181. Investing in bespoke healthcare, cybersecurity and robotics

17 March 2022 (pre-recorded 8 March 2022)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION] 

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. We’re joined today by a European manager to discuss major themes including inflation, technology, resource scarcity and demographic change. While we touch on the geopolitical tensions in relation to these themes, this is not the focus of the episode. This interview was pre-recorded on March 8, 2022 and is intended for a UK audience only. 

Ryan Lightfoot-Aminoff (RLA): I’m Ryan Lightfoot-Aminoff and today I’m joined by Zehrid Osmani, manager of the Elite Rated FTF Martin Currie European Unconstrained fund. Zed, thank you very much for your time today.

Zehrid Osmani (ZO): Thank you, Ryan. Nice to see you.

[INTERVIEW]

RLA: Now, Europe, hasn’t been immune to the rising inflation, although interest rate rises don’t seem to be on the agenda quite yet. That hasn’t stopped the rotation though, from the growth stocks into value stocks. What have you been doing with your fund in this time? Have you been topping up on those funds [stocks] that are now better value?

ZO: Well one thing to mention Ryan is this is a type of period in the economic cycle where you would expect some increased volatility in style leadership. Our view is that we’ve moved from the recovery phase of the economic cycle towards the expansion phase of the economic cycle. And, as this happens, monetary policies tend to transition from being accommodative – which is what has been the case – to normalising, which is something that the market has had to effectively digest, those shifting monetary policies towards normalisation. And, as this happens, volatility increases and style leadership volatility increases. We expect this typically to then normalise once market expectations of higher interest rates are fully digested. And this would be putting aside any geopolitical risk that has really further dialed up the volatility in the last few weeks as we’ll probably talk about later on. 

In our view in this phase of the economic cycle of expansion, you want to focus on companies that deliver consistent, supportive, structural growth, and have some element of quality. Given that we are heading into a year where earnings growth expectation is more into the mid-single digit, after a year of 2021, which has been stellar in terms of recovery, where expectations have been for plus 48% growth at the global level, and closer to plus 55% year-on-year at the European level. So, you can see that it’s been a stellar recovery followed in 2022 by what will be a very pedestrian growth. And therefore looking for companies that’ve got good structural growth is an important focal point. 

The other aspect, of course, is inflation pressures have been stronger than expected, which fits into that monetary policy normalisation and central banks having hike rates perhaps more rapidly and more significantly than the market was expecting about six to nine months ago. Those inflationary pressures we can touch on later on about whether they’re structural or frictional.

Our view remains that they’re frictional, but they’ve certainly been stronger and longer lasting than both us and the market has been expecting. As a result of that, we want to focus on companies that have strong pricing power, because whilst last year you might have had those inflationary pressures. The strong recovery has led companies to have strong operational leverage, which has permitted them to somewhat hide that inflationary pressure on their margins. In a year like 2022 or indeed 2023, where growth is much more scarce, those inflationary pressures are going to have a more negative impact on margins. So, we want to focus on companies that have pricing power because that permits them to protect those margins, because the inflationary backdrop is somewhat uncertain as to whether this is going to be longer lasting. 

And again, bringing the geopolitical risk into play, and the flare up in energy prices and in some commodity prices, means that there’s more upward pressure to this inflation coming through. And so the final point we want to mention here is quality growth companies therefore to us give us that better aspect, but coming back to the economic cycle, there is a risk given, this geopolitical risk, that we are moving instead of moving into expansion, we’re moving into slow down. And in the slow down phase of the economic cycle, growth and quality actually perform. And what performs very strongly is earnings momentum. So, companies that can deliver either consistent earnings or positive surprise to their earnings growth, in a market that will likely be starting to see earnings downgrades, given the pressure on the economic momentum from this geopolitical crisis.

RLA: Thank you very much. You’ve got sort of three investment mega trends that you invest for in the fund. The future of technology, resource scarcity and demographic change. We’ll go through these perhaps starting with resource scarcity given we were just talking about that. Europe’s dependence on Russia for energy has being very well documented in recent days. Do you think the situation as it is now will lead to even a faster move towards green energy and green technology?

ZO: Yes, we do. I mean, and it is an important question you’re asking Ryan here. The resource scarcity for us is not just natural resources. It’s also physical resources. It’s also education. It’s also access to capital and it’s also human capital. And, therefore, robotics and automation is part of that resource scarcity mega trend. But focusing on the energy and the energy dependence of Europe, clearly this geopolitical crisis is highlighting to European countries the importance of diversifying their source of supplies. And indeed, it’s going to lead to an acceleration in investing for alternative energy of which green energy is one, but there will be also some focus on looking for gas supplies outside Russia. So LNG could be an interesting potential opportunity and it might even bring back the debate about nuclear energy as a solution – an interim solution whilst we are going through this transition period towards greener energy sources. And the nuclear energy topic is one that is quite divisive even within the European countries, with some countries being more pro and others being against, but certainly a geopolitical crisis of this nature, where clearly there is potential major risk of cut-off of energy supplies, which can lead to a sharp down impact on economic momentum, will bring that back to the forefront.

RLA: And then perhaps the second one, the future of technology. In this topic, you include security and defense, very topical at the moment. How do you think that the Russia/Ukraine conflict could influence this area? 

