🔑 Key Takeaways
- NZS Capital, founded by astrophysics enthusiast Brad Slingerland and math expert Jon Bathgate, uses complexity theory to approach investing in companies and markets, catering to institutional investors worldwide, including a specific fund for non-US investors.
- Global economic stimulus post-pandemic caused acute demand, but fragile supply chain led to inflation. Governments planning to reel back stimulus, creating tension between advocates and opposing groups. Market seeking homeostasis through volatile fluctuations.
- In market cycles, growth assets can create the most value over the long-term, but investors should be prepared for hidden crashes. It's important to have a personal investment strategy that balances resilience and optionality to manage volatility.
- Growth tech companies like Zoom and Coinbase can be profitable and industries with pricing power can pass on price increases to customers, but it's crucial to consider the balance between pricing power and customer demand. Understand market cycles and discern hyper-profitability during turmoil.
- Companies' price increases may indicate both strength and competition. Factors such as inflation in the talent market and production costs contribute to Netflix's recent increase. Microsoft and Alphabet thrive due to high non-zero-sum offering while Facebook faces doubt over their negative impact on social networking. Larger companies generally display resilience, but Tesla's future is uncertain. Nvidia's stretch in valuations is a cause for reconsideration.
- When investing in businesses, consider their valuation, ecosystem, and future potential through optionality. Look for power laws, network effects, and increasing returns during the digital transition, but also be aware of government regulations. Safe predictions, such as the growth of electronics, can offer excellent long-term investment opportunities.
- Early adoption of digital technology is advantageous, however, investing in semiconductors comes with risks. Interest rate increases can provide opportunities for investment in digitalization trends.
- Semiconductors are crucial for the growth of digital economy and offer profitable business models. Short-term fluctuations should not affect long-term investment decisions due to its promising future.
- Technology has consistently been deflationary over the last 300 years, allowing for more productivity with less input cost. Labor automation and software automation are examples of this trend, which helps companies reduce labor burden and costs.
- While technology can address labor shortages and boost productivity, it's important for investors to focus on long-term investments and not let psychological factors influence decision-making during market corrections and volatility.
- Successful investing requires humility in good times and confidence in bad times, with a long-term perspective. Diversify your portfolio with resilient and optionality elements, and accept that being wrong is part of the process. Building a resilient business culture requires capitalization, product structuring, reliable distribution partnerships, and hiring talented, long-term focused people who work well together.
- Focus on your strengths and prioritize your time on important tasks like investing, developing team culture, and partnering with the right clients. Choose a sustainable and transparent investment strategy aligned with your values. Share knowledge and interact with others for mutual benefit. Research with Tegus.
📝 Podcast Summary
Uniquely Complex Investment Strategy of NZS Capital for Institutional Investors
NZS Capital is a public stock market investor that targets institutional investors like big insurance companies, endowments, and pension plans. They have different public market investment strategies mainly for institutional investors, but they also have a fund for outside of the US investors as well. Brad Slingerland, who co-founded NZS with Brinton, is passionate about both astrophysics and the stock market. He has an education in economics and astrophysics. Jon Bathgate, who joined NZS at the beginning of 2020, has an education in math and is also obsessed with markets since he was in fifth grade. They both utilize complexity theory to think about investing in companies and markets, which is fascinating and different from everything else we've heard.
The Fragile Supply Chain and Tension between Inflation and Interest Rates
The global economic stimulus, both fiscal and monetary, post the pandemic brought uncertainty in 2020, which exploded into a period of spending in 2021, causing acute demand for some things and not for others. However, the supply chain, being fragile, could not meet the demand leading to an increase in inflation level by 6-7%. Now, the governments are planning to reel back the stimulus given last year by signaling raising interest rates, creating tension between two groups - one advocating inflation to be killed, and the other arguing that abruptly removing the excess money could be as bad as the initial situation. The market is trying to find a homeostasis point amidst these extreme bouts of volatility up and down, through this bouncing back and forth between the two equilibriums of rates going up and growth stocks coming down.
Balancing Resilience and Optionality Investments to Manage Volatility in Market Cycles
In market cycles with rate hikes, there is an initial fear over high growth, high multiple stocks that may not have current earnings. But ultimately, growth assets tend to be the ones that create the most value long-term, so investors gravitate back towards them. However, the market can experience hidden crashes, like the recent one in growth stocks that caused a lot of downward compression on multiples. When faced with volatility, investors should come back to their investment strategy and balance resilience and optionality investments. It's important to understand that we can't predict the future, so everyone should have their own way of managing their portfolio based on their personal investment strategy.
Debunking the Myth: Profitable Growth Tech Companies and the Balance with Pricing Power and Customer Demand
There is a misconception that most growth tech companies are unprofitable and do not generate cash flow, but many companies like Zoom and Coinbase actually are. Additionally, industries with pricing power like semiconductors and tech companies can pass on price increases to customers. However, there may be some demand destruction when prices rise, making it important to consider the balance between pricing power and customer demand. It's also worth noting that market cycles are complex and unique, and investors should discern what's hyper-profitable or not in growth software land during market turmoil.
