Innovative companies are likely to be mispriced due to the complex nature of what they are developing, a fund manager has said.
This gap can be seen as a “complexity arbitrage”, and used to investors’ advantage, Mikhail Zverev told FTAdviser.
Zverev manages the TB Amati Strategic Innovation Fund alongside Graeme Bencke and Gareth Blades, which launched in May last year.
He began his career as an investment banker at Trigon Capital, and spent 11 years at Standard Life Investments, most recently as head of global equities.
He then spent nearly three years in the same role at Aviva Investors, which he left to join Amati Global Investors in February last year.
People sometimes don't give full credit to the UK for its innovation expertiseMikhail Zverev, Amati Global InvestorsThe innovation fund, which was £5mn at the end of January this year, returned 0.4 per cent in the six months to March 13, compared with the sector (IA Global total return), which lost 3 per cent.
It focuses on mid-caps, not mega-caps; last May the average market cap of the fund’s investments was £29bn; and it aims to outperform global equity markets over a three to five-year period.
Early indicators
The beauty of small and mid-cap investing, Zverev said, is that you learn about the future of innovation before the rest of the world realises.
To take an example, Arm Holdings was talking about the future of smartphones when they were a mere £100mn cap company, he said.
The semiconductor and software design company, which is planning to IPO in the US, was bought for $32bn (£26.3bn) in 2016.
“Imagination Technologies were telling us you can build 3D graphics on a TV screen long before it became a known thing,” he said.
“Cobra biomanufacturing, a little known company now part of Charles River, told us that the future of pharma is biologics.”
The UK in particular is a good place to find these kinds of companies, as it punches well above its weight in innovation, Zverev said.
“People sometimes don't give full credit to the UK for this.”
On top of this, investors in innovative companies can benefit from what Zverev calls the “complexity arbitrage”.
We believe innovation is still worth pursuingMikhail Zverev, Amati Global Investors“We are focused on innovative businesses doing spectacularly complicated things…they are more likely to be mispriced [as a result].
Technological change is not always priced in, because it is complex and uncertain, he said.
“So there is a great combination of a large opportunity creating a lot of value [that is] not fully priced in by the market."
“Despite all the drama in markets around innovation stocks for the past couple of years, we believe innovation is still worth pursuing.”
Three camps
When looking at what to invest in, the team divides companies into three groups: pioneers, enablers and adopters.
Pioneers are the investors, the leading lights, for example Tesla, which is a pioneer of the electrification of passenger vehicles.
The enablers are companies which provide the equipment for the innovations, for instance semiconductor manufacturers.
“These are the picks and shovels, suppliers and components, ingredients and services,” Zverev said.
The third group, adopters, are companies that benefit from this innovation without being an investor or enabler of it, but are a fast follower.
One example of this is Volkswagen, which has invested more in electric vehicles (EVs) than Tesla.
“If the EV transition does not go as fast as we hope, the Volkswagen still has an extremely profitable business in internal combustion engines, as well as the halfway house plug-in hybrids," he said.
“There is not always consensus, but we pick an area and [invest in] companies we think have a better risk reward.”
Cash in hand
The fund’s managers deliberately invest only in companies that are profitable.
Innovation companies are long-duration assets, Zverev said, and there are many companies in the sector that have a spectacular growth forecast but not a lot of profitability.
“Most of the value of cash flow security occurs far into the future, and [the company] might be dependent on ongoing access to our generous capital markets.”
In the past few years, when interest rates sat at incredibly low levels, the market was forgiving of this.
We cannot rely on the amount of capital availability seen over the past several yearsMikhail Zverev, Amati Global Investors“A lot of innovation investing that was going on two years ago was looking to capture the value of these transformative innovations, but unfortunately this was also a big lower-for-longer interest rate bet.
The regime has now changed, he said, adding that the last three years were the exception, not the rule to how markets operate.
“We wanted to build a fund that does not contain such a huge inherent interest rate bet in it.”
All of the companies the fund invests in are profitable, generating cash and funding their growth themselves with what Zverev calls “decent balance sheets”.
“For us this is important as we cannot rely on this, frankly unprecedented, amount of capital availability that we have seen over the past several years.”
sally.hickey@ft.com
