Year end special edition

I dislike commenting on short periods of fund performance primarily because it leads to short-term thinking, something which markets certainly don’t need more of. However, it’s important to be transparent to our clients and admit that the second half of 2018 has been a particularly tough period for our representative global sustainable equity strategies. Mid-cap growth investors like us have found these market conditions very challenging.

It is easy to be unsettled by the velocity at which the stock market has turned down and rotated into large-cap and traditionally defensive sectors. But we invest in companies, not sectors. We want to identify long-term disruptive trends, not short-term factors. When stepping back and framing things in this context, conviction is not hard to come by. We are positioned for a future beyond the next couple of quarters and history suggests that volatility will throw up great investment opportunities.

Figure 1: Relative large cap and small cap equities performance second half of 2018

Source: Factset

I believe we are at the intersection of two very powerful supply and demand curves.  Technology led deflation (supply) is converging with the greatest sustainability challenges the human race has ever faced (demand). Capital markets (particularly publically listed companies) can be the bridge between that supply and demand. The demand is unfortunately inevitable, but so is the supply. I am optimistic. It is evident to me that this intersection is driving a wave of positive change in global markets.

This will create opportunities for the forward thinking investor. I believe that the market repeatedly underappreciates this sort of disruption. It requires imagination to think beyond the world we inhabit. The market may be efficiently reactive (some might say over-reactive), but I do not believe it is efficiently proactive. The tyranny of the discount rate, short-termism and backward looking investment strategies (passive and quantitative) leave the market blind to the meaningful medium and long-term disruption caused by such change. So what are these ‘inevitable’ intersections?

Electric vehicles will disrupt transportation and truly enter the public consciousness over the next two years. Declining battery costs and an availability of highly desirable and affordable electric cars will intersect with a strong consumer demand to go green.

Lithium-ion Battery Pack Prices (US$/KWh)

Source: Bloomberg New Energy Finance

Disruption in power generation and transmission will become clearer over the next five years as cheap battery storage combined with the relentless decline in solar and wind power costs make traditional fuel sources increasingly uneconomic as well as unsustainable. This should upend geopolitics too as coal, oil and gas producing countries become less relevant in the world order. Distributed micro generation of power will flip the traditionally centralised power station utility business model, exacerbating risks to businesses deploying the traditional model.

Levelised cost of energy

Source: Lazard estimates. Levelised Cost of Energy (unsubsidised) .Primarily relates to North American alternative energy landscape, but reflects broader/global cost declines.

Genomic analysis will drive an exponential growth in our understanding of biology and disease, causing positive disruption in medicine.  Moore’s law will also increasingly permeate medicine with new software and hardware led healthcare technologies thus reducing the cost of healthcare and improving outcomes. Within ten years, cures and life-changing solutions that are currently viewed as pie in the sky, could become our reality.

Cost per Genome

Source: National Human Genome Research Institute

The cost of automation will keep falling. Physical robots, machine learning and artificial intelligence will disrupt labour markets and supply chains. Adoption will accelerate across new industries and consumer products, increasing productivity and dramatically reducing waste. Low skilled jobs will be lost and labour will shift back to developed markets. Previously unimagined new jobs will be created. We will experience a deflationary boom. Within ten years, fully autonomous driving will add to the transport disruption noted above.

Source: ARK Investment Management LLC

I believe these intersections (and others that I don’t have space to include) to be inevitable. They provide an opportunity for sustainably minded investors to capture alpha. But identifying companies that can effectively bridge the gap between this supply and demand and having the courage to back them will not be easy. Despite the recent volatility and bearishness in the market, it is our intention to continue seeking out these #SustainableDisruptors and building investment portfolios with them.

Have a great New Year… and remember the falling prices we should be focussing on are not necessarily in the stock market.

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