By Garvin Jabusch, Chief Investment Officer
Stock market volatility is here. There’s no avoiding that truth. Fear about what inflation and interest rates might do in the near future has hurt markets overall, with particularly severe share price pullbacks in industries and companies focused on innovation and climate solutions, almost to the extent we observed during 2008 and 2009. For us at Green Alpha, this is an indication that inflation and interest rate risks have now been priced into those stocks to a degree that the market, for these stocks, has very arguably become “inefficient.”
So, What’s the Problem?
The problem is, in fearing volatility, most asset managers and their algorithms are now positioning themselves to perform closer to the Dow 30 or S&P 500 Indices. The issue with this index retrenchment is that the indices are relatively short on the innovations that are defining and will define the global economy over the next five to ten years.
Repositioning one’s portfolio to get closer to the Dow 30 or the S&P 500 often means selling companies with business models focused on innovation (such as AI, robotics, genomic medicines, and renewable energies), despite how well they’re doing financially, or how much market share they are poised to gain, or are at this moment gaining (think of the current proliferation of renewable energies, for example). Left out of the buy-side equation today are those companies giving rise to pioneering change by taking advantage of the rapidly developing technology and science that is capturing big chunks of forward market share in multiple industries (AI and machine learning in general are the gravity pulling together multiple new innovations, be those in medicine, automation, DeFi including the Blockchain, you name it).
This means innovation-oriented investors have generally underperformed over the last year; however, many of the best and most promising companies of the future can now be purchased at multi-month, if not multi-year, low share prices.
But why this fear of innovation? Some capital markets traders may think risk only refers to short-term volatility, but that is not true. In fact, there are two types of risk in capital markets – volatility and structural- and there seems to be confusion about the difference and their relative importance over the long term.
Volatility refers to shorter-term share price movements, which can indeed pose capital risk for people investing under short time horizons. Structural risk is about conditions that exist and are unfolding in the real economy, and what those mean for the evolution of business, technology, the means of production, and consumers’ and business’s ability to purchase. These two market-place risks—short-term price movements and long-term economic shifts—each pose potential opportunities and dangers for investors, depending on their time horizon.
Structural risks and opportunities over a long-time horizon are what we at Green Alpha focus on as asset managers. We seek to achieve the dual goals of delivering outsized performance for clients over the long-term and creating meaningful change on the economy by deploying investment assets to companies creating more innovative solutions to our greatest systemic risks. Structural risks are issues such as the climate crisis, resource degradation, political instability, and widening inequality – the primary forces that will determine the direction and velocity of capital. Yes, price volatility can matter a great deal if an investor has a short time horizon; if prices fluctuate too much, they might lose money on the trade and not have enough time for it to rebound before selling the position and moving on to the next trade. But from our perspective as portfolio managers investing for the coming decade and beyond, we’re less concerned about short-term fluctuations than longer-term opportunities – such as the rise of new technologies displacing older, less efficient, more destructive ideas and means of production – a process now occurring in response to swelling structural risks identified above. It is important to note here that many structural economic risks have now become existential risks, thus adding a dimension of imperativeness to the forward direction and velocity of capital.
The Power of the Long Game
It’s not that Green Alpha is unaware of or doesn’t care about volatility – we certainly think about and understand it, but from our perspective as long-term investors, we care more about long-term structural trends than short-term price fluctuations. So, when in a period of widespread selling of shares in companies associated with projected future growth—as we are in now—we recognize an opportunity to take advantage of market inefficiencies. We can buy companies at relative lows today, and subsequently help our clients enjoy what we firmly expect will be some of the greatest economic tailwinds of all time.
One note on the growth vs. value aspect of this discussion, part of the recent narrative-driven rotation going on now, is that value is only defined by most algorithms as in reference to a company’s assumed intrinsic value as of last quarter’s report. We would point out that many of the innovators working to fix our largest systemic threats are going to gain market share also because, as they grow, their technologies will fall in price (see Wright’s law) and therefore become accessible to very large markets; this aspect is not appreciated in the usual growth vs. value conversation. Intrinsic value a few years from now can be, and in many cases will be, a very different picture than it is today.
This too is an important reason for diligent active stock selection. One limitation of algorithm-based trading that can make markets inefficient is inherent in its purpose, which is to greatly simplify markets. When we simplify problems, we inhibit our ability to identify meaningful solutions. Future demand and thus market returns will be correlated with the structural trend of climate change; algorithms have no way of assimilating that into stock selection. When we try to reduce ourselves to algorithmic rules of life, that eliminates our ability to be nimble in the face of change.
A real-world example of this is CRISPR Therapeutics AG (NASDAQ: CRSP), a biopharmaceutical company focusing on the development of innovative gene-based medicines for patients suffering from life-threatening or debilitating diseases. They are accomplishing this through gene editing technology – the modification of an organism’s DNA at a specific location, allowing it to perform new functions or eliminate undesirable ones – via the CRISPR/Cas9 system. This method makes use of RNA to locate the targeted DNA sequence and cut it out, either to mute or replace it with desired DNA strands. The company was co-founded by Dr. Emmanuelle Charpentier, whose research co-discovered the CRISPR-Cas9 technology, for which she holds multiple intellectual property protections and was awarded the Nobel Prize.
The transformative power of Charpentier’s and her colleagues’ work is inestimable. CRISPR Therapeutics is currently developing potentially curative treatments for cancer, diabetes, and many other diseases, and the promise of direct gene editing goes much further – new materials, fuels, and means of agriculture will emerge. CRISPR Therapeutics AG and its partners will directly provide many medical applications, and many more emergent applications being developed by other firms require the licensing of CRISPR Therapeutics’ intellectual property. CRISPR Therapeutics (along with several other genomics names we hold) are literally redefining many aspects of the global economy at present and, we believe, will be rewarded appropriately over the long term. And yet, CRISPR Therapeutics’ share price is down 70% from its January 2021 high (as of this writing), because many investors (and their algorithms) have determined it is too innovative and therefore too speculative to be “safe” in an inflationary environment.
This example provides the very definition of volatility risk vs. structural risk. Long-term investors possess the opportunity to buy firms that, because of their structural advantages and in terms of the evolution of the economy over the next decade, have better-than-average chances of dramatically growing their revenue, and to buy them at what we think are now absurdly low long-term share prices. These opportunities have been made possible by the shorter-term proclivities of volatility-focused risk analysis.
For these reasons, and in Green Alpha’s opinion, the era of blanket index-tracking should have come and gone by now. In fact, we think indexing and index-correlated investing in the present context represents a partial misallocation of capital. To appropriately capture forward market share and the resulting market cap growth, we believe it is critical to be benchmark agnostic, and to engage in active research and stock selection, which involves judging companies on their merits over the long-term, not by their presence on, or absence from, an index holdings list, or by their ability to help a portfolio correlate with such a list. Stock market volatility is here. There’s no avoiding that truth. But the underlying truth is that our structural threats present much, much more economic risk than does volatility. In trying to assimilate that awareness into an investing process, we can chart a safer course forward.
Nothing in this article should be construed to be individual investment, tax, or other personalized financial advice. All statements made about any company or security are simply statements of beliefs or points of view held by Green Alpha. At the time this blog was written, Green Alpha Advisors held some client assets in CRISPR Therapeutics (ticker CRSP). This holding does not represent all of the securities purchased, sold, or recommended for clients. Past performance does not guarantee future results. Please see additional important disclosures here: https://greenalphaadvisors.com/about-us/legal-disclaimers/