There is more than one way to approach growth equities

The last few years have ushered in a new macroeconomic era with shorter and more volatile cycles, increased geopolitical instability and accelerating technological change. One of the most dominant narratives to emerge over the last few years has been that of the “Magnificent Seven” and US exceptionalism. Recent market moves are now challenging that narrative, however, highlighting that there are other ways to think about growth equities that may help uncover still underappreciated opportunities amid ongoing volatility. A globally diversified approach that dynamically combines a qualitative growth framework with insights on the structural trends that are reshaping economies, sectors and companies could help investors look at growth equities differently. Here are four action points for investors seeking to capture the opportunities that this different perspective may bring.

1. Embrace diversification on a global scale
   Stocks have become more correlated to the sector or theme they belong to rather than the region as technological advancements have enabled companies to have global operations and revenue streams. At the same time, growing regional divergence is a key feature of the new regime in which companies now operate as geopolitical rivalry is driving governments to protect their strategic sectors. Managing that complex picture requires, in our view, a globally diversified investment framework that balances the still rich opportunity set we see in the US with meaningful exposures to other markets, most notably Europe, where amid peak pessimism we have identified numerous quality companies that we believe have the potential to surprise.
   
   In our opinion, diversifying on a global scale could also reduce the risks stemming from an over-reliance on a handful of US-domiciled stocks and a largely linear AI development narrative. As AI competition intensifies, we think it is likely that this model will come under increased scrutiny, with potentially adverse implications for less diversified portfolios.
2. Understand emerging structural trends
   For much of the post-pandemic period, equity markets were largely driven by US exceptionalism and AI dominance. In our view, this singular narrative masks a more complex reality of shifting structural trends that will increasingly impact companies, sectors and markets globally. With this narrative now being tested by the markets, we think it is an opportune time to assess what these structural trends are telling us.
   • Since the beginning of the year, the dominant narrative has shifted from one of economic resilience to uncertainty given a pullback in consumer spending, depressed consumer and industrial confidence and the potential for persistently higher inflation.
   • As the range of outcomes has once again widened — largely due to US policy implications — companies in Europe look well-positioned to benefit from high personal savings rates, accommodative fiscal policy and lower interest rates driving domestic growth.
   • In addition, we see signs that the broadening of the AI revolution is starting to take place, with technology enablers of the digital transformation playing an increasingly important role.
   • On the downside, volatility spurred by US-imposed tariffs and other countries’ retaliatory responses, while still an evolving situation, again underscores, in our view, the importance of assessing potential impacts through the prism of sector dynamics rather than just focusing on a given company’s location.
3. Double down on fundamentals
   In practice, we find that these trend insights have their greatest value when they can be combined with a repeatable fundamental research framework. For instance, in our own approach, we seek to systematically answer the following questions, with quality as the underlying theme to help us identify promising growth companies for our portfolio:
   • How sustainable is revenue growth?
   • Can it translate into high and improving free cash-flow margins and strong returns on capital employed?
   • How attractive is the potential for capital returns, be it dividends or share buybacks?
   • To what extent do valuations reflect fundamentals, based on our discounted free cash-flow model, and is there any upside?
   • Are fundamentals improving and is there scope for exceeding consensus earnings expectations?
4. Dynamically align with areas of high-quality opportunity
   In our opinion, leveraging such a robust framework with trend insights on a global basis can provide the wider scope and flexibility needed to navigate today’s more complex and volatile environment, with the explicit emphasis on quality acting as a stabiliser.
   
   We believe that attractive areas often emerge from targeting stocks with the most compelling combination of growth, quality, capital returns and valuation upside. And we think an active approach to portfolio construction can help to continuously exploit these opportunities across sectors and regions.
   
   The market is still generating opportunities for quality growth companies, for example in Europe, where low starting valuations and high personal savings rates provide an attractive backdrop for retailers with strong franchises to win a higher share of customer spend. Globally, digitalisation aided by AI will likely drive generational technological transformation, but the benefits extend well beyond today’s perceived winners. To support the build out of data-centre capacity, energy supply and distribution will need to expand to meet rising power demand. Availability and efficiency of data and analytics can also drive higher growth for payments and market data services companies. These are only a handful of the examples where we believe a dynamic combination of a fundamental research framework with insights into trends can help optimise exposure to quality opportunities.

Putting this approach into practice: two case studies 

German defence company

This company has enjoyed a rapid expansion of its order book and free cash flow since 2022, helped by Germany’s decision to raise defence spending to over 2% of GDP after decades of underinvestment. Despite recent share price strength, we think its valuation remains attractive given the defence contractor’s quality characteristics, including strong organic revenue growth bolstered by both cyclical and secular tailwinds. We believe increased European military expenditures could be boosted by geopolitical instability.

UK consumer goods company

We see a path to further improvement  in this company's rate of capital returns to shareholders under new management. The company has refocused away from value-destructive M&A to organic, mid-single-digit profit growth, which we think can drive margin and free cash-flow growth over the medium and long term. A dominant market position anchored by strong consumer brands supports stability, in our view, with additional upside to valuation from growth driven by pricing power and volume as well as increasing share buybacks.

What’s next?

Despite the rapid rise in volatility, we believe that equity markets continue to offer opportunities for growth-orientated active investors able to cut through the heightened noise and complexity. But we think that finding those opportunities today requires a different approach. Key, in our view, are both a strong fundamental research framework and the ability to dynamically combine global diversification with insights into how structural changes are reshaping economies, sectors and companies.

This material should not be viewed as a current or past recommendation and is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities. PAST INDEX OR THIRD PARTY PERFORMANCE DOES NOT PREDICT FUTURE RETURNS.