Fund in Focus: Global Innovation
Fund in Focus: Global Innovation
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[00:00:00] Nick Peters: Hi, my name's Nick Peters, investment advisor at Marlborough Group, and this week I'm joined by Guy Fell, the fund manager of the Marlborough Global Innovation Fund, and his colleague Tom Hutchinson, an investment analyst who works very closely with Guy on this fund. Morning, gents.
[00:00:25] Guy Feld: Good morning, Nick.
[00:00:26] Tom Hutchinson: Morning, Nick.
[00:00:28] Nick Peters: So, I think just to kick off, let's explain what innovation means to you as the fund's philosophy.
[00:00:35] Guy Feld: Yeah, so, the word innovate is derived from the Latin word novus, which means new.
[00:00:43] Guy Feld: The fund is about providing investors with exposure to progress in terms of new things and new ways of looking at and doing things.
[00:00:52] Guy Feld: Most will think firstly of technological progress with artificial intelligence, cloud, mobile computing, and the digital age coming to mind.
[00:01:01] Guy Feld: The fund's got good exposure to these. But the fund also plays directly and indirectly to other areas of advancement, which are driving society and business forward.
[00:01:11] Guy Feld: One example of this is water conservation, a significant theme for the fund, where innovation enables the conservation and treatment of increasingly precious water supplies. Another example is an electrical company whose services are essential to and benefit from the innovation waves of solar energy, battery storage and cloud computing.
[00:01:33] Guy Feld: Innovation means new things and new ways of doing old things. And that can apply to any area of human activity. That's what the fund is trying to tap into.
[00:01:44] Nick Peters: Okay, thank you. The fund's objective is to deliver growth over five years. Is that a nod as to how long it can take for a innovative company to be appreciated by the market?
[00:01:56] Guy Feld: Yes, that is one factor. Over time, the market will want to see some solid execution to back up the story told. The other point is that this also reflects the fund's skew to smaller companies.
[00:02:09] Guy Feld: So smaller companies tend to be more sensitive to economic cycles and stock market conditions. The fund felt this hard in the last couple of years.
[00:02:18] Guy Feld: Other speed bumps include the need for management change in order to achieve their goals more effectively. They often require more time and more capital to prosecute their growth plans. The uptake of new products and services can take longer to mature and potential end markets can turn out to be different from those originally envisaged.
[00:02:40] Guy Feld: When it comes to emerging winners, you often see that no plan survives contact with the enemy. Nevertheless, we know full well that outstanding returns can be made as a company's potential is realised over the long term. One only has to look at the explosion of innovation driven technologies companies on the US stock market in the last 30 years to understand this.
[00:03:02] Nick Peters: You mentioned emerging winners and you classify the positions between emerging winners and established innovators, why is that?
[00:03:11] Guy Feld: The fund plays the innovation theme, but there's more than one road to Rome. And, we're conscious of having a balanced approach to getting the exposure that we need.
[00:03:22] Guy Feld: As we said before, there's a small cap bias to the portfolio. Emerging winners will usually be smaller, less liquid companies, maybe with weaker financials. Established innovators, however, will tend to be larger and more liquid companies, but usually with a lower growth rate potential as you'd expect.
[00:03:43] Guy Feld: So really it's about balance and risk mitigation as the fund can benefit from having more liquid stocks in harsher stock market conditions.
[00:03:51] Nick Peters: And can you give us an example of each of those currently in the portfolio?
[00:03:56] Guy Feld: Yeah, I'll kick off with Vertex. Vertex Inc. fits into our established innovator category. Vertex is approximately a $4bn market cap US company that provides tax compliance and management software for indirect taxes such as vat, sales payroll and important export taxes.
[00:04:17] Guy Feld: Indirect taxes are collected on behalf of a tax authority by a third party, so we most often see this when we pay vat on goods and services.
[00:04:27] Guy Feld: We see Vertex as an automation digital data science company operating in a hugely complex area where accuracy is vital. Vertex helps its corporate customers pay the right tax by the prescribed deadline. Penalties for not doing so can be very high.
[00:04:45] Guy Feld: Many governments at all levels, both state government and local government, are under huge fiscal pressure at the moment, so policing of tax dues becoming more aggressive.
