This year, Morgan Stanley Investment Management is celebrating the 20th anniversary of the Growth Team. The team’s strategies emphasize long-term concentration of capital in what the team believes to be high quality companies with sustainable competitive advantages and an attractive free cash flow profile: MSIF Growth Portfolio, MSIF Advantage Portfolio and MSIF Global Advantage Portfolio.
To commemorate this milestone, Morgan Stanley’s distribution team for the Latin American and US Offshore business, led by Carlos Andrade, invited more than 80 investment professionals, including fund selectors, portfolio managers, CIOs and top producing offshore financial advisors, to the EAST Hotelin Miami to participate in a discussion about disruption and permanence and how both concepts are incorporated into portfolios. Leading the debate, three members of the Growth Team: Stan DeLaney, Managing Director and disruptive change researcher, Armistead Nash, Managing Director and an investor on the team, and Mary Sue Marshall, Managing Director and portfolio specialist; who shared their views on secular trends and big changes coming from disruption on technology and disruption in business models.
The disruption landscapes
According to the Growth Team, disruptive changes play a very important role in their research process. As long-term investors, they focus on companies they believe to have a sustainable competitive advantage. To separate the wheat from the chaff, they need to have a good handle on the competitive environment that these companies face and the tech disruptive forces that may impact them over time.
From their experience, they state that disruption almost always fits into one of two types of paradigms: bottom-up disruption or top-down disruption. The first one, would represent those products or services that are not that good, but are so much cheaper than anything else in the market. Over time, people adopt them, the products or services improve, and the adjustable markets expands. The second type, a top-down disruption, would consist of those products or services that have a premium performance and price comparing to existing offer in the markets. As the technology improves, their cost declines and their markets expand.
“Back in 2004, we started working on the digitalization of advertising. At that time, executive directors and media had already realized that online advertising was a completely different animal, mainly because of its measurability. Our hypothesis was that, over time, companies will eventually migrate their ads from traditional media into internet. Fourteen years ago, 20% of the media time was spent on the internet, but only 4% of the advertising dollars were spent there. The relationship between advertising dollars and GDP has always being about 2% to 3%, and we do not think that will change. Today over 35% of advertising dollars are spent online, being online roughly internet and mobile, and over 50% are media that have transferred to online”, said Stan DeLaney.
Optimizing for the minimal disruption risk
Additionally, Armistead Nash believes that it is necessary that investors have a view on disruption and the competitive landscape the companies they invest in are facing. Especially nowadays, in a world where disruption is happening faster than ever before, driven by several different forces.
“One important factor of disruption is certainly the internet software space. The price of computing power has come down significantly with the advent of large cloud infrastructure players. Small businesses now have the capacity to outlay less capital investment upfront for their technology infrastructure. They can just rely on the computing power provided by these large cloud infrastructure players, and consequently, there are more start-ups coming to the internet and software space. We also feel that, with the advent of the internet and global funds, companies can have a broad distribution and approach to services like never before at a much lower cost. All these factors are driving an accelerated pace of innovation and change and starting out some new competition. It is precisely in this environment when it is more important to have a handle on the competitive landscape and to have a view out for the next three to five years, to invest in those companies that are exposed to minimal disruption risk”.
Considering its relation to disruptive change, Nash differentiates four groups of stocks: “First, we try to invest in companies that offer a product or service with very few or no substitutes. Second, we invest in companies that have an innovative culture, that despite incurring into failures, continue to invest a significant amount of capital back into new product launches. The third type of stock that we include in our portfolios are those that have the willingness to alter their product or business model based on the consumer preferences or the market demand. And, finally, the fourth type of company we invest in, are those companies that are not over-earning or over-charging relatively to the value that they provide to customers, avoiding creating an environment in which other enterprises can generate disruption in terms of pricing.
At a portfolio level, we intend to mitigate the impact of disruptive change from a risk manager perspective. First and foremost, we make sure we are using conservative assumptions in our financial projections for the companies that we invest in. Next, we avoid those businesses in which we do not have an edge on or we do not feel we have a competitive advantage”, he explained.