15 August 2022
By Mikhail Zverev
As our readers will know, in the past decade both markets and businesses enjoyed the benefits of low inflation and globalisation. We are now living through a reversal of that trend.
Global supply chains are disrupted, in part driven by the growing geopolitical uncertainty, while inflationary pressures remain elevated, with no let-up over the last month. We have seen increased tensions over Taiwan, with potentially grave implications for both the technology sector and the broader economy. Ongoing uncertainty around European energy supply and the strength of the job market in the US suggests that inflation is persisting.
Innovation offers some mitigation to these challenges. It creates competitive advantages and barriers to entry which often translate into pricing power, which helps to offset inflation. Innovation also brings structural growth that creates resilience to macroeconomic uncertainty. We are looking for these traits in our portfolio holdings as they drive, enable and adopt innovation in their sectors.
July is the beginning of the "results season", when companies report their financial performance which gives us insight into how our holdings are coping with these pressures. We are pleased to report that for the most part they are coping well.
One negative contributor in the month was Polypeptide Group, a contract manufacturer for the biotech industry. It focuses on a particularly promising category of compounds, enabling the development of many innovative drugs by its customers. Its results were indeed impacted by the scale of inflation. It will take a few quarters to pass cost increases through to their customers, but we are confident they will do so given company’s competitive strength and unique expertise. Polypeptide’s COVID vaccine related revenues were also impacted, where a customer had overestimated demand for 2022 and reduced the orders to the company over the next few quarters. We see this as a temporary issue and continue to like the long-term double-digit revenue growth opportunity ahead.
On a positive side, our holdings in PTC, Wolters Kluwer, Hubbell and Iqvia all reported reassuring results in line with our thesis, delivering and exceeding expectations on revenues and profits.
Another positive contribution during the month came from our semiconductor holdings. This sub-sector is a substantial position for us. The industry is cyclical, and the market is concerned about the current down-cycle in demand, leading to sector volatility. June was a weak month for semiconductor stocks, July was a strong one. We like our holdings for their multi-year structural growth opportunities and are prepared to live with market's short-term focus on cycle timing. Such cyclicality is the reason we get these opportunities at attractive valuations.
One promising area of semiconductor innovation comes from managing radio signals in our increasingly connected world.
Mobile phone networks are moving from 4G to 5G - we may not be buying smartphones more frequently, but the performance and complexity in their radio circuits goes up and alongside it the value of those components. Our homes and our cities are more connected, too - from more powerful WiFi to connected thermostats and security cameras to connected cars and shipping containers. All this drives demand for specialist chips - sometimes for performance, such as streaming video over 5G, sometimes for low power - for example enabling a device to stay connected for much longer on one battery charge. Our portfolio holdings Qorvo and Nordic Semiconductor are pioneers and industry leaders in these respective fields.
This technological change is creating another innovation opportunity – radar. While radars have been in operation since the 1930s and in some ways this technology is more than a century old, recent advances are making these devices a lot more effective.
On the "civilian" side, high-definition radars, working in conjunction with cameras and AI algorithms, are making a real difference to the performance of assisted and autonomous driving functions in cars.
On the military side, radar innovation enables detection of incoming artillery shells, mortar rounds and even weaponised drones. The advances in technology allow for placing small high-performance radars on smaller military vehicles, not just ships and airplanes. Sadly, this is an increasingly relevant challenge in our dangerous world today. During the month we added a new portfolio holding - RADA Electronic Industries - which is a pioneer and a world leader in such small tactical radars. It's impending merger with DRS will combine its ability to detect incoming threats with DRS weapons systems capable of neutralising them.
We look forward to sharing more of our thoughts about this innovation frontier with our investors over the coming months.