317. 20 years of innovation: from healthcare to semiconductors

13 June 2024 (pre-recorded 7 June 2024)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. We cover a range of long-term themes in today’s interview, including advanced healthcare, AI, clean energy, and robotics.

James Yardley (JY): I’m James Yardley, and today we’ve got a very interesting fund for you, it’s the Guinness Global Innovators fund. And joining me today is Dr. Ian Mortimer, the Elite Rated fund manager. Hello Ian, and thanks for joining us.

Dr Ian Mortimer (IM): Pleasure. Thanks for having me, James.

[INTERVIEW]

JY: Now Ian, as the fund name suggests, I mean your fund I think invests in innovation, but what does innovation really mean for you? I mean, is this investing in a bunch of early stage startups or small-caps? Or is it something else? Tell us what the fund does.

IM: Yeah, I mean, to us it definitely means something different to that. So this is actually a strategy, we’ve been running it as a firm since 2003, so we’ve been doing it for over 20 years. And I think what innovation means to people today might be somewhat different to maybe how we considered it two decades ago.

I think today it’s often associated with early stage or disruptive businesses. And we can absolutely see that. However, what we are really looking for is essentially quality growth companies. And the way we’re thinking about innovation is really the starting point for where we’re beginning our process, which is looking for companies exposed to long-term secular growth themes. And that’s how we’re thinking about the idea of innovation coming through in terms of those themes, companies with exposure to those themes.

Not necessarily having to have it being the bellwether or the only thing that company does is the very innovative thing that we might be discussing; it could be part of a wider business and therefore we generally do not look at early stage companies. It’s quite difficult to find those ones that’s going to be the big winners. And we’re all about trying to increase the probability of good returns and finding those, as I say, quality compounder type stocks.

JY: Great. And so it seems like it’s quite a thematic approach. I think you’ve got nine themes within the portfolio. Could you tell us a little bit about those and go through each of them briefly?

IM: Yeah, absolutely. So, if we start with the very beginning of what we’re trying to do is ultimately find companies that can grow their earnings faster in the market – if you can achieve that, they’re the types of companies that can actually outperform over the longer term. The problem with that sort of thing is it’s very difficult to predict which of those companies are going to have that success because growth’s really difficult to predict. High growth companies tend to mean revert quite fast. And so you are right, saying our starting point is taking a more thematic approach.

We are looking at nine core secular growth themes where we think they have good long pathways for future growth, and therefore it’s a good starting point to identify as those businesses. And they’re quite broad. You know, we look at these themes once a year and review them. They don’t change that much. But they start with things like advanced healthcare – so there we’re thinking about in areas such as, you know, biotechnology or the pharma industry or even medical technology, artificial intelligence and big data. So clearly that’s one of the themes du jour that people are very interested in, clean energy, sustainability, cloud computing and all the associated parts of that; media and entertainment and how individuals are consuming their media entertainment, mobile technology, internet of things, next generation consumer – thinking about e-commerce and such like; payments in FinTech – you can see that’s evolved very rapidly over the last decade. And then areas, more industrial areas, like robotics and information. And so we have quite a diverse group of themes. We think that’s a really good thing to have.

JY: Great. And you recently said that the semiconductor decade affects almost all of these themes. Can you elaborate a bit more on that? And do you have significant semiconductor exposure in the fund?

IM: Yeah, absolutely. You know, when we are thinking about those themes, it’s very interesting how the market perception of the semiconductor industry has evolved. And really it was a very, very cyclical industry previously because effectively it was all about PC sales: how many computers are businesses and individuals buying? How many chips do they need therefore to supply that? In a positive economic environment, businesses buy lots of it and hardware. Then there’s a recession, people don’t buy very much at all. And therefore you get these bigger overhangs and this steep cyclicality.

However, these days, if you think about, you know, just day-to-day life, we’re finding the demand for semiconductors across all sorts of different areas, whether it’s electric vehicles whether it’s in your mobile phone, whether it’s any of the other devices that you may have, whether it’s around the home or the number of electronic items and, you know, iPads and so forth that one uses all the way through to industrial processes, robotics and logistics for example.

