Since the industrial revolution, the dominant mindset has been on infinite growth via the consumption of the same resources which must deplete. There are no everlasting gobstoppers.
We exist in both a resource and economic growth constrained world. This aligns to the thinking of ‘donut economics’ by Kate Raworth, which calls for a new kind of economics for the modern world to meet the needs of humans, while not overwhelming critical systems: regenerative, not degenerative, growth.
We remain highly positive about continued growth, as technological progress may mitigate or even solve some of these challenges, changing the texture of that growth, as we get more from less.
As part of this changed growth, there is a shift as companies look to allocate an increasing proportion of their budgets to knowledge capital such as IP, buying in strategic assets, investing in human and relational capital rather than in physical capital, which can be leased or minimised under post pandemic models.
Of course, it is not just about the amount of spend, but the intelligent application of that investment, using data to enhance decision making, targeting specific new and existing capabilities to build competitive advantage.
Companies that master the deployment of intangibles will be well positioned to outgrow their peers. Levels of R&D investment dovetails with this and IT investment in particular is expected to remain high for many companies. China now leads global peers in future investment, with 79% of Chinese companies expected to increase R&D over the next two years.
It is important to assess this kind of intent by managers, which is both a quantitative and a qualitative exercise and typifies the type of hard-to-define, intangible premium that certainly exists for areas such as management execution, leadership skills, and corporate culture.
We capture these differentials in our analysis of the often-silent ‘S’ in our ESG framework which we believe is likely to become more measured, managed and tangible as a result of changes to working practices, societal views, business models and regulation.
The last year has seen emerging market innovation beyond China. This has been assisted by better availability of capital following global diversification efforts from some investors. Indeed, in the eleven months to the end of November 2021, 71% of M&A activity was in emerging markets outside of China.
To better understand the companies at the forefront of driving innovation, we model all of our investments with a 40-year time horizon, looking back 40 years to 1982 – yes, the world looked a little different. CDs were seen as a new technology, Chrysler was the best performing stock and the MSCI emerging markets did not yet exist. 40 years may seem long but it corresponds with empirical evidence on medium business life cycles.
A less considered valuation of companies over the longer term is what allows us to identify mispricings. Companies that dither and delay may think that they can catch up and maintain some flexibility by retaining that money, but that is not so. No action today has an associated cost, while reduction of the risk should be seen as a benefit, simply, the sooner the better.
A companies spend on technology can also have a knock-on effect on its sustainable abilities.
Sustainability directly increases or detracts from company competitive advantage. We are looking to invest in companies that are gaining a first mover advantage in new technologies, taking valuable near-term action and doing so in size. The epitome of this in our portfolio is Reliance Industries in India, who have spent $10bn across solar, hydrogen, fuel cells and battery storage, and entirely pivoted the business from what was a hydrocarbon refinery business to a new energy and digital services company.
Returning to the tale of Willy Wonka. Markets are in a perpetual state of greed and fear – mirrored in the eager entrants to his chocolate factory, consumed by greed leading them to act irrationally and emotionally. The winner is Charlie Bucket, who throughout it all, and regardless of the behaviour of others, remains patient and responsible – as investors, we should try and follow Charlie’s lead.
Naomi Waistell is fund manager, global emerging markets at Polar Capital
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