For innovators, commercial success also requires exceptional management teams. When creating a new market, management must have vision and focus, always with an eye on competitive threats and a willingness to “self-disrupt” their own processes to stay ahead.
Enablers: Leaders Behind the Scenes
Don’t just be seduced by headline-grabbing products. Instead, look further afield as technology enablers are often a better source of investible innovation in public equity markets. Enablers might not have the sexiest products or services. However, these companies provide the underlying technology to power blockbuster products and burgeoning trends. As a result, they tend to benefit from powerful demand drivers. And because they don’t dominate the headlines or investors’ attention, they often offer much better valuations and long-term return opportunity.
For example, suppliers of car safety systems aren’t household names, but they are almost certain to benefit from steady growth as automatic braking systems and blind-spot detection systems become mainstream in vehicles. Sophisticated sensors are becoming commonplace in a wide range of products, from computers to trains to spacecraft. Companies that make components for the Internet of Things are well positioned to benefit from an increasingly interconnected world.
Platform companies that benefit from network effects are another wellspring of innovative potential. Network effects are the disproportional benefits generated by the addition of new users. Think about companies like PayPal and Salesforce.com; they function as matchmakers, reducing business friction as the number of participant connections grows. That helps grow a company’s total accessible market—and effectively lower transaction costs, which can stabilize revenues.
What’s the secret to success for high-density platforms? Leaders enjoy a protective supply and demand model that often assures consistently high return on invested capital and stable sales growth. Would-be disruptors struggle to cross an ever-widening network-effect moat. For example, in the US, Zillow’s online real estate database controls most of the country’s house listing supply and most of the viewer demand—a high barrier that new entrants can’t seem to clear. And great platform businesses tend to yield strong-performing stocks—not just among the few concentrated at the top but across a broad swath of global companies.
Emerging-Market Innovation: Not Just China
Innovation is no longer just a developed-market story. In emerging markets (EM), too, investors can discover abundant innovation. That’s why technology and internet-centric companies make up about 40% of the MSCI Emerging Markets equity benchmark—up from only 11% in December 2007.
Investors should look beyond the usual suspects for EM innovation. It’s not just about exports and it’s not just in China. The new wave of EM innovation is focused on developing new technologies for domestic use. Local internet companies are growing fast and establishing strong market positions in countries as diverse as India, South Korea or Russia. Poland’s Allegro, for example, is an internet shopping destination with a 33% market share of Polish e-commerce, well ahead of US competitors such as Amazon.
In fintech, India is one of the world’s fastest-growing markets. In 2020, India processed US$25.5 billion in real-time payments, according to ACI Worldwide. Banks in India are leveraging technology and big data to grow their business. For example, HDFC Bank has developed technology to approve personal loans for customers in as little as 10 seconds; its personal loan business grew over 12% year over year in April 2021.
Green Revolution Drives Change
Innovation is not only driven by technological change. Sometimes social change, like increased environmental attention, can drive change. In both emerging and developed markets, growing global efforts to combat climate change are creating fertile ground for innovators. For example, although EVs are still a niche product today, with only 7 million vehicles in the global fleet of 1.6 billion, technological breakthroughs are widely expected to promote a huge increase in adoption. By 2030, we expect 200 million EVs on the road around the world. The beneficiaries of this shift will be not only EV manufacturers, but also auto-parts suppliers, battery-makers and certain semiconductor companies that are enabling the transition.
In the rapidly evolving world of climate solutions, many companies are pioneering completely new industries with rapidly growing demand drivers. Investors can take innovative approaches to find them, for example, by searching for companies with formidable carbon handprints. In contrast to carbon footprints, which measure the negative impact of companies on the environment, companies with carbon handprints are creating positive solutions to global climate challenges. Companies with formidable carbon handprints will be at the forefront of efforts to reduce the world’s carbon intensity. Many offer products and services that will facilitate the transition to a low-carbon economy or help communities become more resilient against the physical effects of climate change. Examples include companies providing decarbonization solutions for clean energy, resource efficiency, transportation and sustainable agriculture, as well as resiliency solutions for water and infrastructure.
Novel Funding Models and Portfolios
Alongside the vibrant innovation driven by companies, the financial sector is rapidly offering new ways for companies to raise money and for investors to back them.
In equity markets, special purpose acquisition companies, known as SPACs, have become wildly popular on Wall Street over the last year as an alternative to initial public offerings (IPOs). In this model, investors fund a “blank check” company with the intention of purchasing a yet-unnamed privately held company and taking it to market. SPACs have helped hundreds of companies find a speedier path to market than traditional IPOs, but they also have a complicated financial structure and present risks to the initial financial backers—who don’t know what the target company will be. Although SPACs have existed for some time, their recent popularity surge demonstrates the market’s growing appetite for innovative funding structures that break through established Wall Street norms. While the SPAC boom is opening up exciting new funding opportunities for innovative companies, investors must approach these deals with caution and be aware of the risks, as they are typically signing a blank check for a target company to be determined later.
Fixed-income investors are also seeing big changes in issuance structures, particularly when it comes to environmental, social and governance (ESG) bonds. While green bonds to finance a specific environmentally focused project or projects have been around since 2007, the concept has been expanded and enhanced in recent years. Today, investors can also buy bonds that are dedicated to social projects—such as new buildings for communal benefit, educational programs for underprivileged demographics and more hospital beds for low-income areas. Green and social bonds offer the ability to marry an investing strategy to a project aligned with a responsible investing agenda (Display).