So what we’re seeing now is really if we look across all of our different themes, we do see quite strong demand for semiconductors in each of them. That’s therefore been incredibly interesting for how that sector has evolved. And you’re right, we have had quite a big overweight to the semiconductor industry for a number of years. And our view on that was actually, I think the demand side we felt was very positive, therefore, we felt that the revenues of these companies could grow.

And then the more interesting part was also that potentially the industry was going into a period of change where it was becoming less cyclical. It’s not that it’s not not cyclical anymore, but much less than it was, because the demand picture is so much stronger. And therefore that was also interesting to see the potential for quite a big uplift in terms of the valuation that market participants might place on them. And that’s something we’ve definitely seen in particular, over the last 18-24 months where that particular space has really outperformed quite significantly.

JY: Yes. And do you see it as a long term, super cycle then for semiconductors? Or will you still   trade around that cyclical element, which remains?

IM: Well, I think I would pause in terms of saying super cycle. I think that might be more associated with commodity type stocks, et cetera, because that implies an exponential growth in demand. And I do think it’s, you know, it is a long-term trend absolutely.

But I think what’s really helpful to note is within the semiconductor industry there’s quite a lot of different types of business. So, you have things like foundries, so very big manufacturing plants like Taiwan Semiconductor; so they’re actually making the chips. You then have companies that supply equipment to those foundries. They’re called the semiconductor equipment manufacturers. So, they’re doing a lot of very technologically advanced machinery. So that’s things like ASML of the Netherlands in Europe or KLA in America, for example, and they’re really crucial to that manufacturing process. They very much help improve yields, so avoiding errors et cetera in the manufacturing process, which is massively important. So that’s another part.

And then the third part would be those, what’s called fab-less semiconductor companies. So things like Nvidia. So really what they’re doing is they’re designing the intellectual property, if you like, so they’re designing the chips. They’ve spent huge amounts of R&D to be able to achieve that. They’ve got all the technological advancements and then they pass that on to a Taiwan Semiconductor to actually manufacture them for them.

So, three quite separate businesses going from more cyclical in terms of semiconductor equipment manufacturers all the way up to things like Nvidia, which is more like a software company in many respects.

JY: Yeah. And speaking of Nvidia it’s hard to get away from it at the moment. It has been a big holding for you in the fund. I mean, how are you thinking about Nvidia and the AI story at the moment? Obviously it’s had such a strong run – I think you were trimming it last time we heard from you.

IM: Yeah, so absolutely you are right. You know, it is the company of the day, if you like. And for good reason, I mean, it has an absolutely extraordinary performance and not just its share price, but in terms of actually how well the company is doing in terms of its sales and its revenue growth and its earnings growth. I mean, it really is very unique in that sense.

Nvidia’s a company we’ve actually owned in the Guinness Global Innovators fund for more than 15 years, so it’s been a very, very long term holding for us. And you know, we’ve seen that performance really come through. It’s been a big part of our performance track record, but one must remember not to get too carried away. You know, what we always think about is stock specific risk. So, we are always trying to think about the balance between letting your winners run – so you own a company that’s doing incredibly well, you want to try and capture much of that strong performance as you can. The risk is though, that if a company is doing that, it becomes a bigger and bigger part of your portfolio. These things don’t necessarily last forever and if you end up on the wrong side of it, you’ve then got a very big weight in your portfolio. If that then turns, you can then suffer quite big drawdowns and maybe you give up quite a lot of that strong performance that you previously had.

So, what we do in our fund is we actually run a 30 stock equally weighted portfolio. So we’re happy to let stocks run but if they’re starting to get above the 4.5%, 5%, 5.5% level in our portfolio, we tend to step in and reduce that back down, taking some profits along the way. And that’s something we’ve done with Nvidia over the last 18 months. So, we’re not trimming it constantly, you know, we want to get that benefit of these strong share price rallies, but we want to be conscious that stories can change, narratives can change in markets and therefore we manage that risk if you like, through the systematic application of our investment process.

JY: Very good, yes, it’s of course something the Guinness funds are all famous for having that equally weighted approach. And do you see AI as being a big benefit and opportunity to investors? I mean, or is it also potentially quite a big threat to a lot of industries and stocks?