Price Increases, Strength, and Competition in the Tech Industry
Price increases by companies can indicate both strength and creating competition. Netflix's recent price increase may be due to inflation in the talent market and costs of production. Microsoft and Alphabet have strong network effect businesses with high non-zero-sum offering and value proposition. Facebook's potential negatives around social networking cast doubt on their value creation. Companies over $1.5 trillion in market cap are generally resilient but Tesla's range of outcomes is still relatively wide. Nvidia was formerly a resilient position but stretch in valuations led to reconsideration.
The Importance of Valuation, Resilient Ecosystems, and Optionality in Investing for Future Giants
Valuation plays an important role in investing, and highly valued businesses often require precise predictions that may not always be accurate. Investing in businesses that have both resilient valuation and ecosystem is crucial. Trillion-dollar companies and potential future giants often benefit from power laws, network effects, and increasing returns, especially during the analog to digital transition. However, government and regulatory tensions may push back on their growth. Investing in optionality can be a good strategy as it offers a low margin of safety, and businesses with potential optionality can be held for the long term. Predictions that are relatively safe, such as electronics pushing deeper into the world, can offer good investment opportunities.
Digitalization's Influence on Industries
Digitalization is transforming industries, with semiconductors, software, cloud, and connectivity as foundational concepts. More payments are going digital, while analog businesses are becoming more digital, vertically integrated, and data-driven. Industrial companies are leveraging digitalization, while healthcare and financials are struggling due to regulations. Companies that adapt to digital technology early gain an advantage over their competitors. Semiconductors underpin value creation, but there are risks if we hit the wall with Moore's law or can't find enough uses for chips. Investing in the semiconductor industry comes with risks, but it's a big part of the portfolio. Interest rate increases can be seen as an opportunity to invest in digitalization trends.
Semiconductors - The Future of Digital Economy
The demand for semiconductors is continuously growing and is well-positioned to capture a lot of value as the economy goes digital. Semiconductors are used in every tech trend, including autonomous driving, machine learning, crypto, and Metaverse, among others. The business models in semiconductors are phenomenal and profitable through the cycle, and companies will eventually over-order, even in times of shortages. Moreover, shortages and seeing the market valuing semiconductors' role in the digital economy have improved its secular trend post-COVID. The near-term push and pull and potential inventory correction should not be the main concern for long-term investors given the trend line's demand for semis is probably going up. Semiconductors are as well-positioned as any part of the economy to capture net new value creation waves, and individual investors with a longer time horizon should take advantage of the attractive valuations.
The Deflationary Impact of Technology on Modern Capitalism
Technology has been a consistent engine of growth and productivity over the last few hundred years of capitalism. Semiconductors and software have been at the base of that growth. The fear of inflation in the market is legitimate, but technology has always been deflationary over the last 300 years of modern capitalism. The deflationary aspect of technology is being able to get more for less over time, which means being able to displace expensive, manual processes with automated and less expensive ones. Labor automation and software automation are two examples of this trend, which can help companies reduce labor burden and costs. Technology enables people to be more productive, allowing for more value to be generated with less input cost, which ultimately makes technology deflationary.
The Role of Technology in Sustaining Economic Growth and Addressing Labor Shortages
As the global population declines and immigration slows down, technology is becoming a necessary means for achieving productivity gains and sustaining economic growth. While this may lead to a labor shortage and inequalities, the use of technology can lead to better alternatives and enhancements in productivity. The outcomes of market corrections and volatility are unknowable and difficult to predict, but focusing on long-term investments and maintaining muscle memory can assist in making decisions. Selling resilient positions and reallocating to optionality positions are necessary decisions, but psychological factors can make them hard to execute. As investors, it's important to remember that we're never as smart as we look when stocks are going up, and we're never as dumb as we feel when stocks are going down.
Balancing Humility and Confidence in Investing and Building a Resilient Business Culture.
To be a successful investor, you need to balance humility and confidence. When stocks are rising, stay humble, and when they are falling, stay confident in your process. Maintaining a long-term time horizon is key, and investing in resilient and optionality elements is crucial. Having a broad range of outcomes and understanding that sometimes you will be wrong is also important. In order to build a resilient business, capitalization, product structuring, and partnering with a reliable outside distribution partner are essential. In addition, hiring talented people who work together, trust each other, and are long-term focused is crucial to creating a successful business culture.
Prioritizing and delegating for business success.
Focus on what you're good at and delegate the rest. Building a successful business requires setting up your priorities so that you spend almost 100% of your time on the things that matter, such as investment team culture, putting together a portfolio, and partnering with clients. Negativity and pessimism can hinder success, therefore, it's important to align your investment strategy with your values and strengths. NZS, a long-only fund, offers a sustainable and reasonable approach to investing that values transparency and education. Interacting with others and sharing knowledge can be a selfish way to gain value from the community, but it ultimately benefits all parties involved. Tegus offers great research and is worth checking out.