10.02.2017

I Always Feel Like Somebody’s Watching Me

By Andrew Harmstone, Portfolio Manager, Morgan Stanley

I always feel like somebody’s watching me.

And I have no privacy.

— Rockwell

The lyrics to Rockwell’s 1984 hit Somebody’s Watching Me are the musings of a paranoid individual worried that his neighbours, his mailman and the IRS are watching him. Since then, concerns about data privacy and cybersecurity have grown far beyond the snooping mailman, due to the internet, the volume of data gathered and developments from spyware to smart TVs that actually do watch back.

Data privacy falls within the Social pillar of Environmental, Social and Governance (ESG) considerations and, in our opinion, can translate into tangible value. In May 2018, the European Union (EU) General Data Protection Regulation (GDPR) will become effective. Its goal: to give EU citizens control over their personal data.

Andrew Harmstone, Morgan Stanley

Because large companies are global, the GDPR will likely have far-reaching effects – non-compliance could mean significant penalties of up to 4 percent of a company’s annual global turnover or €20 million, whichever is higher.[1] Along with responsibility, accountability (making automated decisions such as profiling contestable), explicit consent, and data portability, the regulations include a new right to erasure.

This suggests that investors who purchase shares of companies that are behind the curve in terms of data privacy protection capabilities and general cybersecurity could be assuming real risks. Potential lawsuits, reputational damage, revenue loss, intellectual property theft and the cost of infrastructure repairs are significant risks on their own. The prospect of a fine bolsters the case for considering a company’s strict adherence to the regulations when considering potential investment.

There is a massive amount of information that could now be subject to ownership rights at the individual, data-subject level under the GDPR. That data was already owned by the companies that collected it, analysed it and sold it for big profits. For industries that have grown up around a model of data being free, this could lead to significant disruptions.

For others, it creates investment opportunities. The number of security incidents against companies has been rising at over 60 percent a year since 2008[2]. The growth of the “Internet of Things,” with now billions of connected items, will likely open up new sectors to the risk of cyberattack, from household items to medical devices to autonomous vehicles.

As a result of increasing cyberattacks, spending on security software in the Americas, EMEA and Asia Pacific (including Japan) is on a consistent upward trend, with highest spending in the U.S. We would not be surprised to see other regions catch up: the GDPR for instance, should increase cyber security spending in Europe[3]. This supports our more general view that the economy is undergoing not just a cyclical increase in investment, but also positive secular trends.

Opportunities are not limited to the investment side. Stock prices also appear to react to how well companies handle privacy along with other ESG issues. We found that over 12 months ending June 2017, social scores in the U.S., Europe and Japan were positively associated with IT sector stock market performance, and the highest scoring companies were the best performers.  Understanding cybersecurity and acting as responsible shepherds of customer data contributes to reduced risk for companies. It could also lead to a more attractive cost of capital and lower operating costs.

 

This index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results. See Disclosures for index definitions.

Performance of IT sector stock baskets constructed based on social score. Source: MSIM. Data based on Sustainalytics and Datastream. Performance data from 30 June 2016 to 30 June 2017, scores as of 30 June 2016. Based on social score; the number of stocks examined is shown in brackets next to sector name. U.S. equities are based on the S&P 500 constituents, European equities are based on the MSCI Europe constituents and Japanese equities are based on the MSCI Japan constituents.

What was paranoia in 1984 is reality in 2017. Somebody is watching you and gathering your data in previously unimaginable quantities. But with regulations such as the GDPR in Europe, you will own your data. This regulatory change is one aspect of the fast-evolving cyber-environment, which is disrupting industries worldwide. The risks and costs to companies of not keeping up with change is great, be it from fines, reputational damage or lower productivity due to cyberattacks – each can erode companies’ profitability. Therefore, data privacy and security, within the Social pillar of ESG concerns, is a factor worth considering when assessing investment opportunities.

[1] Morgan Stanley Research – Sustainability: ‘Data Privacy: EU GDPR “Security Solutions Stocks”’, published 15 May 2017.

[2] Source: PwC, CIO, CSO, Morgan Stanley Research — Sustainability: ‘Big Data & Consumer Trust — How Much Do You Value Your Privacy?’ (23 March 2017).

[3] Source: IDC. Morgan Stanley Research – Sustainability: ‘Data Privacy: EU GDPR “Security Solutions Stocks”’, published 16 May 2017.

Andrew Harmstone is a Portfolio Manager for the Global Multi-Asset team at Morgan Stanley

 

The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all portfolio managers at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific Morgan Stanley Investment Management product.

Certain information herein is based on data obtained from third party sources believed to be reliable. However, we have not verified this information, and we make no representations whatsoever as to its accuracy or completeness.

The information herein is a general communications which is not impartial and has been prepared solely for information and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Charts and graphs provided herein are for illustrative purposes only.

Past performance is no guarantee of future results.

The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto. The S&P 500® Index measures the performance of the large cap segment of the U.S. equities market, covering approximately 75% of the U.S. equities market. The Index includes 500 leading companies in leading industries of the U.S. economy. The MSCI Europe Index is a free float-adjusted market capitalization index that is designed to measure developed market equity performance in Europe. The term “free float” represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The performance of the Index is listed in U.S. dollars and assumes reinvestment of net dividends. The MSCI Japan Index is a free-floated adjusted market capitalization weighted index that is designed to track the equity market performance of Japanese securities listed on the Tokyo Stock Exchange, Osaka Stock Exchange, JASDAQ and Nagoya Stock Exchange. The MSCI Japan Index is constructed based on the MSCI Global Investable Market Indices Methodology, targeting a free-float market capitalization coverage of 85%

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