Global Alpha
Research Agenda

Growth and the Value of Disequilibrium

A constant theme running through previous Global Alpha Research Agendas has been that of change. As growth investors, we are naturally drawn towards areas of dynamism and transformation. Periods of change and upheaval present huge opportunities for the innovative and ambitious to challenge incumbents and to reshape industries or create new ones entirely. While an investment approach based on ‘reversion to the mean’ may work during periods of stability, when this status quo is upended the gap between winners and losers can widen inexorably.

For those investors who successfully identified emerging areas of disequilibrium over the past two decades, the rewards have been enormous. Powerful and persistent forces, such as the advent of the internet, the spread of the smartphone, the application of digital technologies and the re-emergence of China have created the opportunity for decades of exponential growth in companies on the right side of these changes. Despite the frequency of references to ‘disruption’ in financial press, our belief is that there are many industries which may only just be starting to enter a sustained period of disequilibrium. Many industries, including communications, entertainment and retail, have been transformed over the fifteen years we have been managing the Global Alpha strategy. However, pivotal areas, such as healthcare, education, real estate and energy, would still be entirely recognisable to someone working in those industries fifty years ago. As investors looking to identify durable growth opportunities, the likelihood of continued flux, the scope for innovation, and the potential for new value creation across broad swathes of the economy excites us.

Web 3.0

The emergence of the internet saw a period of wild experimentation. A plethora of new dot-com companies and business models emerged, benefiting from the open-source nature and interoperability of the internet. This set of common standards was born out of the non-profit nature of the organisations, such as government agencies and academia, that laid the groundwork for the modern internet. However, the bursting of the dot-com bubble dampened some of this early enthusiasm and set the scene for the emergence of the internet we know today. The unique nature of the digital world, a (virtual) world of zero-marginal costs, of increasing returns to scale and of powerful network effects has led to the rise of a number of internet giants, that have captured between them the majority of the time we spend online. The quality of the services these organisations provide has been an enormous and a hugely positive enabling force and the benefits they have brought to users has been immense.

We sense that companies from Amazon and Facebook in the west, to Alibaba and Tencent (owned via Naspers) in the east, must continue to prove their value to society at large, to innovate, and to increasingly self-police. Some platforms will likely strike the balance well, while others may struggle. As has so often been the case, we believe that we may be receiving valuable early warning signals from China. Not only have we seen heightened regulatory activity, but we have also seen the emergence of self-policing social platforms such as Bilibili, and the breakthrough of vast new consumer apps, such as Bytedance and Pinduoduo, offering innovative entertainment and novel buying experiences. The rapid scaling of these new entrants challenges our thesis that incumbents are protected by scale and that dominant platforms have an enduring monopoly on profitability. Through 2021, we plan to focus even more of our attention on understanding continuing evolutions in the Chinese digital ecosystem and to think carefully about whether these may indicate the potential for similar changes in the west. We also intend to further our conversations relating to the likely sources of future digital innovations and whether we may be about to enter a period with a more diverse range of winners.

The Imperative of Societal License

Of course, it is not just technology platforms where proof of societal value is important. Our hypothesis is that the era of aggressive capitalism could be in retreat, to be replaced by a new zeitgeist which promotes ‘doing the right thing’ above short-term profit maximisation. Consumers, governments and society in the west now expect more than the basic provision of goods and services at lowest possible cost; they are demanding an increasing environmental awareness and an ethical approach to employees, suppliers and customers, in addition to a great product at a competitive price. Individuals are becoming more discerning, more assertive and more vocal. This will potentially drive customers towards businesses and brands with ethically-aligned missions and authentic purpose: consumers want to align themselves with brands which they see as sharing their values. This may represent an additional threat to many legacy attitudes and business models, but an opportunity for companies with a strong, positive culture and clear message. Offering consumers what they want, while making them feel good, may be a source of durable competitive advantage. This is likely to increase the importance of understanding a company’s cultural DNA and how they seek to maintain this as they grow. As a private partnership, this is a challenge we have thought deeply about in relation to our own business.

If working with the grain of society is becoming more important in the west, it has long been a prerequisite within China, where it is already clearly understood that a company’s licence to operate can be revoked if its mission fails to align with the broader well-being of Chinese society. The larger the company, the greater the responsibility. Size alone does not make regulatory intervention inevitable, but it increases visibility and the pressure on a company to be seen to ‘do the right thing’. Businesses which manage these pressures and are pro-active in addressing and balancing the needs of regulators, users, customers and the societies in which they operate are likely to be at a significant advantage to their more reactive and flat-footed competitors. We must be alert to identify the potential winners and losers among our investments from this increasingly difficult balancing act, as well as where new opportunities may present themselves.

The Great Energy Transition

We are at the beginning of a great energy transition, from a system based on fossil fuels to one based on renewable-energy sources. In 2019, renewables accounted for approximately 72 per cent of all new capacity additions worldwide. This is driven not just by a desire for safer and cleaner sources of energy, but also cheaper ones. Renewable energy technologies follow a learning curve, meaning that as cumulative installed capacity increases, price per unit of output falls. This has driven exponential declines in the cost of renewable energy sources such that they are now among the cheapest sources of power. By contrast, no such learning curve exists for fossil fuel-based sources (or nuclear), meaning that this cost differential will only expand.

As the capital cost of renewable power continues to fall, the prospect of marginal energy costs falling to zero is no longer a pipe dream but a distinct possibility. Energy from the sun and wind is, after all, free and the operating costs of renewable power plants are comparatively low.

Our 2020 Research Agenda looked at the enablers and the incumbents of the energy transition. We considered the likely structural and permanent changes to energy supply, demand and prices. We look to build on our understanding this year by exploring two related questions. First, what are the second-order effects for industries as we move from a world of energy scarcity to one of abundance? What might this mean for energy-intensive industries, such as mining? Could new business models emerge to disrupt incumbents? Second, the desire for energy security has shaped global geopolitics for half a century. If we move to a super-abundance of energy sources, what are the new bottlenecks which may emerge in getting this power to where it is needed and how will companies or governments seek to mitigate or exploit these?

Global energy transitions are incredibly rare and have the potential to fundamentally reshape the societies we live in. The implications cannot be fully anticipated at the outset but will be felt for many decades to come. Understanding these changes will be vital for any long-term investor.

Risk Factors

The views expressed in this article are those of the Global Alpha investment managers and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in March 2021 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

Potential for Profit and Loss

All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.

Stock Examples

Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.

This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.

All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.

The images used in this article are for illustrative purposes only.

Annual Past Performance (net, %) to 31 December Each Year

Source: Baillie Gifford & Co. US Dollars.

Past performance is not a guide to future results. Changes in the investment strategies, contributions or withdrawals may materially alter the performance and results of the portfolio. All investment strategies have the potential for profit and loss.

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Qatar

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