Is the Era of Passive Investments Over?
The market environment is definitely changing. Value versus growth, passive versus active — it’s time to have a look at the one overarching parameter that actually drives pricing power and earnings: innovation.
“There should be a shift back towards active investment. Passive has gone too far,” Elon Musk stated on Twitter already in May this year. While we don’t always agree with Tesla’s founder, we too see reasons for investors to reorient towards actively managed funds, especially when markets are in turmoil. “With five years experience in applied innovation investing, we can say that there is a time-transcending element to it,” states TSG CEO and Co-Founder Evelyne Pflugi. “This results in strong portfolio fundamentals through the cycle— which is the type of long-term value that passive vehicles such as ETFs won’t provide.”
Exchange traded funds (ETFs) passively track indices and thus provide easy and low-price access to markets for retail investors. They have also gained popularity among institutional investors given their high availability, breadth of available markets, liquidity, and tradability. Recently, however, fund managers have noticed a shift in demand. “Some investors have used ETFs as a handy vehicle for trading, but in the long-run, investors are looking for quality products to complement their core portfolios,” explains Pierre Guillier, TSG’s CIO.
Applied innovation drives earnings resilience
TSG’s investment approach centers around the belief that applied innovation is the key driver of resilient revenue- and earnings growth. “Investors seem to consistently underestimate the pricing power of innovation,” Pflugi notes. “They associate tech with risk and volatility. Applied innovation, however, provides the opposite: superior earnings - through the cycle.” To build active, long-only equity portfolios, TSG applies a proprietary innovation scoring system to a global equity universe. The key to innovation scoring lies in the close collaboration with the Singularity Think Tank, a network of entrepreneurs, executives, and academics with deep insights into innovation value chains. The resulting Singularity Score quantifies a company’s exposure to innovation domains (Singularity Sectors) worldwide across all market capitalizations and industries.
Since its inception in 2017, the Singularity Strategy has delivered an annualized 19% earnings growth rate, while the reference index MSCI ACWI only achieved 9%. “Interestingly, the most innovative companies managed to preserve or even grow their earnings during the pandemic, a strong proof of their resilience,” says Guillier.
To which extent is this superior growth profile the main driver of past performance? How much of future performance is priced in? The answer lies in a detailed look at earnings and multiples. The chart below compares the Singularity Strategy to the global market as reflected by the MSCI All Country World Index (MSCI ACWI): Over the long run, earnings growth is what drives performance while any multiple expansion or compression is a leading indicator of market expectations and responsible for the short term performance. “We can see, for example, how the market responded to the COVID crisis by correcting on a multiple basis and then rebounding sharply, looking beyond the pandemic once reassured by governments and central banks,” explains Guillier. “The market has been anticipating earnings declines since early 2021, shown in multiple compression since then. Currently, the MSCI ACWI is still pricing in more earnings than it has been able to deliver. The Singularity Index, on the other hand, paints a different picture: The innovation-driven portfolio has been overly punished by multiple compression while earnings suggest more room to the upside.” What this analysis also shows is the difference between the market overall versus an active strategy selecting for innovation revenues: the screen separates the wheat from the chaff.
Unique buying opportunity
“Overall, despite a challenging backdrop, company fundamentals in the portfolio remain strong. We continue to have a portfolio that is made up of highly profitable companies with low debt levels on average and a solid growth profile,” says Guillier. “For instance, the portfolio exhibits 20% higher margins and return on equity than the reference index. Coupled with the superior growth potential of innovation, this is a powerful engine for value creation.”
Facing a new regime of higher interest rates, inflation, and possibly a recession, companies can only sustain their position in a selective portfolio if they can offer a unique proposition. “In the current market environment, pricing power comes in handy,” notes Pflugi, further alluding to examples such as cloud integration and services or semiconductor frontend equipment. The place to find pricing power is applied innovation: “True innovators can price at a premium — through the cycle”, she states. “With PEs at an all time low for our strategy, we believe it is a unique opportunity to buy a portfolio of innovative companies offering superior growth and return over the long-term at an attractive entry price,” adds Guillier.
So is the era of passive investment actually over? “Active and passive investing can peacefully coexist,” concludes Pflugi. “However, if investors treasure strong portfolio characteristics, applied innovation is the place to be. The only place to find applied innovation is in an actively managed portfolio.”
About The Singularity Group (TSG)
The Singularity Group makes applied innovation investable in listed equities. TSG is the initiator of the Singularity Index™ (Bloomberg ticker: NQ2045), a global, all-sector benchmark and gold standard for applied innovation. The Singularity Strategies include The Singularity Fund (UCITS Lux) and the Singularity Small&Mid (UBS AMC). The Swiss investment boutique works closely with the Singularity Think Tank, a network of entrepreneurs and academics with deep insight to innovation value chains. Their input forms the foundation of TSG’s proprietary innovation scoring system that quantifies the engagement of companies within a set of curated Singularity Sectors worldwide across all market capitalizations and industries. The Singularity Score defines how much value listed companies are generating through applied innovation.
For more information on our investment solutions, please visit www.singularity-group.com.
