After 30 years of globalisation, the world has changed. The rise in geopolitical tensions, the reappearance of armed conflicts in Europe, the revival of economic protectionism and daily cyberattacks are all examples of this shift.
The challenging geopolitical context is a tangible reality with a concrete micro-economic scope. Charles Darwin said: “It is not the strongest species that survives, nor the most intelligent, but the one that best adapts to change.”
This observation also applies to companies. They will have to rethink their value chains, cyber defence and even capital allocation. Only then can businesses become truly resilient and thrive in this new normal.
The rise of populism, return of politics and geopolitical risk are anchored and permanently embedded in our environment. These changes have major economic consequences and must be taken seriously by any investment manager. In the same way that the 1980s proved beneficial to companies embodying globalisation (export industries, fashion and luxury sectors, technology, leisure, etc), the coming era will allow certain companies with very different profiles to outperform over the long term.
Some trends are already standing out as potential investment opportunities, for instance the increases in military spending and cybersecurity solutions. These two dimensions are the expression of the long-term rise in geopolitical risk and present an inexorable need for investment. If we take NATO alone, the underinvestment in military equipment amounts to $1,400bn over 30 years compared to what was provided for in the organisation's statutes when it was founded.
European NATO members are now set to increase their spending from 2% of GDP to 3%. This amounts to a $190bn increase in defence expenditure. In such a scenario, demand for equipment might grow by close to 100% as the current European fleet is ageing.
With regards to the defence sector, we hold Thalès and BAE Systems. Thalès is a French global defence company that designs and builds flight deck systems, avionics, as well as equipment for air, land and naval forces. Notably, the company is a main supplier to the Rafale air fighter. BAE System is one of the most diversified defence companies globally and is involved in a range of activity from ammunition manufacturing to ship design and air fighter components.
Similarly, the cybersecurity market is growing fast (14% annual growth expected for the next eight years). The rise of cyber espionage is here to stay, forcing corporates to keep on purchasing advanced solutions. This represents massive business opportunities for security software companies with cutting-edge, innovative technologies.
We also expect there to be increased demand for preventative medicine. These are the solutions and equipment that make it possible to deal with emergency situations or sudden tensions, for instance vaccine production, equipment for molecular diagnostics, etc.
Resilience will be the key to a company’s success, specifically the ability to decide their own destiny independently of political, geopolitical and economic upheavals. These are typically companies with a high level of vertical integration, little dependence on imported components and making a significant part of their turnover in the domestic market. Their robustness will also depend on proven financial solidity and a low level of debt.
The current composition of most financial indices embodies 30 years of globalisation with a prevalence of exporting companies, present in services or technology. Conversely, purely industrial companies have seen their weight decline over the past 20 years under the yoke of competition from Asian countries. Companies that could be described as resilient are not very present in the MSCI World top 100 largest companies. Looking through the lens of resilience, sectors that are particularly attractive are critical infrastructure and water supply.
One standout name is this area is America Water Works (AWW), the leading US water utilities company. In America, more than 75% of the water infrastructure assets are owned by public bodies such as municipalities. We are beginning to see a structural shift towards more privately-owned assets, accelerated by the need to upgrade existing networks. As the sector leader, AWW is perfectly positioned to take advantage of this change.
Also, thanks to its size, the company benefits from massive economies of scale allowing AWW to provide drinkable water to millions of American households at attractive prices. Furthermore, both the water treatment and distribution business are fully regulated, meaning that AWW can operate and keep growing regardless of what is happening in the macro or political environment. Strategic resources is another area of interest, for instance GTT which offers containment system for the shipping of liquefied natural gas.
These types of companies are currently ‘under the radar’ and relatively poorly owned. Their ability to navigate the geopolitical context that is taking shape today will make them tomorrow's winners. Investors should capitalise on these opportunities now whilst there is still time.
Aymeric Gastaldi is an international equities manager at Edmond de Rothschild. The views expressed above should not be taken as investment advice.