By Virginie Maisonneuve, Head of Global and International Equities, Schroders
"Is the global economy close to reaching a tipping point? The impacts of the key themes in our portfolios -demographics, climate change and the emerging market supercycle - are combining with the ramifications of the global financial crisis to create an environment where growth is reaching a point of "saturation". In this world, focussing on the sustainability of growth becomes more important than ever. This is important for investors as the global economy painfully adjusts to new realities and follows a rocky path to normalisation.
"The concept of growth saturation does not necessarily equate to zero economic growth, but rather implies that economic growth will be constrained at a lower level. Society, industries and investors must adapt to survive potential shifts from abundance to "scarcity economics" in some areas. In this environment, picking companies with sustainable growth is more crucial than ever, and understanding how sources of such growth might shift is key to building successful equity portfolios.
"For the five years since the financial crisis, the developed world has been dependent on waves of liquidity (quantitative easing), becoming beholden to governments and central banks to cushion the destructive adjustment process underway. In this transitional environment, with greater state involvement and tighter regulation, there has been much discussion about the need to develop a sustainable model for economic growth, less dependent on leverage. With this in mind, for an austerity plan to be more effective, it should be accompanied by badly-needed structural reforms to improve competitiveness and mitigate the impact of population ageing as well as environmental challenges. Alongside this, the crisis presents an opportunity to increase awareness of a broader concept of sustainability. It gives the chance to reshape the global economy to sustain growth in a saturated world."
Stock-picking in a saturated world
"The combination of environmental pressures and the global economic rebalancing precipitated by the financial crisis creates an evolving investment framework that both investors and companies must focus on in order to stay ahead of the curve. Below are a few areas of particular importance for picking stocks in a saturated world."
1. Regulation and Policy
"First, over time, it is likely that pressure will build for governments to adopt regulations and policies more suited to a scarcity framework. For example, policy could incentivise "good" behaviour or penalise - possibly via punitive taxes - companies that inefficiently or excessively consume environmental resources, or contribute far more than their peers to carbon emissions. This changing operating framework creates a competitive dimension for companies in resource-intensive industries, such that those with best-in-class resource usage and ESG practices will win. Even if governments are slow to establish appropriate frameworks, market forces will continue to drive resource prices higher, which will also alter the relative competitive landscape. Within this framework, investors should investigate the ability of company management teams to lead in changing political, economic and environmental circumstances. Proven ability for innovation and acuity will be rewarded, as these management teams will have the best chances of adapting to either gradual or sudden change."
2. Financial Systems
"Second, financial systems will most likely evolve towards a model where capital is allocated to investment opportunities with the best sustainable growth prospects, rewarding companies with efficient processes and resource utilization, as well as innovators and entrepreneurs. Scarcity economics will not only apply to the use of environmental resources but also potentially to other resources, including capital. Although interest rates are expected to stay low - even close to zero - in many countries for the foreseeable future, the need to deleverage combined with a low velocity of money and regulations encouraging capital hoarding are resulting in some degree of capital scarcity for many companies or governments."
3. Innovation
"Third, true innovation is key at times of structural change, and spotting the next leaders will be rewarding. In particular, innovation in the way we share information or produce, transport and use materials, will be crucial for developing sustainable growth models. Demonstrable promoters of productivity and efficiency will profit, especially when the efficiency gains are applicable to resources or processes under strain. For example, technologies enabling productivity increases in water treatment - desalination, purification and waste management - will be particularly valuable, especially in large and growing emerging market countries in light of potentially drastic climate change.
"Another area of sustainable growth will be for companies who can improve the monitoring, prevention and reduction of environmental damages. For example, Toyota has clear leadership in hybrid and electric vehicles; consumer goods giant Unilever has developed dry shampoo and single-rinse laundry products to reduce water usage by its customers.
"When thinking about innovation, one must also be open to radically new ideas and technologies that could have dramatic impacts on the established production systems in various industries."
Conclusion
"Growth investing may seem inimical to a saturated world with lower levels of overall economic growth and shifting growth patterns, particularly as fragmentations in the global village intensify (as discussed in our previous paper). But we believe the discipline to continually evaluate the sustainability of growth will be crucial to successful equity investing in a saturated world. Traditional analysis of company business models and competitive advantage remain important, but investors will also need to integrate new ways of understanding competitiveness in a scarcity economics context, with reference to resource intensity and environmental impacts. In this framework, the premium for growth companies should rise as "good" growth becomes scarcer. Given the risk of tipping points, any investor with a long-term horizon should be minimising portfolio risk by ensuring they invest in resilient companies with highly efficient resource usage and the flexibility to adapt quickly to changing conditions."
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