IM: Yeah, I mean, I think it is, firstly it is clearly a very important technological advance. You know, if we look to leaders globally and then the way they’re describing it, both from a   government perspective and an individual company perspective, this is making big changes and we are seeing that come through in many ways.

Clearly at the moment the market is focused on the picks and shovels, I think is the phrase used, like the Nvidia’s, you know, that’s been the main beneficiary. And in many other cases, the benefits or the reverse of AI, we are yet to clearly see. And I think the risks would be, in terms of more potentially the individual if you like, in terms of – and we’re all worried about is AI going to take over jobs, et cetera – but the positive side would be as a society, I think it’s the potential improvement in productivity that can come through.

So, in terms of how we’re thinking about it, we are having exposure to companies like Nvidia where by the way, the valuation is somewhat reasonable for the growth we’ve seen – we’ve actually seen that become cheaper over the last 12 months because the share price hasn’t kept up with the significant growth in earnings which is

JY: Seems ridiculous, doesn’t it? But I mean, it’s incredible how fast their earnings growth has been.

IM: It’s true, but I think it’s quite healthy in the sense that, you know, this is still not a cheap company. It’s 35 times earnings, you know, that that is a big premium to the benchmark. And it’s   telling you the market’s pricing it.

One must be remembered the rule of big numbers, right? To double from here is much harder than it was to double previously. And I think the growth rates that are baked into the current valuation are still pretty high. They are significant but they’re not much different to the average growth rate that we might have seen, say, over the previous five years. I don’t think we’re going to see that 300-400% type growth in revenues or 600-700% type growth in operating income that we might have seen over the last four quarters, but I think that growth can still come through.

But I think in going back to the original question though, yeah, absolutely. And I think what the market is currently doing is looking very closely at second order effects. So, searching for which of those companies that are associated with this theme that maybe are not necessarily being rewarded with it appropriately. And I think that is also very difficult to do. And I think what we’re cautious of is we’ve seen big rallies in power generation type companies, so utility like, because it’s all about electricity demand, for example. You know, we shall wait and see, but you know, the fundamentals of those businesses do not necessarily reflect necessarily high growth rates – can they achieve that going forward?

So, you’ve got to be a bit careful about how quickly people can jump onto a story. You see the central narrative, you expand it out sideways and you jump onto those pure plays and you see big shifts in valuation. And often that’s not necessarily though the companies that really come through in the end. At the moment, we’re happy to have a broader group of companies that that may be benefiting from that. So, we do have you know, companies like Schneider Electric [Industries] for example, which is an industrial that has some exposure to electrification and so forth and does have some exposure to some data centres for example.

And there’s other companies like Adobe, for example, which are quite successfully integrating AI into some of their products that’s being you know, market leading and potentially could lead to being able to charge more for those products and therefore improve growth and profitability.

So, that’s how we’re thinking about at the moment. I think trying to pick the next big winner is very difficult. And I think seeing the marginal benefits across different types of companies but being cautious of the valuation one must pay for them, we think is the sensible approach for now.

JY: Yeah, I mean, it’s always tricky, isn’t it, because the history of markets is they love to get very over excited about things and tend to get too excited and then of course there’s a big depression afterwards. I mean, do you take a long term approach in the fund with your holdings? I mean, are you looking on a five to ten year view?

IM: Yeah, so turnover of the fund is very low. It’s probably about three or four companies per year, so say 10-15% of the portfolio. If you reverse that, you’re getting holding periods of 5+ years on average. And that’s how we’re thinking across a cycle. Cycles are somewhere between – business cycles – five to seven years, and that’s absolutely what we’re doing. Some companies, as I say, we have owned for more than a decade and that’s how we’re thinking about both our investment horizon and maybe how things can play out.

JY: Yeah, well certainly holding Nvidia for 15 years has been very beneficial, I’m sure. [IM: Yes] And another theme you’ve got in the portfolio is healthcare innovation. I mean, we’ve had previous guests talk about the intersection between healthcare and AI innovation: is that what you are looking at as well, or is there something else in the sector you also you are seeing?

