Bulletins

 

The Guinness Atkinson Global Innovators Fund invests in companies with innovation in their DNA.  We think innovation is the intelligent application of ideas and can be found in most industries, and not just the technology sector as is often assumed. We believe good companies with a culture of innovation and strong capital discipline can deliver what we believe are the key factors behind superior shareholder returns:

Higher than average return on investment Persistent growth over a business cycle Importantly,these advantages don’t just occur in early stage companies with disruptive products. Mature companies can build innovative, competitive strengths that can continue to drive profitable growth.		The Global Innovators Fund received a 5-Star Overall Morningstar Rating among 1001 World Stock Funds for the period ending 9/30/15. Derived from a weighted average of the fund’s 3, 5 and 10 year risk adjusted return measure.

How do we identify innovative companies?

We approach the challenge on a number of fronts, but the first step is to recognize that an innovative company can be at any stage within its business lifecycle: from a start-up raising seed capital, right through to a decades-old multinational conglomerate. The process of identifying innovative companies must therefore take this fact into account and cannot simply be boiled down to a one-size-fits-all methodology.

We do believe, however, that innovative companies can broadly be split into two distinct classifications:

1. Smaller, earlier stage, more disruptive companies, or
2. More mature companies that are using innovation to continue to create profitable growth

For simplicity we classify the smaller, more disruptive companies as Group 1 and the more established, seasoned companies as Group 2. We do not look at ‘start up companies’, as they are often below our $500 million market cap cut off or unlisted.

 

Defining early stage Group 1 companies can be highly subjective since they may not yet have had the time to prove themselves. It is also easy to fall into the trap of confirmation bias when looking at these types of companies by only recognizing and giving credit to ideas and processes that you already believe in or have seen work in the past. We therefore seek third party acknowledgement of a company’s innovative status and also look for ideas from as wide a range of sources as possible. For example, there are several academic and business reviews (MIT, Boston Company, for example) that aim to identify, or quantify in some way, innovative companies. We regularly scour these publications to add to our list of Group 1 companies.

Identifying the more mature companies in Group 2 is slightly less subjective, as they have a longer history of financial results to analyze and have had ample time to demonstrate their advantageous qualities. We believe that innovative companies that have successfully transitioned through the initial growth phase are much more likely to be able to earn a higher return on their investments than their non-innovative peers.  Also, if they remain innovative, they should be able to maintain this advantage over time.

In order to quantify these characteristics we search through companies’ reports and accounts and try to identify only those companies that have consistently earned a high return on capital for an above average period of time. This may not prove they are innovative (they might simply just have a monopolistic advantage, for example), but it does provide a consistent marker that, in our experience, can frequently identify innovation. Despite their size and maturity, these companies have shown an ability to adapt and react to changing market forces. These companies create fairly steady profits, are able to continue to operate well in most economic environments, and often have strong balance sheets

 

Investing in innovative companies

Before considering a company for inclusion in the portfolio, we first analyze it to identify:

1. The level of innovation (disruptive, accelerating, continuous).
2. The driver of that innovation (science or technology, product or service, business model).

 

 

 

		Level of innovation
Key driver of innovation		Disruptive	Accelerating	Continuous
Science/ Technology		Scientific breakthrough leading to new technology with significant potential impact	Rapid improvements in young technology	Small continuous advances in an established technology that can provide incremental benefits to the end user
Product/ Service		A new product/service that has the potential to quickly take market share and change the dynamics of an industry	Rapid advances in adoption of product/service	Small advances in product/service or end user experience that maintains or grows market share or competitive positioning
Business Model		A new revenue/cost model or the confluence of technologies that has significant impact on incumbents	Rapid adoption of business model leads to rapid growth in market share	Continuous evolution of business model to maintain competitive strength

 

 

The level of innovation is indicated by financial metrics such as valuation premium, revenue growth, and consistency of return on capital. The driver of innovation is a more qualitative analysis based on an understanding of the industries and sectors the company operates in. If we cannot easily place a company within this innovation matrix, then we will likely exclude the company from the portfolio.

