A Revolutionary Operating Shift for All Industries
So far in 2022, equity markets have been extremely volatile with a bearish trajectory amid economic uncertainty, monetary policy tightening, recession fears, inflation, and geopolitical tensions. Despite all these macro headwinds weighing on equity underperformance across market capitalizations, there remains one word that investors must keep top of mind to recover equities’ losses: “change”.
“Change” can represent a number of different meanings depending on the context it is used; however, investors must only be concerned with four applications to corporate industries and sectors: radical change, creative change, intermediating change, and progressive change.
Source: Harvard Business School
Referring to the chart above, investors often get these four types of “change” confused. Many innovation investors with complex approaches also misunderstand the time horizons of successful adoption, the companies that are at the forefront of “change”, and those that are a negative byproduct of the “change”.
Most corporate innovation is internal, oftentimes regarding operational efficiencies, personnel turnover, etc. However, the innovation that adds the most value to an investor is the fundamental infrastructure that supports a level of change (which at most intervals is only accomplished through external innovations). In short, innovation does not define change, but change defines innovation.
Currently, many industries are in the midst of multi-dimensional change aligning with the characteristics of progressive (rolling change seen in present and near-term equity returns) into radical change, which is often over a longer time horizon. However, it is important to understand the lifecycle of change. For instance, most change is progressive and creative, then it becomes radical or intermediating and, then levels back off to progressive and creative. Companies that start the progressive and creative change are generally more stable in generating growth of ROC, ROE, and ROA as the company enter the radical change stage with some evolving into an “industry leader.” Therefore, understanding the change lifecycle of industries and the investable opportunities remains pivotal to continued equity returns.
As discussed in the “Disequilibrium of Innovation,” we explained the importance of deeply understanding the assumption of neo-classical economic theory and how it applies to the current complexities of innovation. As we stated back in August of 2021, we noted that equity valuations were at speculative levels when compared to operating efficiencies, and we still believe there remains some room to continue to correct to more rational valuations. Looking back on that statement and the current economic landscape, we continue to question the validity of market reactions to external economic stimuli amid current economic theory’s closed system with bounded applications.
Opportunities for Investors
Thus, we are at an inflection point to invest in kneejerk market reactions for long-term progressive change. Amid equity market’s weaker seasonality in September and October and historical outperformance after Midterm elections, the next five weeks may be an opportunistic time for equity investors to buy at a relative discount and take advantage of more rationale valuations in terms of quality, fundamentally sound companies that have large asymmetrical growth through “change”. One such segment of equity markets that align with this investor agenda is climate investing or investing in companies that positively impact a path towards net zero carbon emissions. ESG debates aside, this is a non- partisan stance to help generate returns. In short, it is sheer common sense based on the equation below:
Innovation (Progressive Change) + Long-Term Growth + Stable Returns + Defensive Tilt = Outperformance (compared to the S&P 500 Index).
In short, the math for sustained equity returns adds up to an outperforming strategy. Whether you believe in the timeframe of climate change or not, it really does not matter as it remains difficult to debate against the path society is currently on may ‘eventually” lead to a weaker environment (in 5, 10, 20, 30, 50, or 1000 years from now). It is also hard to fight against a dichotomy that continues to grow among the most innovative companies in the world (most of BCG’s top 50 most innovative companies): move towards net zero or be left behind.
Climate change enthusiasts believe that investing in public companies that pledge net zero commitments or are putting corporate dollars towards innovating to negate climate change are a successful alternative investment opportunities. Therefore, the result is simple, either you’re a trend investor who doesn’t want to miss out on the change that can permeate across all industries, potentially leading to significant upside potential, or you are a core climate change enthusiast who wants to actively “put your money where your mouth is.” Both rationales are adequate reasons to find funds that accomplish these goals.
However, not all “green” strategies are the same. Investors should focus on strategies with companies that intrinsically understand “Climanomics” and have a defensive tilt to hinder equity drawdowns with a significant portion of the portfolio also in growth holdings to maximize upside capture. They also have the characteristics to smoothly replace investors pure S&P 500 Index exposure with a climate conscious proxy. All these aspects remain pivotal to identifying opportunities that are poised to outperform when looking past all of the current market uncertainty.
In short, investors must take a step back and look past the fear, uncertainty, volatility, and macro headwinds to establish a long-term perspective. Markets appear close to hitting a bottom and the contrarian in all of us seeks to enter equities at this time. The best performing investors focus on quality, undervaluation, long-term thematic growth through progressive change, consistency, and natural defensive positioning while remaining opportunistic. Therefore, we believe that climate equity funds check all of these boxes and NOW may be the best entry point on the journey to a long-term return story.