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April 7, 2022 | A Step Ahead
Let’s Not Talk About (Investment) Regime Change

Olga Bitel, Partner

Global Equity Strategist

Hugo Scott-Gall, Partner

Portfolio Manager,
Co-Director of Research,
Global Equity Team

Have a question for Hugo and Olga to explore on a future walk?

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Olga and Hugo survey the unsettled geopolitical landscape and consider how previous waves of change prompted problem-solving, innovation, and growth. When businesses are searching for alternatives to the status quo, new investment opportunities can spring up in unexpected places.

Hugo Scott-Gall: If I synthesize loads of stuff that I’m reading and hearing, there are so many crosscurrents going on in the world, and there’s a big temptation to say all these crosscurrents add up to a change in investment regime.

But the concept of investment regime is perhaps the wrong way to frame it. I think you would say that understanding how to find growth is always key, much more than headline labels of investment regime, styles, or factors. Let’s discuss instead where to find growth and the distribution of growth. Are the answers now different from what we had been expecting?

Olga Bitel: Sorry, can you repeat all that? I was rather taken by the birds chirping in the background as you were speaking.

Just kidding. I think that’s right. If I look back at what our portfolios contained through the decades, in the 2000s it was all about emerging-market consumers. These markets enjoyed massive improvements in purchasing power and were unsaturated. All the Western brands were having a bonanza, especially the consumer staples. Then China’s commodity boom came to an end. Emerging-market consumer stories started to fizzle out, not to mention the equipment suppliers and the commodities producers.

Next came the new wave of technology and the proliferating platforms, which—much to everybody’s surprise—survived the dot-com bust of the 2000s, relatively unscathed in some cases, and took off thereafter. More recently, you’ve got software as a service powering the efficiency gains of the back office.

What I’m simply getting at—and this goes back to our perpetual-growth machine—is that this growth and leadership transition is constant. New constructs, new geopolitical realities, new monetary orders, new technologies always throw up new opportunities. The way we go about finding these companies and figuring out where future growth is likely to come from will be the same. But where we’re going to find it, of course, may differ. Is that how you’re thinking about it? Or was I paying too much attention to the birds chirping and not enough to you?

Hugo: Well, the birds are wonderful, but they’ve gone quiet.

Yes, I agree with you. Maybe these many crosscurrents contribute to a time of faster-than-usual change in where to find growth. The Russia-Ukraine crisis, combined with a tight commodity supply side, may well elicit a response to find substitutes, alternatives—including security.

Oftentimes, a growth opportunity is triggered by a reaction to solve new problems. But sometimes quite a few problems hit you all at once. I think it’s probably one of those times.

Olga: Yeah, that’s a valid point. So let’s delve into the specifics for a bit. Fossil-fuel energy seems like the obvious place to start. I’m struck by a number of commentators who have referenced 1973 as a similar moment for Western economies that were suddenly hamstrung by the unavailability of the one lubricant they absolutely needed to run their economies, which was oil, black gold.

What happened? Denmark, which is the ultimate fossil-fuel importer, and which was hit quite hard by the 1973 oil-embargo crisis, became an exporter of energy by the early 1990s.

I think we’re on the cusp of witnessing something similar in the 2020s, which is to say that we’ve been looking for an energy transition. We’ve been accelerating our efforts to decarbonize for all sorts of reasons. And the current devastating and unfortunate conflict in Europe is exacerbating the need to find an alternative, high-density fuel.

In the meantime, there may have to be some supply rationing, redistribution, and rejiggering of supply sources, the retooling of refineries, all the rest of it. Europe could be busy building new liquefied natural gas terminals and improving capacity in existing ones, as may the United States.

But the bigger picture here is that we’ve been working on alternative supplies of fossil fuel as dense sources of clean energy. If we put enough resources into it—again, going back to our perpetual-growth machine—a solution can be found. Whether it happens in the next year or in the next five years, of course, we don’t know. But that work was already going on. And now we can expect it to accelerate, such that we may, in a relatively shorter order than otherwise, have a meaningful breakthrough.