ZO: Very much. Indeed again, you’re highlighting a very valid point. So for us, future of technology can go into many directions of which we mentioned robotics and automation, but cyber threat is an important one, and security and defense. 

So, taking them one by one, cybersecurity for us is an important area of focus, which will be emphasised by corporates, given the crisis we’re going through. There’s clearly more risk of cybersecurity attacks both at the national level, but also at the corporate level. And we think corporates are going to be spending more of their IT budget on cybersecurity. We have been estimating a gross potential for cybersecurity of over 10%, possibly closer to 20% annualised over the next 10 years, in a market where IT spending by corporates is expected to grow at closer to 5% per annum. So it gives you the magnitude of that potential increase. The challenge in that market, Ryan, is to find the right type of companies because the market growth potential is strong, but the competitive pressures are also very high. And there is a tendency for companies to need to grow in scale. And, therefore, there’s acquisitive strategies that for us as investors can lead to diminishing returns. So, we need to be very focused on the right companies.

Then on the security and defense side. Absolutely, again, you can see that as a result of this geopolitical crisis with Russia invading Ukraine and the tragic crisis that this has brought and the humanitarian consequences that we’re seeing, is leading nations to decide that the need to spend more on defense and to increase their spending to closer to the 2% of GDP that NATO countries have been inviting to be spending. So again, that’s going to be a longer lasting consequence of this crisis, where you’re going to have more spending on defense, which will benefit a certain type of companies and certainly will increase fiscal spending in that area. So, for us on the macroeconomic side, of course, there’s an impact in terms of fiscal spending, infrastructure spending and a broader spending around other areas of that future of technology like artificial intelligence, in particular, which is connected to both security and defense and cybersecurity.

RLA: Thank you. Now taking sort of a step backwards from the current headlines situation, demographic changes is a major theme for the fund. How are you implementing this in the portfolio? 

ZO: Yeah, demographic changes, when you think about it as an investor, is critical when you’re thinking about 10, 20, 30 years out and beyond, and that’s why demographic changes is one of those three mega trends. We’ve talked about resource scarcity and future of technology. And demographic changes can take various forms. It can be an aging population in some countries, or it can be a vibrant emerging market middle class in other regions. So for us growth in the emerging market middle class is an important driver. The aging population indeed is an important aspect as well. Within that you will have shifts in leisure at time, and shifts in how that aging population is spending – their retirement consumption. You’ll have the live longer, but also live healthier trend within that. As well as sadly, the 21st century diseases that an aging population brings, which for us are obesity, diabetes, and cancers. And therefore again, there’s ways to position a portfolio to capture some of those breakthroughs that are leading to tackling some of these 21st century diseases to stay on the positive side. 

And then there’s a few other aspects like urbanisation. Urbanisation trends are very strong and therefore there’s opportunities to capture these through some very well positioned construction companies or industrial goods, industrial equipment companies. And then what we also like is intersections between demographic changes and resource scarcity, where we’ve got physical infrastructure as one of the aspects, or food and water solutions are some of the potential themes within those intersections, or indeed on the healthcare side. When you think about intersecting, future of technology and demographic changes to tackle the aging population, you have things like bespoke healthcare, like genomics in particular, and the breakthroughs that genomics are bringing in terms of targeted therapy, which increases the chances of success for any patient. You have consumerisation of healthcare whereby more of the populations will be wearing connected devices to give them direct feedback on their vital organs, not just heart rate, but also blood oxygenation. And indeed, the diabetes population is now having this connected devices that can also read them their blood sugar level. So very exciting trends, solely focusing on demographic changes, but you can actually build a very diversified portfolio solely focusing on that one mega trend.

RLA: Thank you. Now we’ve talked a lot about sort of some of the concerns in the market, but thinking more positively, why would you encourage an investor to consider investing in Europe today?

ZO: Well, it’s a critical question, Ryan, we’ve looked at that on many occasions. And if you look globally, Europe is full of companies that are leaders globally in various fields, whether it’s industrial equipment, whether it’s some consumer brands, notably in the luxury good space, whether it’s some companies that are focusing on renewable energy of which wind, where again, you have some leading companies in Europe that deliver in markets globally. And we’ve talked about disruptive healthcare, connected healthcare and some of the robotics and automation that you need it in order to tackle the human capital shortages. And again, some very strong European companies, Swedish companies in particular, in that space delivering on what is a very strong, long-term structural growth trend for us, that’s robotics and automation. So, when you then look at the overall level, Europe gives you a better exposure to the global economic cycle than any other region.

In fact, even gives you a better exposure to the US economy than the US stock market gives you, and gives you a better exposure to Latin American economic prospects than a market like the US equity market. So that’s an important aspect to bring. And when you look at the valuation of Europe compared to the other developed market, which is US, you can see that, on a long-term basis, Europe is more attractively valued at the moment than the US equity market. So, we see more opportunities from a valuation point of view, but also good opportunities to capture global leaders that give us a good exposure across the economic cycle globally in a diversified manner.

RLA: Excellent Zed. Well, on that cheerful note, we will leave it there, thanks very much for your time today. 

ZO: Thank you Ryan. 

SW: The FTF Martin Currie European Unconstrained fund is a high conviction, no constraints, portfolio of quality growth companies with a long-term approach focusing on a 5-to-10-year time horizon. To learn more about the FTF Martin Currie European Unconstrained fund visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts. 

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.