The never-ending series of new innovations is driving the evolution of business models and industries across the economy, and in the process creating new winners and losers.
Hortz: In building innovation-focused portfolios, what portfolio parameters do you use?
Ricketts: We believe leading innovators are rare, and thus are best held in focused strategies of concentrated portfolios of 35 or fewer holdings. Using our investment criteria and unique investment process we aim to identify and own what we believe are the leading innovators, supporting high-quality portfolios with optimal diversification. In addition to true innovators being rare, empirical data is increasingly supporting the fact that more and more industries are experiencing growing concentration in market share and profit take—the leading innovators are taking more of industry profits now than in the past, further necessitating a concentrated approach to investing in innovators.
We believe leaning into a number of areas of the economy undergoing innovation—with attractive competitive dynamics—is the best way to gain value-added diversification versus blanket ownership of every industry and sector. The fact is, many industries are highly competitive and/or near saturation, with low levels of innovation, all factors that lead us to eliminate these industries from consideration.
We also balance this focus with a reasonable level of industry variety—what we describe as optimal diversification—across different industries and sectors. For example, we may own a variety of technology companies, life science and biopharma companies, digital media and consumer companies, select financial services companies, as well as holdings in other industries experiencing high levels of innovation.
Hortz: How would you recommend that advisors and allocators integrate innovation investing, and how is what you do different than other innovation funds or ETFs in the market?
Ricketts: By now, you probably know I would highly recommend that every investor have an innovation allocation. It is simply the most important driver of wealth creation across our economy. But gaining exposure to innovation is tricky and should be done with care. There are a growing number of strategies with the innovation label or wrapper, but few represent high quality offerings, in my opinion. Most innovation strategies, particularly innovation or thematic ETFs, are often built around broad themes with little real research backing up the portfolio holdings. They are just baskets of companies that fit a theme, with little or no research supporting their inclusion. Frankly, most ETFs in this field are developed by marketing organizations. It is important that investors focus on innovation-focused strategies that are supported by rigorous research and a firm that specializes in innovation investing, such as our firm Evolutionary Tree.
There is also a lot of hype out there, so looking for innovation strategies that are thoughtful about stock selection and risk management is key. While investing always involves risk, we believe our innovation-focused strategy is significantly more risk-managed. How? We focus on quality companies with competitive advantages and strong balance sheets. We also seek to avoid hype by leaning into companies and innovations that have demonstrated technical feasibility with potentially attractive business models—the foundations for being ready for mainstream adoption. Additionally, valuation discipline is an important part of our process and is the final criterion a company must pass before we deem it worthy of inclusion in our portfolios. We build risk-managed portfolios of quality innovators.
The bottom-line: innovation is the new value driver in the markets. Investors are increasingly asking their advisors for more exposure to innovative businesses, and we believe innovation investing is emerging as the solution.
Institute for Innovation Development is an educational and business development catalyst for growth-oriented financial advisors and financial services firms determined to lead their businesses in an operating environment of accelerating business and cultural change. We position our members with the necessary ongoing innovation resources and best practices to drive and facilitate their next-generation growth, differentiation, and unique client/community engagement strategies. The institute was launched with the support and foresight of our founding sponsors—Ultimus Fund Solutions, NASDAQ, Pershing, Fidelity, Voya Financial and Charter Financial Publishing (publisher of Financial Advisor magazine).