and technology sectors to other industries. This is due to multiple factors: advances in technology; a shorter payback time between making an investment in automation and seeing a return; declining working age populations; and the ability to automate more tasks and functions.

The obvious beneficiary since 2020 has been warehouse and logistics automation, after demand rocketed post Covid-19. Innovations, embedded artificial intelligence and better vision systems, as well as price deflation, are making automation investments the most economically attractive they have ever been.

Meanwhile, pandemic-related disruptions are also driving automation demand as manufacturing companies rethink processes and localisation in the face of ever mounting labour shortages, longer lead times and rising costs. It’s therefore not surprising to see that the theme of reshoring noticeably accelerated towards the end of 2021.

We now see very clear data points, as well as commentary from company management teams, illustrating that we have reached the tipping point for both reshoring and automation. As the chart below shows, we think the potential for automation remains huge.

Reshoring away from China

In terms of the locations likely to be affected by reshoring, China is an obvious one amid pandemic-related disruption. For example, 90% of respondents in a UBS Evidence Lab survey of companies in the US and North Asia said they expect to move production away from China within two years. Amid continued semiconductor shortages and tightness for logistics infrastructure, most management teams appear to be aiming to stabilise the supply chain.

For manufacturing moving out of China, popular destinations include Japan, South Korea and Taiwan. Southeast Asia appears to be a less popular destination than it was, maybe due to the impact of Covid lockdowns in various Southeast Asian countries like Vietnam and to concerns about supply chain risks. Nonetheless, we still think the region will prove attractive.

Which sectors are reshoring?

Critical industries like medical suppliers, automotive, semiconductors/technology, and aerospace look primed to reshore first. But as a crucial supplier to these industries, the capital goods sector is at the centre of this equation. Capital goods firms make machinery used to manufacture goods and products.

The capital goods sector will benefit from the reshoring trend in two ways.

• Firstly, companies in the sector may reshore or regionalise elements of their own supply chain to decrease dependence on critical components in distant regions and reduce logistics costs.
• Perhaps far more crucially, the sector will be a reshoring enabler. Those capital goods companies which are able to capitalise on their own local and regional supply chains are uniquely positioned to capitalise on reshoring trends.

This theme of automation and reshoring appears to be global. It is likely to continue for several years given that, although it was propelled by the pandemic, it is also backed up by longer-term economic and demographic drivers.

This conviction comes from two reasons. Firstly, companies cannot unwind supply chains overnight and secondly, the scope for automation penetration is vast. There is huge potential for automation to be adopted by new industries, driven by better functionality, safety, and economic payback.

What are the ESG implications?

Angus Bauer, Head of Sustainability Research, and Samuel Thomas, Sustainable Investment Analyst:

Reshoring and automation go hand in hand. By its nature, automation plays an intrinsic role in the balance between labour and capital. It also helps to facilitate reshoring trends. There are a number of ESG implications to this.

On balance, we take the view that reshoring carries positive societal and environmental consequences. That said, as ever with such a broad reaching theme, there are nuances that will require company specific analysis.

On the social implications of reshoring, we note that it can deliver improved wages and job creation at the high skill end. With targeted reskilling and policy support – such as skills matching, development of a Women’s Resources Database or investment in women’s re-employment, all of which have been explored in Korea – it might also have promising implications for gender equality.

It’s commonly said that automation kills jobs, but this is not entirely true. On a standalone basis, the increased use of robotics in the workforce does reduce the aggregate employment to population ratio. It also reduces wages at the low-skilled end. However, there are nuanced factors that must be considered:

• In developed economies, the new job creation from reshoring can provide a cushion to help offset the displacement of low-skilled labour caused by automation.
• The reduction of demand for low-skilled labour requires policy support to yield positive outcomes. Reskilling in combination with deliberate industrial policies, for example, may in time help emerging market labour forces migrate to higher-skill and higher-wage jobs.

We continue to investigate the policy support required to deliver positive societal implications as automation leads to the “leapfrog” phenomenon – allowing emerging economies to skip different stages of industrialisation and move up the value-added chain.

Turning to the environmental implications, reshoring has several positive impacts.

Firstly, by moving elements of the supply chain closer to the end user, reshoring reduces the need for highly polluting ground transportation logistics and often negates entirely the need for sea or air freight.

Reducing emissions in the supply chain can yield substantial improvements in corporate carbon footprints. For the majority of companies, c.80% of greenhouse gas emissions are derived from its supply chain (source: McKinsey – Starting at the source: Sustainability in the supply chains).

Secondly, shorter supply chains help to streamline demand information, improving order reaction times and therefore the efficiency of inventory management. This can help to minimise the excessive energy and resource consumption associated with overproduction. It can also help avoid overstocking and the consequent need to discount products, which has implications for profitability.

Finally, another factor is the potential for reshoring to reduce environmental risks, and the costs associated with them. Climate change, deforestation and water insecurity are expected to cause substantial increases in the operational cost bases of suppliers. Shortening the supply chain enhances companies’ ability to identify and mitigate these risks.

Originally published by Schroders
Authors: Samuel Thomas, Sustainable Investment Analyst / Angus Bauer, Head of Sustainable Research / Daniel McFetrich, Fund Manager and Global Sector Specialist