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Multiple authors
Multiple authors 03-06-21

Why we invest in innovation

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise.

The two all-time greatest investment approaches are undoubtedly value investing and quality investing. Value investing was famously pioneered by Benjamin Graham in the 1930s as a method of identifying bargains during the Great Depression. Quality investing was developed half a century or so later by Graham’s own student and protegee, one Warren Buffett, who after many years applying Graham’s approach began investing in much more profitable businesses with moats to protect themselves from competition.

While value investing earned its reputation as the world bounced back from depression and world war and quality investing by exploiting the subsequent stability of the late twentieth century, the world we live today in presents its own peculiarities.

Our own age is characterised by rapid change, innovation and disruption. In 1997, the Harvard Business School professor and entrepreneur Clayton Christensen wrote a rather technical book called the Innovators Dilemma (we suggest this is not one for the beach), which introduced a new idea to business strategy called ’disruptive innovation’. Christensen’s insight was that new companies can attack old industries in such a manner – with regards to the characteristics of the products and business models they introduce – that makes it all-but impossible for the old guard to defend against them.

Moreover, Christensen showed that true disruptive innovation is not about high-end technology but simple economics. Think of Netflix, which beat the giant that was Blockbuster in the 2000s simply through mail-order DVD rentals and abolishing the late return-fees that effectively covered the bills for Blockbuster’s physical stores. Or even simpler, think of Costco, which pools the buying power of retail consumers through its membership scheme and welcomes them into its warehouses to buy on wholesale terms that other retailers tied to supermarket stores cannot match.

Christensen provided the blueprint for many of what were to become the most successful businesses in the world over the past quarter of a century, and up until his untimely passing away last year he was an inspiration, advisor and friend to the 21st century’s best CEOs including Jeff Bezos, Reed Hastings and the late Steve Jobs.

By contrast, it is puzzling that the world of fund management has been so slow to embrace disruptive innovation as an investment strategy. We have no idea why this is the case because it is just as useful a tool for thoughtful and long-term focused investors as it is for CEOs.

Very few funds are invested in innovation as a core strategy across the whole breadth of the stock market, as opposed to the much narrower strategy of tech investing. Growth funds often lump innovative companies in with general growth stocks, but growth investing does not rank among the greats. Unlike value and quality, it has no rationale, no track record and no heroes.

But innovation does. Its long-term track record as an investment style as measured by peer reviewed academic studies is just as strong as those of value and quality investing. Innovative businesses can deliver high investment returns because they can grow at a low cost of growth. Contrast them to businesses that achieve growth through M&A, for example, which often pay such a high price for growth that it fully offsets any resultant cash flow, adding nothing to shareholder value.

Innovation is about good ideas, which from time to time may be acquired at little or no cost yet are among the most valuable things on Earth. As such, innovative businesses can convert growth into enormous incremental net cash flow. 

In developing our investment philosophy over the past decade, it has seemed obvious to us to put innovation and disruption at the heart of it, and this is why we manage our two global funds – the Liontrust Global Equity Fund and Liontrust Global Dividend Fund – according to our global innovation approach.

But not every great innovation is a great investment. Successful innovators create value for their customers through better or cheaper products, but they must also capture an adequate share of this value for shareholders. This requires them to build a moat to protect profits from imitators and also requires valuation discipline as an investor, both of these being factors upon which we place just as much weight as innovation itself. So, we are inevitably back at Buffett and Graham, and rightly so. In our view, an investment approach based on innovation, appropriately carried out, is simply an evolution of the great traditions of value and quality investing and not a revolution.

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Key Risks 
 
Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
 
Investment in funds managed by the Global Equity (GE) team may involve investment in smaller companies - these stocks may be less liquid and the price swings greater than those in, for example, larger companies. Investment in funds managed by the GE team may involve foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The team may invest in emerging markets/soft currencies or in financial derivative instruments, both of which may have the effect of increasing volatility. Some of the funds managed by the GE team hold a concentrated portfolio of stocks, meaning that if the price of one of these stocks should move significantly, this may have a notable effect on the value of that portfolio.  

 

Disclaimer
 
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances. 
 
This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust. Always research your own investments and if you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances. 
James Dowey
James Dowey
James joined Liontrust in October 2019 as part of the acquisition of Neptune Investment Management. He has researched and taught the history of innovation at the London School of Economics and has a PhD from the London School of Economics.
Storm Uru
Storm Uru
Storm joined Liontrust in October 2019 as part of the acquisition of Neptune Investment Management. Before joining Neptune in 2014, Storm graduated with an MBS in International Business from Massey University and an MBA in Finance at the University of Oxford.

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