Video Q&A: global equities – what are "growth gaps" and how can investors exploit them?
The backward looking and short-term tendencies of markets means they can often underestimate companies’ future growth prospects, creating potential opportunities for active equity fund managers.
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No matter which region of the world or economic sector they operate in, companies that deliver revenues, cash flows and ultimately earnings above the level anticipated by the market can be well placed to also deliver superior share price performances over time. However, as Alex Tedder, CIO Equities explains, equity markets have a tendency to be backward-looking and short-term in nature, and, as a result often overlook future growth.
This creates inefficiencies for active fund managers to potentially exploit, and Schroders' fundamental global equity team sees good potential to add value by focusing on misunderstood future growth prospects. They do this by identifying companies with positive “growth gaps”, including “core compounders” whose competitive advantages position them well to reinvest and grow for much longer than the market expects.
Click above to watch the full video, or scroll down to see an edited transcript of this interview.
What is the philosophy of the fundamental global equity business?
We have a wide range of global equity capabilities within Schroders, which we've been building over the last 10 to 15 years. That encompasses the whole spectrum from systematic through quantitative to fundamental. I represent the fundamental part, and in that business we run a significant amount of assets with a team of about 25 people.
We have different capabilities and different approaches within the equity business, and that applies to global equities as well, but within fundamental global equity, we have a single investment philosophy and a single investment process.
The philosophy, I think, is interesting because it's all about inefficiency. The market is not very forward-looking. The market tends to extrapolate the past, tends to be backward-looking, and tends to be quite short term. When it comes to the future, and in particular future growth, the market very often is really quite inefficient.
That is the case all around the world, including in the most efficient market in the world, which is clearly the United States, and including the largest companies in the world, most of which are in the United States.
To take on example, Wall Street, or the “Street”, has been consistently behind the curve in terms of understanding the future growth of Microsoft, the revenue growth, the changing business model, the development of cloud, and most recently, of course, the evolution of artificial intelligence.
Such inefficiencies, to my mind, are as prevalent today as they were five, 10 or 15 years ago. And that's the opportunity from my standpoint, from my team's standpoint, to add a lot of value by focusing on those future growth prospects that aren't really understood by the market.
Any reference to regions, countries, sectors, stocks or securities is for illustrative purposes only and not a recommendation to buy or sell any financial instruments or adopt a specific investment strategy.
Past performance is not a guide to future performance and may not be repeated.
For more on the opportunities for active fund managers in 2025, watch here:
Video: Global equities – could 2025 be a vintage year for stock pickers?
What beliefs underpin the investment philosophy?
The really interesting thing about inefficiencies is that they can be very pervasive. I mentioned Microsoft already. They can last a long time before the market really starts to understand what's going on, and that's particularly the case when you have what we call “core compounding” companies, core investments.
These are companies that have some franchise, some particular product strength or market strength or even management strength that allows them to reinvest and grow for much longer than the market expects. Take Google, for example, clearly, the uniqueness of that business model is in the search engine itself, and the Street, again, has underestimated the strength of that franchise over multiple years.
So, the idea of core compounding is pretty important to us. And wherever we look around the world, first and foremost, we're looking for those types of compounding situation, that we find time and time again in different industries.
It's not just technology, it's a whole raft of different industries where you have these companies that have really strong competitive advantage and continue to for much longer than the Street expects. That's a big part of what we do, looking for those types of business. But at the same time, we also have to recognise there are many areas that are more affected by the economic cycle, many industries that are just inherently more cyclical in nature.
If you think about the oil sector or the commodity sector or the industrial sector or the financial sector, these are all areas that are heavily impacted by the economic cycle. The number of companies that actually are true compounders for multiple years is actually quite small. Within those industries, the investments we make tend to be more opportunistic, they tend to be more shorter-term in nature, more about the idea of an inflection in the growth dynamic that the market hasn't fully understood.
Take the energy sector in 2022, for example. That was an interesting one because post-pandemic, the market was in a very different situation to the one it had been prior to the pandemic.
The oil sector had suffered from a lack of investment during this period, and indeed in the run-up to the pandemic. So, supply was constrained coming out of the health crisis and yet demand picked up very strongly. That led to a very sharp inflection in the revenue and earnings growth of the energy sector and offered great opportunities for investors who were prepared to step into that sector and think about the inflection dynamic, which we did.
A part of our portfolio is in these opportunistic situations, not just about the economic cycle, it can also be a management change, a product change, M&A activity, other factors that create the dynamic for inflection - those can be powerful drivers of improvement as well. But the common denominator in every case is the idea that consensus often lags and often fails to see that improvement dynamic, fails to see the future growth, and as a result, tremendous opportunities are there for the taking.
What is a “growth gap” and how can this idea help to uncover opportunities?
It's a great follow-on from the previous couple of questions – I mentioned the idea of looking for those situations where the consensus is lagging, where the consensus hasn't seen the potential for improvement.
The growth gap, as we articulate it, is simply the difference between what we think a company can earn in the future and what is currently built into consensus. If you take probably the best example of that most recently, it is in the semiconductor sector where we had Nvidia, a company that has evolved massively in the last three or four years, now almost a household name, but three four years ago really wasn't understood by the market. The technology was not in focus. It was viewed as a niche player in the computer gaming sector because it had a semiconductor chipset that was its core product that was designed primarily for gamers.
And yet, Nvidia recognised quite early on that the evolution of video and complex unstructured data, generally in the internet world, would lead to the demand for a different type of chipset much more broadly. Those are the so-called GPU, or graphics processing unit chipsets that now dominate the semiconductor industry and have become the go-to for all the large platforms that are investing in artificial intelligence. The industry viewed Nvidia as a niche player – we took a view that the industry was changing, and the growth gap in that particular case was very large indeed between what we thought the company could earn and what the Street was estimating back two or three years ago.
Why invest in global equities?
I think there's always a strong case for global equities. Sure, we've had a great run in the sense the S&P 500 in particular has been a spectacular place to invest for the last 10 years. The S&P 500 has been more or less on the straight line since the Global Financial Crisis, with the exception of the pandemic and 2022, which was a year of correction for global markets. The returns from global equities, and the S&P 500 in particular have been very, very strong.
The great thing about investing globally is that we obviously live in a globalised world. That's not going away, maybe at the margin we might see some changes but broadly the globalisation story is very much intact. It therefore makes sense to look and to think globally for your investments, not to focus on a region or a sector, but to look at the wider opportunity set and to look for the best possible companies that you can find on a global basis. That's what we're trying to do. Every time I look at this space, and I guess what keeps me in the industry is a simple fact that there are always opportunities out there - somewhere in the world there is a bull market, and that will continue to be the case.
Any reference to regions, countries, sectors, stocks or securities is for illustrative purposes only and not a recommendation to buy or sell any financial instruments or adopt a specific investment strategy.
Past performance is not a guide to future performance and may not be repeated.
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