Fidelity Future Leaders Fund 'Super' Sector Series: 'Innovators'
Welcome to our series reviewing the ‘super’ sectors of the Australian ASX300 excluding the ASX50 stocks. In part one, James Abela and Monique Rooney look at ‘Innovators’.
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James Abela: Hi. I'm James Abela from Fidelity, and I am the portfolio manager of The Australian Future Leaders Fund.
Monique Rooney: Hi, my name's Monique Rooney, and I'm an analyst and assistant portfolio manager at Fidelity.
James Abela: We are going to produce a four part super sector series, which will look at four groups of the market and put them into correlated groups. That'll be the innovators, the cyclicals, the financials, and the defensives, and Part One of this series is focused on innovators. The innovator is really a future leader, which is creating change for the world, for people, and for business. They are typically high return, high sustainability, and high credibility companies. High return in businesses, high ROE, high sustainability, is large opportunities set, credible accounting, and really highly sustainable as a business. Then credible is really trusting management, trusting the accounts, and also that it's very visible as well so you can trust yourself to make judgements about it, and that is really what an innovator is.
Monique Rooney: Broadly speaking, most contemporary leadership occurs in sectors like healthcare, be it biotech, life sciences and pharma, but also technology, hardware equipment, software and services, but also consumer services, and automobiles and components.
James Abela: The opportunities are really size and scope and penetration to innovate and create a new market and go into that market and take market share. The risks as an investor are really, think of it as a beautiful compounder and falling in love with it so it's really blind love is really the risk. You've got valuation risk, competition risk, management complacency risk, and also the fact that there'll be increased capita required as you go through and penetrate the market further as we see more resistance from competitors. That's really the opportunities and the risks that you need to think about when you look at the innovation group.
James Abela: When you think about innovators, you've got to be very careful, make sure that they are actually quality businesses. You need to have persistency, structural growth, and distinguish that from momentum, which is more cyclical, more temporary, and that's one of the key things that you need to do. When you decide it is quality, make sure it is structural, and it is long duration, and there is persistency, and there is high sustainability. That's really the key thing that you need to think about because, if that is incorrectly assessed at the early stage, you won't be looking at the right set of risks when you are an investor in a high quality, high innovation business.
Monique Rooney: Some of the innovation themes that we're seeing is definitely in technology, software as a service, which is relevant for businesses like Altium. But also in healthcare, be it chronic disease treatment, that's relevant for Fisher & Paykel. But also, I think in the consumer service sector are definitely platform aggregators and that includes Domain and REA.
Monique Rooney: I think key trouble zones are definitely inflation so we're seeing that in commodity input prices, in food from a tight labour market, even property cost. But also, competition is increasing. We're seeing a shift from consumer goods away into services, and then we've also seen evaluation de-rating of high PE names, concept stocks and loss making stocks too.
A long term winner in a innovator is companies that are taking market share or growing earnings, beautiful compounders, have free cash flow yields of over 2%, sustainable return profiles, and good industry market structures or high barriers to entry.
James Abela: Some of the examples, there's a lot of them, in the Australian market, are typically consumer tech and healthcare, so Cochlear, CSL, Domino's, James Hardy, JB Hi-Fi as well has been quite innovative. These are really examples where the stocks have actually gone up 10, 20, and sometimes 30 or 40 times over a decade. That is what a beautiful compounder looks like.
03 August 2022
James Abela
Portfolio Manager, Fidelity's Future Leaders strategies
