The last few years have been filled with a lot of change. The headlines have inevitably been dominated by the negative aspects of that change, whether it’s the rising costs associated with higher inflation rates, the market crashes around crypto, or the lagging economy due to the COVID-19 pandemic. Yet, change always creates opportunities. We sat down with Eli Horton, portfolio manager at Engine No. 1, to talk about where the investment opportunities lie in today’s market.
Engine No. 1 is an investment firm that identifies and pursues value creation opportunities in what they see as once-in-a-generation transformations of economic systems. In fact, they recently launched an ETF – Engine No. 1 Transform Supply Chain ETF (Ticker: SUPP) – that is focused specifically on one of the key economic transformations they believe is facing us today: the changing supply chain. We spoke with Eli about this transformation, the significant investment opportunity it is creating, and how you can help your clients navigate, and take advantage of, a shifting market.
Q: Engine No. 1 is focused on identifying what you call “epic systems transformations.” What does that mean and what are some of those transformations that investors should be focused on today?
A: As the famous saying goes, “The only constant in life is change.” When we talk about ‘epic systems transformations’, we are identifying the economic changes that will define the next decade. We believe there’s incredible value to be unlocked in companies that are transforming their businesses and establishing leadership positions in response to these changes. For example, look at what is happening in the energy sector with the transition to zero emissions or in the supply chain with reshoring and the establishment of localized supply chains.
The changes happening in the supply chain, in particular, are creating some very exciting opportunities right now. As the COVID-19 pandemic, U.S.-China tensions, and war in Ukraine have made clear, it has never been more important for companies to make their supply chains more resilient. Over the past 75 years, global supply chains have been focused on financial efficiency above all else. This has led companies move production and jobs offshore, which lengthens supply chains thereby adding complexity and fragility. Simultaneously, these decisions have reduced US employment – a staggering nearly 7 million manufacturing jobs have been lost from 1980-2020. Global manufacturing has also been more harmful to the environment as most international countries do not have the same stringent standards as we do in the US imposed by the EPA.
However, we are starting to see the beginning of a reversal of the past 75 years. In 2022, U.S. companies were on record pace to reverse past offshoring and localize nearly 350,000 jobs. This change appears to be accelerating and its clear to us that it will continue as one of the themes of the next decade.
Q: Why do you believe that this relocalization trend will continue as one of the defining themes of the next decade?
A: Simply put, the decisions to relocalize supply chains are driven by economic realities that have elevated the strategic importance of supply chains for most companies. We meet regularly with the managers of the businesses we are invested in or actively researching and have found that supply chains have consistently become a board-level priority item. Managers are focused on driving greater resiliency and surety of supply while also locating production closer to design and end market demand. While moving supply chains will be inflationary, the outcome is improved competitive advantage for the manufacturers themselves. To put some context around what we are seeing, over the past 18 months, we have already seen over $350 billion of manufacturing announcements in the US.
The supply chain transformation will also have very positive impacts on communities through the creation of better-paying jobs throughout North America. The 350,000 manufacturing, transportation and warehousing jobs that were relocalized in 2022 creates a 5.1x employment multiplier, which will create significant value over many years to come for companies in related industries.
Q: Those sound like huge changes, which I expect will take a while to happen. How do investors take advantage of them today?
A: By focusing on companies that will lead and benefit from the inevitable supply chain transition, investors can take advantage of what we think will be the next big investment opportunity. Once relocalization reaches full steam, the opportunities for investment in transportation, automation, and innovation in manufacturing are vast.
Q: Can you give us an example of one of these companies?
A: One example is Rockwell Automation. ROK is one of the world’s largest pure-play companies dedicated to industrial automation and digital transformation. The company serves key end markets at the center of the supply chain transformation such as automotive, semiconductor, warehousing and logistics, industrial manufacturing, metals and mining, and others. ROK’s technology is essentially the brains of factory and plant floors and allows manufactures to do more with less while also driving higher productivity and quality of output. Penetration of factory automation technologies has many decades to run, and Rockwell has a strong leadership position in the market. There will also be a further tailwind as manufacturers increasingly relocalize their production and build new plants and factories in North America. This will result in accelerating organic growth, margin expansion and returns on invested capital.
Q: You have an ETF that you recently launched that aims to take advantage of just this opportunity. What is your investment approach with that product to capitalize on this transition?
A: Yes, we recently launched the Engine No. 1 Transform Supply Chain ETF (Ticker: SUPP). SUPP invests in the companies that will succeed in the long term by driving and benefitting from the supply chain transformation. Those companies will create long-term economic value and meaningful social and environmental impacts. No other investors are actively thinking about how the whole system will change – and which companies will profit most from it. We look at these transitions over time and across sectors. Our investment process uses rigorous fundamental analysis and externality-monetization models together, through time, to identify which incumbents are most likely to succeed.
Q: How should advisors think about adding active thematic strategies like this to a client portfolio?
A: Active thematic strategies can be held as a satellite to core holdings to gain exposure to these large systemic changes. They diversify typical “index ETF” cores. If you hold a core index portfolio, an active thematic ETF is a way to have exposure to tremendous upside potential based on how they’re positioned to benefit from specific economic transformations.
Q: Anything else you think advisors should be considering for their clients or conversations they should be having in times of seeming market turmoil?
A: We understand that change can be unsettling for investors, but we also believe that change brings a multitude of opportunities. At Engine No. 1, we are democratizing access to systems change and active management expertise through our ETFs. It’s important for clients to understand how market disruptions also create market opportunities and how they can take advantage of those. We are delivering this today in daily transparency, liquidity and with the tax benefits of an ETF. Advisors should be having conversations with their clients that focus on the future and the defining themes of the next decades.
To learn more about Engine No. 1 Supply Chain ETF (Ticker: SUPP), visit https://etf.engine1.com/supp/.
About Eli Horton
Eli joined Engine No. 1 from Maverick Capital, a long-short investment firm where he invested in industrials and a broad range of industries. His active management expertise enhances the firm’s ability to identify companies leading and benefitting from relocalization and supply chain resiliency.