In Search of Disruptors

00:04 - 00:34

Hi, everybody. Welcome to The Pulse, where we cover trends in the economy, markets and asset allocation for long-term investors. I'm Matt Palazzolo, a senior investment strategist at Bernstein and Head of Investment Insights. I'm excited to be joined here today by Lei Qiu, the portfolio manager of AllianceBernstein Global Disruptors strategy. As I think you'll hear for yourselves in just a second, Lei invests right at the heart of innovation, game changing technologies and business models. So Lei, Welcome to the show.

00:34 - 00:35

Well, thank you for having me.

00:36 - 00:50

So Lei, you and I chatted a little bit before recording this podcast, and you often talk about the world undergoing this, as you describe it, a modern-day industrial revolution. What do you mean by modern-day industrial revolution?

00:51 - 01:49

So this is how I think about it. One of are the biggest obstacles for innovation historically has always been inertia. Nobody wants to change. And so we always say necessity is the mother of innovation, because when there is something that's necessary, you got to do it. So during a pandemic, you got to do it. Everybody has to adjust. Business has to adjust, so behavior change drastically, and that really pushed us up in terms of the adoption curve of many innovative ideas. And even after the pandemic, we say we return to normal. But what is the new normal? Let's look at it. We are returning to a digital society, a society that's connected in ways that never was before. A society with very many new ways of doing things in virtually every aspect of our life, in every aspect of business. And that's what I meant by sort of the new modern-day industrial revolution, if you will. This is the big thing. This is the big idea that we are excited about.

01:49 - 01:58

Is it fair to say that these trends were playing out anyway already before the pandemic, but then they just got accelerated because of it?

01:59 - 02:36

Yeah, yeah. We talk about innovation and these are the big ideas. Big ideas actually don't change that frequently. That's why they're big in the first place, right? They're big, they are open. It's a big new world, but it takes time to adapt. Like, for instance, when we talk about cloud adoption, basically to have a flexible infrastructure, it's been going on for a while now, from zero percent to 10 percent penetration of adoption of cloud infrastructure. It took 10 years. I guarantee you the next 10 percent is going to take much, much less time, maybe two years, maybe three years, but that's about it. And that's what we are excited about, where we are on the adoption curve of many of these big ideas.

02:36 - 03:04

Yeah. Disruptor gets thrown around a lot and certainly has over the last number of years, it’s part of the naming of your portfolio. But really, your job is to pick stocks that are going to be the Disruptors that end up being good ideas, that are good investments. How do you differentiate those Disruptors that don't actually end up being good investments to those ones that will? So, disruption or innovation

03:04 - 03:31

is simply a new way of doing things. We can all identify them, but to find the right company and more importantly, the right investment actually takes a different set of skill set, in my opinion. So if you think about it, we are looking for companies that ultimately will make money for our investors. What does that mean? That means you have to have a big idea that it has a big, big market, but you have to have the right kind of company. And that means the right business model that commoditized the idea.

03:31 - 04:27

But also one of the most important things I think to identify the company is the right management, the true innovator, the one that has guts, frankly, to make the tough decisions. One with vision. And also, I often jokingly say, also a management team that has what I call adult supervision, the one that can actually execute the business idea because no path is smooth. And as investors, there will be bumps on the road. You have to be able to go back to their management and look them in the eye. See, this is someone that you trust, their vision, their passion and their ability to ultimately execute. What we are looking for is a company that consistently can beat market expectation. That's what we're looking for, the beats and raises in these companies that can deliver ultimately much bigger profit pool than anyone possibly can imagine initially. Are  there publicly traded Disruptors that come to mind that never met the expectations that were baked into them?

04:28 - 05:22

Yeah, actually, you know, if I think about it, one come to mind. So for instance, we talk about search and China, and so for most people, search China, OK, that discussion is over. That's got to be a big opportunity. And Baidu is a search engine and it's the dominant search engine in China. So what's not to like? It’s got to be a great stock. But if you look over time, if you look into the details, China is a market that never had an established traditional retail infrastructure, so you can search for a pair of shoes, but the corner shop is never going to show up because it could just be someone operating in their homes. So what ended up happening? The true search winner, the one that actually makes money through commercial queries, is a marketplace named Alibaba. So you may look for the successful search company in China. Sure, Baidu has a disproportionate share. But ultimately, the commercializable opportunity lies in the marketplace called Alibaba.

