Hi, I am Matt Reynolds, and this is Capital Ideas, your connection with the minds and insights helping to shape the world of investments.

The current surge in inflation, rising interest rates and the dramatic fall in equities so far this year could lead to a change in market leadership for years to come. As one Capital Group Portfolio Manager commented recently, this is climate change, not just a passing storm. So, if in fact it does turn out to be climate change, what will all weather investing look like? What are the types of investments that could do well if we see new normal?

Investors will be looking for sectors, companies and themes that offer the best opportunities for resilience over the long term. One of the best places to look for resilience is for business models that can have a good chance of achieving pricing power. I think you can see the potential for pricing power when you see certain characteristics of companies coming to the fore. The obvious one to highlight would be those companies that have cost plus contracts, for example; they can obviously pass on rising prices through their revenue lines, but we also see lots of other opportunities. We see companies that can charge a fee based on nominal prices, like insurance brokers and health insurance companies, having an ability to increase prices as inflation increases. Companies that have brands that can protect them from consumers making other choices, like the branded beverage companies could also do well in this area. Companies with highly engineered and value-added products also have the ability to increase prices and where the purchase frequency is low for consumers, price increases can be snuck in as well and in some respects the list goes on. The key point is that even in an inflationary environment, admittedly one that investors have not seen for a very long period of time, there are still lots of opportunities for investors to seek out businesses that can protect their margins and grow earnings long term.

In my view, the other area for investors to look for new ideas, and resilient businesses, are those that are innovative. Now this is such a broad term, but I think you can really see it in action in a couple of sectors right now and I will start with the healthcare sector. When we discuss the healthcare sector, it too is a very broad idea. So, as an example, let us get even more specific and see some of the advancements in treating obesity with drugs that could prove truly life changing for patients over time. Even further than this, reducing obesity for example, can have strong positive effects on reducing other diseases, such as those related to the cardiovascular system. This means other costs across the healthcare system can also be reduced over time, as all stakeholders stand to benefit and as stakeholders benefit from new healthcare innovations, there is a greater opportunity for long term success.

Whilst I touched on the pharmaceutical area with the obesity drugs, there are other areas such as devices, for example, in say, robotic surgery that have similar long-term, sector-wide positive implications. Healthcare feels a bit unique in that innovation in this sector can achieve what I would call a quadruple benefit: being that the patient benefits, the doctors see greater efficacy, the hospitals see more efficiency and the payers such as the insurance companies and the governments that often reimburse health care costs, all see lower costs over the long term. These innovations can be both life changing for the patient and allow the companies that supply them to participate in long runways for revenue growth. Now, I think that is one of the best examples of what we mean by calling out all weather investing and there are other examples apart from those opportunities were discovering the healthcare sector. For example, in the currently out of favor technology sector, I see similar types of innovation, where there is an inherent benefit to all stakeholders that have the potential to lift the outcome above the prevailing macroeconomic headwinds and make it if you like, all weather in nature, in terms of long-term potential.

Now, many of you will be familiar with the potential virtues of cloud computing. Another example of an area that may be able to provide the similar all weather features of an investment at a much earlier stage are those investments related to the energy transition. It seems to me that broadly, policymakers around the world have effectively outsource the implementation of energy transition from themselves to the financial markets. This likely has significant societal and intergenerational implications that are beyond the scope of this particular podcast. And we may even see policymakers take back the pathway to transition through public ownership of assets over time. But, assuming financial investors now have some control over the transition and its progress, then there will be similar all stakeholder benefit type of opportunities that are created over the long term. Despite the near-term rallies, we have seen in somewhat cruelly bucketed ESG stocks, I am confident that as the implications of the various pieces of legislation that created this outsourcing is fully understood by markets, such as the US Inflation Reduction Act, then we will be able to find durable and compound investment opportunities over time. I think this could be another source of all weather investing ideas.

To finish up, let us close the circle by looking at the characteristics of the individual companies that may fit into an all weather investing approach. Looking back, equity market leadership has changed significantly when there are major events in the market, such as the ‘tech wreck’ of 2000 and the ‘GFC’. Interestingly, not so much following the COVID outbreak because in many cases, the stocks were doing well prior to COVID, they got a huge boost and did well after COVID too.

If the change in market leadership is not just a passing storm, but does turn out to be more akin to climate change and we need to engage in all weather investing, then investors will need to change their focus. From a company perspective it could be more akin to riding super tankers, rather than investing in moonshots, and this may be a better way to go. Investing in some of the dominant companies in their industries that generate solid cash flows, have strong competitive moats, can fund their own growth, and have reasonable understandable valuations based on near-term earnings and cash flows. And I think there is that quadruple benefit popping up again, I think these are all benefits to all weather investing, so with those comments I will wrap up and say thank you very much for listening.

We are always trying to get better. If you have any feedback, including topics you would like to see addressed in future episodes, please send us an email at Capital Ideas podcast Australia. For capital ideas, this is Matt Reynolds, reminding you that the most valuable asset is a long-term perspective.