Today’s discussion is around ongoing supply chain risks and how members of Allspring’s growth equity teams are turning chaos into opportunity for their investors. Susan Raynes, executive vice president and head of the Institutional Client Group and Global Consultant Relations, speaks with Chris Warner, CFA, portfolio manager on the Discovery Growth Equity team, and David Nazaret, CFA, portfolio manager on the Dynamic Growth Equity team.

 

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Susan Raynes: I’m Susan Raynes, executive vice president and head of the Institutional Client Group and Global Consultant Relations, and you’re listening to On the Trading Desk®.

Today we’re discussing ongoing supply chain risks and how members of our growth equity teams are turning chaos into opportunity for their investors.

Joining me are Chris Warner, CFA, portfolio manager of our Discovery Growth Equity team, and David Nazaret, CFA, portfolio manager of our Dynamic Growth Equity team. Chris and David contributed to our recent paper on this topic, Whipping Supply Chain Chaos, One Company at a Time. We invite our listeners to read this paper as a companion to this podcast, which can be found on our website, allspringglobal.com. Chris and David, thanks so much for being here.

Chris Warner: Great to be here, Susan.

David Nazaret: Thanks for having us.

Susan: So, let me set the stage. In this paper, we discuss some of the margin pressures that many companies are facing as they attempt to manage really all aspects of their supply chains against what has been a very difficult backdrop. These challenges range from purchasing and production decisions to optimizing inventories, product mix, and pricing wild swings in demand.

On the one hand, we’ve seen long delays in getting some basics like new appliances and hot holiday items and chip shortages impacting the supply of new cars. But on the other hand, we’re now seeing some retailers dealing with large excess inventories on certain goods as we come out of COVID-19 lockdowns. The paper highlighted specific risks that retailers in particular are managing, but similar issues are dogging industrial companies. Since the paper’s publication, we’ve seen a gradual easing in some of the bottlenecks that the media highlighted last year. But is this a sign that supply chain risks are fading? Or is there something more structural taking place? Chris and David, could you comment?

Chris: This is Chris. The paper certainly highlighted some of the cyclical factors that have impacted retailers. But there are signs of structural factors at play more broadly across the market.

Global instability this year, specifically, the Russian-Ukraine war, or the spike in EU (European Union) energy prices, and a continuation of China’s zero-COVID-19 policy have made it challenging for multinationals. We’ve seen a shift in where capital is being invested. Since the beginning of COVID-19, U.S. reshoring announcements are up 2X and foreign direct investment in the U.S. is up 80% versus 2018 and 2019.

On the flip side, China has been a share loser with foreign direct investment as a percent of the total investment down 400 basis points while the U.S. has gained 800 basis points. Whether it’s deglobalization and localization, the shift has been driven by a need for more resiliency and security.

Government policy is also a factor, particularly in the U.S., with the passage of the Inflation Reduction Act, the CHIPS Act, and export controls to China. All these factors have made pure globalization trickier than it was in the past. What do you think, David?

David: I agree with a lot of what you said, Chris. The only thing I would really add is that I think we’ve definitely seen the worst of it past us. Earlier on, when we were seeing a lot of these supply chain challenges, we’d hear horror stories.

Back to your point, Susan, about companies making industrial equipment, we would hear stories of a company that would normally pay $40 for a semiconductor having to go on the spot market and paying close to $3,000 for that same part just to get the equipment out the door. So, I think we’ve certainly gone through a lot of that. I think part of it’s a little bit that some more suppliers has come on. I think companies try to react pretty quickly, especially once they understood that demand was starting to come back stronger than expected.

And also at this point, now that demand is starting to ease as a result of some of the actions the Fed (Federal Reserve) has taken to combat inflation, we’ve been seeing some of those imbalances start to ease, as well.

Susan: So, it feels like different sectors are impacted very differently. And, also, there’s a question of is the past going to be the future and will things change going forward? So, if I can boil it down, it seems like there are many fundamental dynamics that will impact how the global economy will operate in the future and how different sectors of the economy will operate, and that companies literally of all stripes will be forced to adapt their business models and operate differently.

So, what do you think are some of the company traits that truly separate the winners from the losers in this new environment going forward? Chris, do you want to comment?

Chris: I think the biggest challenge will be how do you add resiliency without an increasing cost to the customer?

High-cost regions like the U.S. will require new operating procedures for companies to remain competitive. Improving productivity through technology will be paramount. We believe automation will be a big winner in the new world order.

A couple examples of that would be machine vision, which helps improve warehouse productivities. In the paper, we mentioned RFID (radio frequency identification) systems from a company called Impinj that help manage inventory around the world and have better data to operate.