Hugo: Here’s another argument for a change in investment regime, which is that globalization’s over, that we’ve begun to deglobalize. I think I know what you’re going to say: It depends on who you are. It may well be that for the average person in Africa, the world is still globalizing, but it may well be that for the average person in the United Kingdom, the world might deglobalize a little bit. Does that, therefore, mean we have less growth?

It seems to me that it doesn’t mean we have less growth. It means, again, the growth might be in different places. If you say that the driver for the average multinational company was chasing the spread of capitalism opening up new geographies, that created great growth opportunities for them. But that might have taken growth opportunities from local competition. Similarly, if you want to reshore production, that can create growth for anyone who provides solutions or knowledge to build local supply chains. Would you agree?

Olga: Totally. Any sort of dislocation, any sort of change, can be an opportunity for somebody. Moving the supply-chain discussion from “just in time” to “just in case” is a little too simplistic. We’ve all seen the headlines where some European automakers were forced to temporarily halt their production because some of their harnesses were produced in Ukraine. A month ago, you could have argued, that’s already regionalization or localization. After all, Ukraine is practically in Germany’s backyard. Nevertheless, we have a major disruption here. And so that introduces a level of nuance but also brings forward individual country politics and policies, and where to locate production, and how to gauge whether these new locations will continue to be secure and profitable. That’s not a trivial question.

To your point, there might be loads of local companies that do very well coming out of this. It’s not a coincidence that if we look at the broad benchmarks, small caps in the past decade have tended to do poorly relative to the large caps, and particularly mega caps, which is not what you would have expected, right? Smaller companies are usually faster growers; they’re nimbler.

So there could be quite a lot of opportunities that the globalization of supply chains and the nationalization of policies have failed to address. I think the current war has really brought some of this walk-back to the forefront. But a lot of these have been lurking behind the scenes for quite a while.

Might we see an accelerated shift in profit pools? Absolutely. Will local champions emerge? Highly likely. Does that mean duplication of supply chains? Perhaps, but it really means more alignment between where you’re producing and where you’re selling.

Hugo: I don’t think we can get too blue and down about deglobalization. I think we just have to understand that it might be the end of something that leads to the beginning of something else. For us as quality growth investors, we’ve got to actually dust off our passports and maybe visit some different places, or renew our mental models.

Again, as we think about the commodity cycle, or even inflation itself, there’s a big opportunity in problem-solvers. Should we therefore see a wave of innovation as we seek to create alternatives for inputs that have become more expensive? And we innovate around efficiency as well. So, if there’s a lag in making something cheaper to replace something expensive—like oil and gas, or certain mineral resources—in the meantime, we go for efficiency.

That seems to me like a great opportunity set, conceptually. You can frame an investment regime as inimical. But oftentimes, if you take the other side, if all these things are problems, how do you find growth? You look for the solvers.

Olga: Oh, absolutely. I would actually extend what you just said to include not only solvers and innovators, but also companies that are then using these solutions to improve their businesses. When times are good and demand is plentiful, why would you increase your efforts to digitize your back-office operations, for example, when the payout from that is highly uncertain?

In times when your margins are squeezed, and you’re trying to extract every last ounce of efficiency out of your existing operations, you may very well choose to invest in more efficiency, in more digitization, in removing inefficiencies and excess labor.

There are some interesting places in the world where a lot of these efficiency gains may start to turn up. Since the unfolding of the Ukraine-Russia crisis, one of the stock markets that has held up relatively well has been Israel. Normally, a jurisdiction like this would be absolutely battered. But if you are looking at the changes that have quietly but consistently taken place over the past decade, everything from discovering gas offshore and cooperating with Egypt to develop that, to building a desalination plant powered by Jordanian solar energy, to working with leading European and American tech and electricity-delivery firms to put in new fiber-optic cables to connect Europe to the far reaches of the Saudi Arabian peninsula, these are things that may drive massive improvements in efficiencies. And these investments were unthinkable 10 years ago.

This is just one area, but there are probably loads. To your point, we probably all need to start going to different places than we’ve gone to before. And we might find loads of opportunities, I reckon.

Olga Bitel, Partner

Global Equity Strategist

Hugo Scott-Gall, Partner

Portfolio Manager,
Co-Director of Research,
Global Equity Team

Have a question for Hugo and Olga to explore on a future walk?

Send us your suggestions at astepahead@williamblair.com

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