05:22 - 05:39

And you look back over time, Alibaba substantially outperformed Baidu as a stock. And Lei, you're an equity portfolio manager looking on a global basis for companies that are the Disruptors today and will be for some significant period of time.

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What are some of the themes that you're investing behind today that you think will play out over this prolonged period of time?

05:46 - 06:13

So I mentioned cloud infrastructure and big data. That's obviously a big, big trend that we're seeing. Since everybody's digitally connected, there's a tremendous amount of data that is being generated and the company that has ability to analyze, collect and frankly manipulate the data to their advantage will be the successful winner of tomorrow. So big data and cloud-based infrastructure is definitely one; more and more companies are using that as part of their digital infrastructure.

06:13 - 06:47

So if you think about a digital society, I think the infrastructure that underlying it, we are on a new grid that's all digital. And so the company that provide any kind of applications that ensure we live in a safe, connected, always-on environment, it's one that's going to be the one of tomorrow's winner. And if you look outside, just sort of pure tech tech, if you will, that you think about omnichannel. I like a lot of these logistics models that enable the omni hannel to actually exist and be successful. And then also that industrial automation and Internet of Things is a big area.

06:47 - 07:47

Absolutely. We're seeing a rapid adoption of automation in connected factories globally because, my gosh, we cannot just have toilet paper shortage forever, right? So we, and not to mention the sophisticated electronic vehicles that we're making. So it's a lot of stuff that's exciting that's going on industrial area and then coming out of pandemic, genome sequencing. Obviously, that's been a big area. We've seen explosive growth. We have new ways of discovering diseases and identify them and then find drugs that's very targeted. But outside that, even the application of a synthetic biology is outside. It's just the way that we think about medicine. It's used in other areas to come up with new materials that's more sustainable, that's more efficient, that can address different needs. That's another thing that we're excited about. And last but not least, I think we think about the resource efficiency. You know, we are at the cusp of really EV or solar alternative energy, that's really being adopted rather quickly, and that's another area that we're very, very excited about.

07:47 - 08:33

I'm glad you went into these other areas beyond just technology, right? I think people unfortunately think of Disruptors as being really tech focused, and it may very well be, but it's not the only sector that is being disrupted or has Disruptors. So you said energy, retail, industrial, medicine. So that's great to certainly make that point. Now again, Lei, you're investing in stocks of companies that are the Disruptors. However, many of these companies are well known, and the possibility arguably is baked into their stock price. How is it as an analyst and as a portfolio manager, you get comfortable or do you sometimes not get comfortable with the valuations that are attached to these great companies?

08:34 - 09:18

First of all, I never get comfortable, right? You constantly check it out. I deal with expensive stocks or perceived to be expensive stocks. But that said, I think what I'm doing is not as a growth investor and particularly in disruptive innovation. I'm not doing anything that's that different from a value investor. Yes, valuation is one of the factors I do take into consideration. But what I'm focused on is, again, a value investor is looking for mispriced asset. They are looking at the value. I'm looking for mispriced asset based on the earnings potential. I'm looking for where there is a mismatch between what the market believe, whether it's the size of the market, the growth trajectory of the company, or ultimate the profitability of the company and looking for that mismatch.

09:18 - 10:03

That's why I said the beginning. I'm looking for the beats and raises. If you go back and then frankly, I can say Amazon, but you can look at all the FAANG stocks. They were always expensive at the early stage of growth. Every single one of them, and today everyone's very comfortable with them saying that's where the quality growth is. Because first of all, over time market does pay up, pay a premium for sustainable growth. The compounders that year after year deliver your high growth and quality growth. But those are the ones that actually in the earliest stage, they invested in their business to ensure that they establish entry barriers, high entry barriers so they have the competitive mold to get to where they are today. So we like a company in a big market and we don't penalize company that actually invest in their business so their profitability may look a little lower

10:03 - 10:44

initially, but guess what, if Amazon didn't invest in its retail business, it would not be able to deliver the things to you at the speed that they do today. And if it did invest in business, you would not have another business within Amazon, which frankly many people didn't even think about, which is Amazon Web Services. One of the most profitable enterprise businesses out there. So again, goes back to, we get into the company, get into the company's DNA, get into the management, know what they're doing, what they invest in. Get comfortable with that. We focus on the fundamentals. Valuation is an input that we put into our risk model, but it's not the determinant of whether or not we look at a company. And valuation arguably is part of risk management, right?

