Tapping into innovative theme with mutual funds

Change is inevitable and so is its rapidly increasing pace! So much so that it surpassed even the predictions of Moore’s Law. As a result, markets are placing greater emphasis on a company’s potential future value rather than its current earnings . This has led to underperformance by companies with questionable business models or those facing disruptive forces, while innovative companies are thriving. So, what really is in-vogue currently?

In today’s world, companies that are nimble, adaptable to change, and able to counter ‘Digital Darwinism’ are highly valued in the markets . These companies are rewarded well by the markets and sometimes enjoy a stratospheric valuation as compared to the conventional players. The classic example would be some of the companies in electric vehicles and artificial intelligence space. Their valuations are reaching billions of dollars despite being in the early stages of product development .

This shift in market focus is driven by an idea-hungry post pandemic world, where innovation is more important than ever. Companies have realised that even if they struggle with innovation in the short term, they must foster a culture of innovation to stay relevant in the long term.

Disruption does not just mean a ‘slow-to-adapt’ incumbent being thrown out of business by a radical new-comer, it instead is about using the modern techniques to reinvent the wheel and remain competitive. For instance, a train engine-maker firm started with the steam locomotive business in pre-1960 changed to diesel locomotive with 100 kmph speed in 1960, it then turned to electric traction in 1970 with an output of 140 kmph, then came the transition to AC powered locomotive with a speed of 150 kmph in 1995 and finally the semi-high-speed train like Vande Bharat with a speed of 180 kmph. Disruption is all about the way a company makes their business model sustainable, both at the micro and macro level. It is about evolving and reprioritising the resources for future growth.

There are typically three types of innovation, the first being the radical innovation, where one replaces an existing product with a brand new one, for example a reel-camera now being switched with a smartphone camera. The second is the disruption innovation, where the new affordable product and services cater to a large customer base, like washing machines or refrigerators; and lastly, the incremental innovation, where a customer upgrades by replacing the existing products, like switching from an old TV to an LCD TV and thereon to an LED TV.

Innovation has been accelerating since the last century, and continues to pick up pace. For example, it took more than 60 years for stoves, steamships and telephones to reach 50% of the US population, but smartphones accomplished the same feat in just seven years. As a result, companies that prioritise innovations are outperforming their non-innovating peers. The median age of the top 10 companies in S&P 500 dropped from 85 years in 2000 to 33 years in 2018 and is projected to fall to 12 years by 2027.

It must be noted that innovation can be found across sectors. It could be technology led innovation or it could be process oriented. Recognising the potential of innovative companies to drive growth, ICICI Prudential has launched an offering based on the innovation theme. This fund is designed to take a bottom-up approach to invest in companies across sectors, market capitalisation, demonstrating innovation traits—a mix of both, quality and growth. The fund will also have overseas equities in the portfolio as a means to capture themes like cloud computing, entertainment and driverless cars. The present context of the COVID-19 pandemic has highlighted the importance of innovation in supply chain diversification, making it an encouraging time to support the innovation theme. .

Even in a high inflation environment, the demand for domestically manufactured products would drive more innovation, leading to lower costs benefitting the scheme. At a time when the global central banks’ may resort to pausing the interest rates, an offering which has a growth bias, such as this innovation-themed fund, could perform well in a normalising interest rate environment.

Disclaimer: The article is authored by Harshvardhan Roongta, CERTIFIED FINANCIAL PLANNER CM (CFP CM) with Roongta Securities Private Limited. The opinions expressed are those of the author and do not necessarily reflect the views of Business Insider India. Mutual Fund investments are subject to market risk. Read the scheme-related document carefully before investing. Do your own research (DYOR) before deciding to invest in any financial asset class.