(Bloomberg) — Shares of companies renowned for potentially innovative and disruptive products took a gut punch in the past year, but a senior executive at Goldman Sachs Asset Management has a simple message for investors in them: Keep the faith.
Katie Koch, chief investment officer for public equities at GSAM, joined the “What Goes Up” podcast this week to discuss the state of play in markets and why, despite share prices that have crashed over the past year, investing in innovative companies is still a good idea for those with enough patience to ride out the market storm.
Below are lightly edited and condensed highlights of the conversation. Click here to listen to the whole podcast, and subscribe on Apple Podcasts or wherever you listen.
Q: You manage $20 billion of tech/innovation assets. Yet, so far this year, growth assets have underperformed. How are you thinking about this?
A: We are big believers on investing client capital into the innovation space. I did just want to impress upon something that we’ve been saying for the last several years, which is that we think when people step into these innovation themes, they really need to be committed for the long term. I don’t think any of these things are tactical trades. Generally, I think it’s really tough to time the markets, but I think it’s particularly true in a lot of these high-innovation areas. So I do want to say that it’s strategic, not tactical.
The second thing that I would say, is that I do think that the dislocation has been very severe, particularly in public markets. The very basic explanation for that is that growth assets, their cash flows are the furthest out. So they’re the longest-duration assets, if you will. And they’re the most hurt when it looks like rates are going to rise, which is obviously the environment we’re in. And so that was a big leg down of most of the pain that’s been experienced in tech. And everything is correlated effectively to one, so that’s been a painful absolute-return experience. But we think people who are already in these assets should have patience around it, because eventually we will be in a world where growth is scarce and these assets should rerate on the back of that. And if you don’t think you have enough exposure to this part of the market, I think the recent correction actually provides some really compelling entry points to get exposure to technology as a secular theme. So, that’s how I would think about it. Tech is down at the moment, but it’s not out. Don’t give up on it.
Q: What is toxic about inflation and rising interest rates, specifically for those long-duration tech companies? Is this all about that risk-free rate?
A: As rates go up, these cash flows are further out. It puts downward pressure on these stocks. But it’s not that in isolation. A second issue is just where valuations were. So valuations for broad equity markets were in their high-90th percentile, most expensive relative to history. Equity markets have corrected 17% from the highs, roughly, and valuations are still in their 90th most-expensive percentile. So there’s only two things that can really drive equity markets, which is multiples and earnings, and the multiples were already quite high, demanding mostly good news, and actually what we’ve gotten is mostly bad news. So I think the valuations are certainly part of it.
So you have this long-duration issue of cash flows working against you. You have the multiple was too high, arguably broadly and in tech specifically. And then related to a lot of this is the inflationary pressures and this dawning realization that the central-bank put is gone. In other words, the market got used to the reality that when things were difficult, the central bank would come in and cut rates. But, if they’re actually performing another important task, which is trying to control inflation, they’re less likely to do that in the absence of a major recession. And so, it’s a combination of all of those issues that are really weighing down on this part of the market.
The CEO of Microsoft, Satya Nadella, said on his call he was being pushed on this very issue, ‘The macro environment’s tough, how are you gonna operate through this?’ And he gave an answer that was like, ‘I don’t focus so much on that day-to-day because over the next decade, tech as a percentage of GDP spend is going to double.’ So it’s an incredible opportunity. And we know that company managements all over the world are going to continue to invest in innovation just to survive and also to take market share.
So, these things will work and they’re going to work really, really well. It’s just at the moment, it has been dislocated. I would think about that as an opportunity, if you have patient capital, to come in and step in here and buy some of these assets. I just think you have to be balanced. I have very little conviction on that on a 24-hour, one-week, even couple-of-month-view. I think it will work out over the long term, but you have to be patient and you have to be balanced about it. We are not, in my view, going to have a V-shaped recovery. That’s not what we’re set up for here. We’re set up for the hard work of hopefully stabilizing the multiple and these companies delivering earnings. And so, in my view, there will be strong recoveries and return opportunities from here. But it’s going to take longer for that to be realized.
Q: Can you narrow down what you’re finding attractive?
A: So, themes that we’d focus on, just because we’re talking about innovation, the way we do we do this is we think about how’s the world going to change over the next decade, what are the big themes, and then obviously trying to pick the right companies within those themes. So the themes that we’re focused on here is the energy transition. This is climate, for example. We also are interested in the future of tech, so the technology companies beyond the Faangs, down the market cap around the world. We like the disruptive future of health care and how that’s going to change the world. The consumer, particularly the millennial and Gen Z consumer. And then we’re invested in the real estate and infrastructure that will underpin all of that. So those are some of the major themes.
But it’s always prudent to have some balance in these strategies. So yes, we like these themes, but we don’t have to just be in companies that are growing at any price. We can own more expensive innovative companies, for example: software, a Snowflake, which still trades at 20-times on EV to sales. These are still, despite the correction, rich multiples, but they’re high-growth companies. We can own that in the future of tech alongside, for example, something in the semis space, which trades at much more reasonable valuations, a 20% discount to where it’s been relative to the last 10 years, in certain instances, and get that balance in the portfolio between the high-growth names and some of those more value or cyclical-oriented names. And we do that really across every theme. In health care, we own some of the medical-device companies, which are more valuation grounded. And then we own stuff in the genomic space, which is obviously very high-growth oriented. So we focus on the themes, pick the companies and try and have a balance within those themes of those high-growth companies along with some of the more cyclically exposed value-oriented names as well.
Q: You recently noted that returns will be lower for the next 10 years — can you talk about that?
A: It is what I believe to be true and something I really want people to reflect on as they manage their own personal wealth. I think about that through the lens of the 60/40 portfolio, so 60 stocks, 40 bonds. And I say that because that’s generally how most people around the world are allocated. And that’s been a phenomenal asset to own through the last cycle. That has returned 8% real returns, so after-inflation returns. You compound that 8% annually, that’s incredibly powerful and great news, particularly for people on a fixed income. That return is more like 5% over the last 100 years and about negative -9% year-to-date.
So my point is that a lot of returns were pulled forward into the previous 10 years, which suggests the next 10 years, returns are going to be harder to come by. People need to be prepared for that environment as they plan for their retirement, as they think about what they’re going to spend. And I think they need to prepare for it by being more active in their portfolio and seeking out those returns. And that leads us back to, so what do you do? In our view, if we are going to have inflation, we would recommend people be overweight equities relative to fixed income. And in the equities bucket, I want to acknowledge my biases here as an active manager, but clearly these tremendous dislocations in markets create really interesting entry points and opportunities for active managers to hopefully do a lot better than that passive portfolio.
And I don’t think that we’re set up for the lost decade of the 1970s. There’s a lot of reasons. It is actually different this time. I won’t go through the whole list, but, for example, employment’s in a much stronger place, inflation’s nowhere near as high as it was then, and we have more of the tools to tackle it, more independent central banks globally, et cetera. But it is going to be a decade of lower returns. And you’re not just going to be able to sit and own passive assets and hope it all works out. You’re going to have to take more control of your destiny. And we’re working with a lot of people to do that, particularly in their equity portfolios.
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