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.
Key Risks