IM: Yeah, I think it’s a mixture. And again, I think I would be somewhat cautious of finding the   the big winner in AI for healthcare, right? And that’s the only thing they do. I think what we’re seeing if we’re just purely focusing on the AI-type area would be companies like a fairly recent addition to our portfolio, Siemens Healthineers. So, that’s a large part of its business is scans and diagnostics for example and they’re seeing integrating AI within that process, right? So, improving patient outcomes, improving efficiency of reviewing those scans and so forth, you know, and that’s not their only part of their business, right?

What we’re trying to think about is actually we think that’s quite a strong business. It’s actually quite, we think, reasonably good value because it’s maybe been a bit oversold for things like, you know, potential exposure to China. They also have part of their business – which is diagnostics – which has actually been underperforming. And that’s somewhat turning around, we think, going forward. So there’s more to it, right, the bigger picture is we think this is a very strong business. We think it has been somewhat overlooked by the market. We think they can actually improve parts of their business that have actually been underperforming. We can see a good pathway for them to do that. And that should therefore lead to a potential re-rating of that stock over time whilst we’re also receiving that growing earnings, which is ideally what we’re looking for.

Now, part of the interesting things that those types of companies do is they have quite a big research and development spend, they are technologically advanced businesses; they’re constantly reassessing, reinvesting back into their business to keep improving and provide better outcomes for their clients. And as part of that, they’ll clearly be looking at things like AI and technology and software improvements to continue that. These are the types of companies we think are quite well placed to take advantage of that because it’s somewhat in their DNA already, if you like. So they’re   getting the benefits of using some of that new technology to improve what they’re already doing.

And that’s the sort of thing that I think we’re going to see more and more of, and companies that can successfully re-implement these new technologies will clearly have an advantage relative to their competitors.

We think it’s the businesses that have shown a good ability to do that historically, whether it’s whatever new technology it is and they can continue to do that because it’s, as I say, it’s built into what they’re doing and how they think about constant improvement and keeping that technological edge versus their competitors.

JY: Yeah, that makes a lot of sense. And I wanted to finish with a holding or two maybe that our listeners won’t have heard of perhaps which is doing something interesting. Do you have any of those in the portfolio?

IM: Yes, I would hope we do, yeah. I think a lot of what we own will be companies that people have heard of. You know, it is interesting at the moment that, you know, some of the highest growth or best quality growth businesses happen to be some of the biggest ones; the household names – the Microsoft and the Alphabets of this world, and they’re absolutely things that we do own.

We also have some exposure to some of the weight loss drugs, so Novo Nordisk we hold in the portfolio. So that’s another really interesting area, not necessarily associated with AI but again, one I think you know, a lot of your clients would know of.

The latest additions to the portfolio have been that Siemens Healthineers that I just described and then also the London Stock Exchange Group. So I think that’s, again, one I thing your listeners would’ve heard of but I think it’s quite interesting in terms of that business is a pretty small proportion of what they do now is actually associated with the exchange and IPOs et cetera.

Actually, a big part of what they’re doing now is a lot of essentially data crunching through their Refinitiv business. And I think that change in terms of what maybe is once associated with the company to what they’re actually doing now and how they’re adapting, and things like companies with significant amounts of historic data, that is becoming more and more valuable in terms of being able to use that data, package it up and provide new insights.

And I think areas such as that are examples where we are looking outside of the tech space in the US to find opportunities for reasonably priced, high quality growth companies and Siemen Healthineers in Germany and the London Stock Exchange in the UK would be a healthcare company and a financial company in Europe. And so I think, you know, that’s also helpful to remember, taking that global view can hopefully give you the best opportunity to find those great businesses.

JY: Brilliant. Well, thank you very much, Ian, that’s been really interesting. You know, the fund’s been doing very well, you’ve been delivering some great performance for investors, so please keep that up and thank you very much for joining us today.

IM: Pleasure. Thanks for having me.

SW: This fund will be of particular interest to investors who like to be at the forefront of innovation. The two managers are highly experienced and have developed a clear and consistent process which has proven to be successful — long term performance has been excellent. The fund will naturally have a heavy bias in favour of the growth style of investing.To learn more about the Guinness Global Innovators fund please visit fundcalibre.com