[00:04:56] Guy Feld: Vertex sites a large global addressable market of about $22 billion. It's got over 800 million data-driven tax rules, which are constantly updated, and they have special expertise in highly technical industries.
[00:05:11] Guy Feld: The company is set to grow its use of artificial intelligence in both the preparation of its content and for critical areas such as customer support. We think Vertex can continue to generate solid double digit growth on decent and improving margins for some time to come.
[00:05:27] Guy Feld: We see it as a high quality innovation play for the global innovation fund for the longer term. I'd now like to hand over to Tom, who's going to talk you through Gentrack.
[00:05:38] Tom Hutchinson: Thanks, Guy. Gentrack is a New Zealand based company operating principally in New Zealand, Australia and the UK, providing billing and CRM software to energy and water utility companies.
[00:05:49] Tom Hutchinson: They also have an airport management software business, which provides resource planning solutions to more than 120 airports globally, along with a handful of other customers where people traffic is high. The company sits within our Emerging Winner category.
[00:06:02] Tom Hutchinson: Our core investment thesis revolves around utility companies needing to modernise their systems after years of underinvestment. And we anticipate a big wave of change occurring driven by initiatives to save cost and improve margins, whilst also adhering to specific regulations.
[00:06:18] Tom Hutchinson: Additionally, many utility companies use on premise solutions from the likes of SAP and Oracle. And given that SAP are phasing out their legacy offering, these utility companies are reassessing their requirements, which opens the door to Gentrax's utility centric cloud based solution. And many are determining that Gentrax's offering is superior from a functionality and cost perspective.
[00:06:40] Tom Hutchinson: Moving forward, the company expects to grow revenue at 15 to 20 percent per annum over the next couple of years. International expansion, the release of new products and modules in conjunction with upsell and partner led opportunities via Salesforce, for example, will be the key revenue drivers. And given the defensive nature of their clients, Gentrack should continue to perform irrespective of the economic uncertainty, especially given their solid balance sheet.
[00:07:06] Nick Peters: Thank you. Just turning to the fund more generally, although it was repurposed relatively recently in late 2021, it's already seen a surprising number of corporate takeovers, what do you put that down to?
[00:07:20] Guy Feld: Because real and greater value in those companies has been recognised by both financial, i.e. private equity, and trade, i.e. industrial players and competitors, by those players.
[00:07:33] Guy Feld: We have, of course, got mixed feeling on this, Nick, you know, as these trains have often reached their destinations early, so to speak. But it is, we think, a form of validation for the fund's strategy.
[00:07:46] Guy Feld: We had some new takeovers on the UK market to which the fund has a relatively high exposure and again, that supports another thesis of ours that the UK is one of the cheapest developed markets in the world with some outstanding innovation plays.
[00:08:01] Nick Peters: And just talking about the performance of the fund more generally, you mentioned earlier that it has been challenging of late. Could you maybe give some color to that? And have you made any subsequent changes to the process?
[00:08:14] Guy Feld: The fund was highly exposed to very small illiquid companies when the bear market impacted. The UK listed exposure, as I've just mentioned, has been high, and that compounded the issue as this market has been particularly disfavored.
[00:08:29] Guy Feld: We've adapted the process now, such that we intend to diversify more, taking the number of holdings over time closer to 50 from around 40.
[00:08:40] Guy Feld: We'll be more tightly controlled on the very smallest companies in terms of their weighting and how to scale in positions. Although we still think that the UK is one of the cheapest developed markets, you'll also see fewer UK listed companies in the portfolio going forward.
[00:08:55] Guy Feld: So, the weight of these should reduce and we anticipate more exposure in particular to North American, European and Asian listed stocks.
[00:09:04] Guy Feld: One last point. We've also been more active in taking advantage of price spikes and pullbacks. These are often more pronounced with small companies in particular in order to trim and add where we maintain a decent amount of conviction.
[00:09:20] Nick Peters: And you've mentioned a few times the exposure to smaller companies, and there are a number of commentators out there that smaller companies should do better as we see interest rates beginning to be cut across the globe. What are your thoughts on that?
[00:09:35] Guy Feld: So we've got to put this in greater context. I mean, you have to remember that interest rates would come down in theory because of the prospect of an economic slowdown or even possibly a recession.
