Appetite for Disruption

Portfolio Manager Michael Oh explains what innovation means to him and what his guiding parameters are for choosing disruptive growth stocks.

What makes a company innovative?

We believe innovation is demonstrated by any company implementing new ideas to build a successful business in Asia and the emerging markets. The most obvious example would be a business that is offering innovative products that are creating or expanding markets. But innovation also touches on those companies that are implementing unique strategies or business models that may build entry barriers and sustainable economic moats—in other words that provide a company with a unique ability to maintain its competitive advantages over rivals.

What factors influence innovation?

The size and nature of the investment pool that business owners and entrepreneurs have access to is a major factor in influencing the degree of innovation in a market. For example, in the U.S. and China there are large pools of capital for innovative companies to pitch for, including venture capital and the initial public offerings (IPO) market. In less developed economies, innovation tends to come more from incumbents—established companies that are expanding their markets by bankrolling their own innovative products and services. Thailand and the Philippines are good examples. Here, it’s the established financial services companies that are launching innovative digital banking products rather than nascent fintech startups, which are providing many of these services in other markets like China and South Korea.

Labor pool is another influencing factor. Human capital is essential to innovation. Asia produces more PhDs than Europe or the U.S. and this is a good foundation for innovative industries. The size of the market itself is also a key determinant for levels of innovation. This has been especially relevant for China. The vast size of its domestic market has attracted lots of capital.

What about research and development?

R&D is definitely a key influencer to innovation. Robust R&D investments have helped Asia get ahead of other emerging market regions in areas like technology, communications, financial services and e-commerce. China, South Korea and Japan, for example, are helping Asia lead the world in new patent applications. More generally, R&D is enabling Asian companies to come up with their own innovations and increasingly they are targeting these products and services toward their home audiences. They’re trying to figure out what’s going to be popular in Asia markets and they are getting traction.

There’s been a lot of regulatory headwind, particularly coming out of China over the past year. Does regulation stifle innovation?

Not always. Regulation is a necessary part of a healthy economy and in many cases, it can improve prospects for long-term growth and fuel innovation. Looking at China, it’s true that regulatory interventions have hurt sentiment and weighed on the stock prices of many innovative companies. But one thing to note is that companies don't have to reinvent their business models because of these reforms. It’s more about making sure that they're complying with any new regulatory guidelines. In the case of China, one of the biggest priorities has been to protect consumer rights and data privacy while another objective has been to encourage fair competition among innovators. In my view, China’s regulatory efforts are generally aimed at generating sustainable long-term growth.

Which sectors are the most innovative?

Information technology, health care and communications services are innovative industries but innovation can come from sectors that may not be perceived to be dynamic or disruptive. Generally, it’s good to try to avoid thinking of sectors or markets as being more innovative than others. What’s important is assessing companies on their individual merits regardless of what industry they are in or what the latest consumer or industry innovation happens to be.

Name one key variable for assessing innovative stocks in today’s markets.

Right now, across the global landscape, we have an emerging inflationary environment combined with markets experiencing sharply contrasting sentiment. One manifestation of this is the substantial discount among the top technology companies in the Asia ex Japan region compared with similar companies in the U.S. That’s despite the fact that Asia tech companies have higher earnings-growth estimates for this year and for 2023. This tells us that the sell-off in Asia has been mostly sentiment driven and that the fundamentals of these companies are intact and offer long-term upside potential.

What innovative trends have you excited?

For the most part, companies that offer the potential for structural growth are exciting. In other words, businesses that offer innovative approaches in cornerstone-growth sectors, like autos.

For example, I believe in the next 10 to 20 years most new cars being sold around the world will be electric. That's going to bring a tremendous growth opportunity. Chinese and South Korean companies dominate the EV battery space and the pressure to innovate and improve their products has been intense. On the component side, China and South Korea companies are also key suppliers, along with Taiwan businesses. They are engineering EV car parts that are light, take up less space and are competitively priced.

Other cornerstone-growth sectors that have plenty of innovation are technology, health care, leisure, entertainment and financial services. If you look at industrial technology, the political and economic disputes between the U.S. and China have been a catalyst for innovative growth within China’s semiconductor industry. Personal computer makers and manufacturers of other electronic goods in China have historically been dependent on imports of U.S. semiconductors. Recent moves by the U.S. to restrict China’s access to U.S.-made chips has driven a large Chinese effort to build up the domestic technology supply chain. This innovative ‘import replacement’ trend has created a new structural growth market for Chinese chipmakers.



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