And then even robots taking over manual tasks. One of the important suppliers there is Novanta. So, technology will play an important role because if you go to a high-cost area, improving your costs and even higher ROI (return on investment) on these CapEx (capital expenditure) investments will be important.

But outside of tech, there’s also interesting opportunities in the infrastructure that are needed to support these new manufacturing facilities. We see opportunities in the transportation sector, as well as industrial real estate. David?

David: I would add that most companies understand that managing their supply chains effectively in any environment is mission critical. And a lot of it comes down, beyond the things that Chris was talking about, to just basic blocking and tackling, so to speak, just matching that supply to demand.

I think on a basic level, most companies do that well. Supply chain management, logistics, and demand forecasting have come a long way over the past 30 or more years. The problem is when you have that accumulation of acute and wide-ranging supply disruptions that we saw in the early part of the pandemic.

I think here is where companies that take a much more proactive and longer-term view of the environment can really shine. I would highlight the example of Monolithic Power Systems, a semiconductor manufacturer. Back in 2019, when the industry was experiencing one of its periodic downturns, most companies were either pushing out manufacturing expansion plans or shelving them altogether. Monolithic, on the other hand, recognized that these headwinds would be temporary. They leaned in and they worked to broaden their supplier base and expand their capacity. Fast forward into 2021 and 2022 when demand came roaring back and supply was in short supply, you had this company rapidly expand their pace to share gains, outgrowing peers by 30 points versus their typical 10% to 15% gains versus them before.

So, I guess, again, the lesson is look for companies that are being proactive rather than just reactive to the environment.

Susan: So, Chris and David, how are both of you finding these companies that fit your descriptions of companies that really are nimble and managing the supply chain issue?

David: We employ an all-cap approach to research. We investigate and own companies up and down the market-cap range. And I think that gives us a really great view in terms of all aspects of supply chain from the suppliers to the customers and to the vendors.

And I think from channel checks that we do there, talking with customers, talking with their customers, talking with their competitors, and talking with the companies themselves, it really allows us to glean a lot of these insights.

Chris: We’re looking for companies that can compound growth over time. So, you have time as your friend. You can grow into a valuation and you can compound cash flows over time that create value.

And to do that, you need to find companies that kind of are on the right side of history or the right side of change. And it starts with a holistic view from the management to the competitive position to the products they’re offering. And it’s a lot of fundamental, bottom-up type work that our investment team does.

Similar to David, talking to people in the industry, talking to companies, suppliers, competitors, and then having a view on where the world’s going, like where’s the structural change happening in the world and who is on the right side of history. And so that’s where we spend our time.

It’s very important to us to allocate our attention to the areas we think will be the most fertile hunting grounds for new ideas. It’s a constant challenge and I think all the things that are happening in terms of supply chain and everything else in the world makes some interesting opportunities to generate alpha over time.

Susan: Really appreciate that perspective. To wrap it up, it seems like we are literally in sort of mid-innings in how companies are responding to ongoing structural changes posed by various supply chain chaos. Do you think that there is a special role for active managers going forward taking all this into consideration? Chris, do you want to jump on that first?

Chris: I think the important thing is that change is constant. And you could argue that change is actually increasing and being active and adjusting your positions or investing in new ideas that are adaptable and that finding companies that really can lean into this as opposed to being hurt by this, I think will be the winners. And I think the delineation between winners and losers will get even more stark as all these structural things happen across the world at a faster pace. And an active management is a great way to take advantage of this.

David: Absolutely. I couldn’t agree more. On the Dynamic Growth team, we have an acronym called SCODI, which describes the software, cloud, online, digital, and innovation aspects of the economy that we look at. And I think these acute challenges that are persisting really give opportunity for companies to help other companies manage through these challenges, be it automating more of the labor to be able to drive headcount down or managing their supply chains better. I think there’s a lot of different ways to look for active management to be able to take advantage of these trends.

Susan: That’s great stuff, gentlemen. Thank you both so much for joining me today.

David: It’s a pleasure.

Chris: Thanks for hosting us, Susan.

Susan: So, that wraps up this episode of On the Trading Desk. If you’d like to read more market insights and investment perspectives from Allspring Global Investments, you can find them at our firm’s website at allspringglobal.com.

To stay connected to On the Trading Desk and listen to past and future episodes of the program, you can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you get your podcasts. Until next time, I’m Susan Raynes and thanks for listening.

 

Disclosure: CFA and Chartered Financial Analyst are trademarks owned by CFA Institute. 100 basis points equal 1.00%. Alpha measures the excess return of an investment vehicle, such as a mutual fund, relative to the return of its benchmark, given its level of risk as measured by beta. Alpha is based on historical performance and does not represent future results.

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