10:44 - 11:02

Thinking through that, trying to find, you said that the beat and raise. Beat, the earnings estimate, and then raise, your numbers going forward. But how else do you think about risk management? What else do you do to ensure that you're taking on an appropriate amount of risk given the opportunities that you see in each and every one of these companies that you invest in?

11:02 - 11:52

So we look at the company individually at the risk that they carry and we have a portfolio. So we want to make sure that we understand the correlation about these companies. We want to make sure that when we take risks, it is the intended risk, right. So if you look as a growth investor, you can run a portfolio ultimately will be tilted towards growth. So that would be a big factor there. But that said, we do look at the sizing of each position and we look at the risk characteristics each company carry and how they relate to each other. And ultimately, what we try to avoid is not to have a very concentrated portfolio with a lot of positions with high correlation to each other. In other words, we understand we are taking some risk with this type of companies; what we don't want to do is par risk on top of risk that's unintended. So that's how we think about our risk management.

11:52 - 12:44

I think that's great, as we call it inside baseball, because often investors from the outside of our industry think about portfolio construction or portfolio management as just going to buy the 30 or the 50 or the 70 stocks that an investor likes the most and just putting them in a portfolio. But that might bring undue risk. You have to think about how they work together. You talked about correlations amongst those individual stocks, so by picking your favorite names, that's only part of the job. You also have to put them together in a thoughtful way. That's a key part of driving success in the investment management business. Lei, we're going to start to pull it together. I got just one more question for you. And it's real open-ended so you can take this anywhere you want to. But what is it at this point in time? We're towards the end of 2021, we just got through a global pandemic, the market has climbed back. What makes you excited about the future at this point in time?

12:45 - 13:12

So a couple of things. One is, I truly believe that we are at the dawn or in the midst of industrial revolution. So there are all these great ideas and we are really at the cusp of it across so many industries. I believe the pandemic really brought disruptive innovation to the center to say tomorrow's society will be very different from yesterday's. And then people use the word roaring 20s, right? So they compare it to the Spanish flu like every 100 years, and then we get this pandemic.

13:12 - 13:46

And if you look in the 1920s, what happened; there was mass production of the automobile. There was a highway system. People became very mobile and radio was invented so information, it was distributed much more freely. In a way, we're having another roaring 20s, except this time when I think about infrastructure, the underlying of the society, it's a digital one. It's one that is very different from where we think about just traditional brick and mortar, and I think about the many areas that we consume. Technology is different. Technology has become the underlying utility of tomorrow's society, and that's where we are looking for opportunities across all industries.

13:46 - 14:18

And last, I would say this, and maybe it's a little tricky. Not everyone will agree with me, but you know, I get asked the question all the time. Is it over yet? Why are these stocks so expensive? So to me, they're still nonbelievers out there. So I can't say […]. Well, you know, these value stocks, they're so cheap. Why don't we own those instead of these? And I would say, well, if they're nonbelievers out there, there's an incremental buyer out there, and bull market climbs a wall of worry, and that actually gets me excited to convince more people that, you know, this is a different tomorrow, a better tomorrow.

14:19 - 14:44

Well, I consider myself an optimistic person, but you made me even more optimistic for the future. So I appreciate that. We're going to have to have you back on the show if I'm ever feeling a little bit blue or a little bit nervous about the markets. But we're going to have to leave it there. Thanks so much for this really fascinating conversation and for the opportunity for you to share with our listeners about your global Disruptors portfolio and your thesis and your philosophy and how you put it all together. So Lei, thanks for joining us.

14:44 - 14:45

Well, thank you. Thank you for having me.

14:46 - 15:30

And to all of our listeners, thank you for joining us on this episode of The Pulse. I hope you've enjoyed listening and learning from Lei as much as I have. For more on her strategy, we’ll link to a recent blog that Lei wrote in the description for this episode. And as always, we'll continue to monitor the key trends and the risks in the market and in the economy and share them with you here on The Pulse. If you've enjoyed this podcast, please subscribe and rate us on Apple Podcasts, Google Play, Spotify, or wherever you listen to podcasts and e-mail us all of your thoughts and questions or any feedback that you might have to insights@Bernstein.com. Be sure to find us on Instagram and Twitter at BernsteinPWM. Thanks a lot.

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And be well.