[00:09:46] Guy Feld: However, in many cases, again, and particularly with smaller companies, some or most of this has been factored into their share prices. Yes, absolutely, a lower interest rate environment should give a helping hand to both equity markets in general and especially to small companies. We saw what happens to markets when rate cycles tighten as evidence of the opposite of that.
[00:10:13] Guy Feld: A lower rate set up improves the funding environment for small caps and increases the appetite for risk. The valuations of growth companies whose big profit years are further out tend to benefit from a lowering of interest rates. We spoke about takeovers, the funding for predators of all stripes also improves in that environment.
[00:10:34] Guy Feld: Another point to make is that a lot of small companies have 'toughened up' in the harsher environment. They've had to become leaner, more efficient and more profit focused. This should pay off strongly for shareholders as conditions improve.
[00:10:52] Guy Feld: From where i'm standing i'm more positive about smaller innovative companies than for some time and I think the fund has some very exciting positions, that will help to repair performance in the short to medium term. And we've begun to see this improvement come through in recent months.
[00:11:12] Nick Peters: Thank you, and lastly, I think it's perhaps worth just talking about some of the innovation sub themes that are running through the fund currently.
[00:11:21] Guy Feld: There are several sub themes, if you will. I would point to the theme of software automation in the portfolio. So I don't think this is a new theme, and with all its excitement, I see artificial intelligence (AI) as a direct evolution of that.
[00:11:38] Guy Feld: I spoke about one established innovator earlier, Vertex, which automates tax computation, management, and compliance.
[00:11:47] Guy Feld: Another example is emerging winner Active Ops, whose software automates back office operations at financial services and healthcare companies. Active Ops saves its customers real money by improving efficiency of large teams, with enhanced matching of labor supply to work demand, improved planning and project management, with better and more consistent workflow executions.
[00:12:13] Guy Feld: Bytes Technology Group is a leading Microsoft software reseller, and there is much anticipation about the potential of Microsoft's co pilot product. Which is an AI product that can automate the generation of content in applications such as Word, PowerPoint and Excel, greatly enhancing
[00:12:34] Guy Feld: I'd now like to hand over to Tom to talk about water conservation.
[00:12:39] Tom Hutchinson: Thanks Guy. A key investment theme for the fund is water. The UN estimate that 2.3 billion people live in water stressed countries,
[00:12:48] Tom Hutchinson: of which over 700 million live in high and critically water stressed nations. The World Economic Forum estimate that there will be a gap of 40% between global water supply and demand by 2030.
[00:13:02] Tom Hutchinson: It's considered to be a top global risk fueling conflict and arguably could be seen as a key factor causing tension in parts of Africa, Asia and the Middle East. However, let's not forget, it's not just distant high temperature regions that are impacted.
[00:13:17] Tom Hutchinson: The US estimate that $750bn is required to maintain their current service levels of drinking and wastewater, now it's interesting that President Biden's infrastructure bill made strong commitments to improving water infrastructure in the nation.
[00:13:32] Tom Hutchinson: I'd also add that key industries such as food and beverage manufacturing, life sciences and semiconductor manufacturing are heavily reliant on water and the lack of supply and impurities can be catastrophic to operations, so supply and quality is critical.
[00:13:48] Tom Hutchinson: With that in mind, the fund invests in a handful of water orientated companies. One is Xylem, a US listed business with an annual turnover of over $7bn. This company provides a range of solutions to allow utilities and companies across a range of industries to improve the way water is managed.
[00:14:07] Tom Hutchinson: Another is an innovative and recent addition to the fund, Energy Recovery, a company that designs and manufactures water technology used in desalination plants and in industrial customer sites where a lot of wastewater is produced.
[00:14:22] Tom Hutchinson: Interestingly, their innovative pressure exchanger technology generates little to no emissions when operating, thus lowering costs whilst providing an innovative solution to fluid flow.
[00:14:34] Nick Peters: Okay. Thank you. Guy, Tom, thank you very much for your time.
[00:14:38] Guy Feld: Thank you very much, Nick.
[00:14:40] Tom Hutchinson: Thanks nick.
[00:14:41] Nick Peters: So that was Guy Feld and Tom Hutchinson. If you'd like to hear or read more about the Marlborough Global Innovation Fund, then please go to our website, www.marlboroughgroup.com. Thank you very much. Goodbye.