“Being right means being non-consensus at the time of investment. In sort of practical terms, non-consensus translates to crazy” Alex Danco – Scarcity, Abundance and Bubbles [Invest like the Best, Episode 121]
Show the average investor the chart above, and there’s a good chance they’d roll their eyes. We’re taught to be cynical of such outlandish forecasts. We’re constantly reminded of past bubbles and the naïve market behaviour that they imbue. The pithy wisdom of legendary investors like Warren Buffet is usually translated to the mantra: invest in established quality companies and sectors at a discount, anything else is …. Crazy!
Dynamic power (getting there) is completely different from static power (being there), but the two are often conflated…The key to strategy is identifying emerging scarcity. Scarcity is where innovation can create power” -Hamilton Helmer, 7 Powers: The Foundations of Business Strategy
Helmer is a highly successful investor and strategist. Here he’s saying that identifying emerging competitive advantages requires a different approach to identifying established competitive advantages. A lot of investment value can be captured when evidence of advantage is just beginning to emerge. This often arises around new innovation (technology and / or business models) which addresses an emerging scarcity.
In short, we should not measure the rebel on the same metrics we measure the Emperor. The rebel won’t have a castle, but might have a new flying machine and a novel strategy for sacking the Emperor’s. The table below shows that some of the biggest rebel winners of the last 10 years looked very expensive on traditional metrics in 2008.
Best and worst performing stocks 2008-2018
Source: Factset. 8 Best performing and 8 worst performing stocks (continuously listed) within the MSCI AC World Index between the end of 2008 and the end of 2018.
So what’s my point? My point is that I believe investing in higher multiple growth stocks can be counter-intuitively contrarian. It is psychologically challenging for the following reasons:
- It requires volatility tolerance: By definition, more of the value of a fast growing business will be in the long-term future. Thus, in the short-term share prices can be very sensitive (i.e. volatile) to seemingly slight changes in long-term growth expectations and / or the assumed cost of capital.
- It requires a thick skin: Being ‘crazy’ can draw a crowd of not so friendly onlookers. Sometimes they throw stuff.
- It requires being wrong… often: You strike out more often if you always swing for the fences, but this approach increases your chances of hitting home runs. This is called the “Babe Ruth Effect”.
Focusing on the last point, according to Kahneman and Tversky, the pain of loss is about 2.5 times as potent as the pleasure of an equivalent gain. As a result, people are a lot happier when they are frequently right. But being right more often does not necessarily determine investment fund performance. Weird I know, but more often a few stocks going up or down dramatically will have a greater impact. In equity markets, the distribution of returns is skewed positively towards a small number of stocks that deliver extreme upside.
Hendrik (Hank) Bessembinder, Do Stocks Outperform Treasury Bills? (May 2018)
Great.. but what does all this have to do with sustainability? Well nothing… unless……. Unless, sustainability trends are a form of disruptive change?
In the early 1900’s humans were encumbered with very high transport costs and a terrible horse manure problem. These frictions were resolved by relatively cheap oil, the combustion engine and Henry Ford. It took a while to become clear (not as long as some like to pretend), but these solutions created clear frictions of their own…..
In my view, investors who have a sustainability mind-set combined with a disruptive growth mind-set will increase their chances of gaining exposure to the extreme positive returns of the future. The trade-off is that we will strike out more often, which will make us feel bad in the short-term.
Warren Buffet is a legend but we deliberately take a different approach. He backs the Emperors to stay in power, while we invest in the rebels that try to profit from their emerging weaknesses. I’m not saying Mr Buffet is wrong….. he’s just a different kind of crazy.
“Our approach is very much profiting from lack of change rather than from change.” Warren Buffet
About the author
Craig Bonthron is an investment manager in the Equities team, responsible for co-managing global equities portfolios. He joined us in 2014 from SWIP, where he was investment director in global equities. In addition Craig also had analysis responsibilities for the tech, energy and utility sectors. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors, a member of the global environmental equity team. Craig has a 1st Class honours degree in Building Surveying, an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 17 years’ industry experience*. *As at 30 November 2018