The aim is to invest in the 30 ‘best ideas’ from the innovative companies in our investible universe. We do this with a strict value discipline. Simply being identified as an innovative company is not in itself sufficient to be selected for the portfolio.

We regularly seek to generate ideas for further due diligence by screening the universe for different combinations of factors. The screens are designed to focus our minds towards companies that offer exceptional value relative to their own history, attractive value with improving sentiment, or have underperformed their peers.

Once we’ve selected candidates for further analysis from within our investment universe, we subject these companies to a thorough due diligence process. We construct models to understand how the company has evolved over the previous 15 years (if possible). Covering factors include: growth; margins; uses of cash amongst capital expenditure, acquisitions, share buybacks and repayment of debt; balance sheet evolution; drivers of return on capital; key geographic regions; valuations relative to peers and the company’s own history; earnings sentiment; and dividend cover. We also seek to understand what the analyst community is forecasting for the company and understand the drivers behind the analyses. They will seek to form an opinion on more subjective factors surrounding industry trends and company-specific issues.

We are keen to meet with the management of companies we are analyzing, but this is not a prerequisite for investment. We have a preference for attractive metrics over good themes (or catalysts), as we believe informational advantage is of diminishing value. Identified themes or catalysts are often priced into the valuations of companies, with commensurate stretched expectations of growth leading to higher risk than is often perceived.

Summary

 

We like to distil our investment philosophy and process into four key tenets that describe the way we invest and what we are aiming for in our management of the portfolio:

	Philosophy		Process
Innovation	Innovative companies should create more value than their peers and therefore outperform over the long term		We focus on companies that have the ability to earn above average return on capital
Value	Over the long term value has historically outperformed growth  We do not want to over-pay for future expected growth		Sentiment and hype can drive up the valuations of some innovative companiesWe therefore maintain a strict value discipline
Growth	Growth can be hard to come by and therefore warrant a premiumHigh expectations of growth in the future is not attractive		We aim to identify companies with profitable growth and avoid those companies who are ‘growing at any cost’
Conviction	To outperform, a portfolio must be significantly different from the benchmark and we want all positions to have the ability to add meaningfully to performance.		The Fund typically has 30 equally weighted positions

 

Matthew Page, CFA and Dr. Ian Mortimer, CFA
Guinness Atkinson Global Innovators Team

 

The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus and summary prospectus contains this and other important information about the investment company, and it may be obtained by calling 800.951.6566 or visiting gafunds.com. Read it carefully before investing.

 

Mutual Fund investing involves risk. Principal loss is possible. Investments in foreign securities involve greater volatility, political, economic and currency risks and differences in accounting methods. These risks are greater of emerging markets countries. Non-diversified funds concentrate assets in fewer holdings than diversified funds. Therefore, non-diversified funds are more exposed to individual stock volatility than diversified funds. Investments in derivatives involve risks different from, and in certain cases, greater than the risks presented by traditional investments. Investments in smaller companies involve additional risks such as limited liquidity and greater volatility.

Opinions expressed are subject to change, are not guaranteed and should not be considered investment advice.

Past performance does not guarantee future results.

Return on Investment is a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments.

Return on Capital is a financial measure that quantifies how well a company generates cash flow relative to the capital it has invested in its business.

Morningstar Proprietary Ratings reflect risk-adjusted performance as of 9/30/2015. For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating™ based on a Morningstar risk-adjusted return measure that accounts for variation in a fund’s monthly performance including effects of sales charges, loads, and redemption fees, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. The Guinness Atkinson Global Innovators Fund (IWIRX) received 5 stars for the three-, five- and ten-year time periods ended 9/30/2015 among 1001, 758, 393 World Stock Funds, respectively. Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in distribution percentage. Other share classes may be rated differently. ©2015 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

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