Last month, the Morningstar Investor Conference in Sydney hosted one of the most fascinating panel discussions that I’ve attended in years. Called “Inflation Confrontation – Dual Perspectives”, the panel featured Hyperion Asset Management’s Lead Portfolio Manager, Jason Orthman, and Schroders Head of Australian Equities, Martin Conlon.

The discussion turned out to be less about inflation and more about two contrasting styles of investing. For context, Hyperion is an Australian and global equities manager that’s found huge success with its growth-style of investing over the past 15 years. Meanwhile, Schroders is primarily known as the investment manager to the ultra-rich – conservative, hard-nosed, principally fundamental and value-driven.

The way Orthman and Conlon dress and talk epitomize the differing investment styles. Orthman sounds and looks like someone working at Microsoft or Google might. He’s optimistic, confident that innovation can change the world and confident that Hyperion can capture many of those changes with its investments.

Conlon is old school. He’s more pessimistic about the future, less of a believer in technology transforming the world, and more concerned with the here and now of things like industry supply and demand, and company valuations.

The Hyperion view of the world

Despite being a bottom-up investor, Orthman says that Hyperion does have a macroeconomic outlook which it uses to frame the future. He believes that after the financial crisis, the world became a low growth, low interest rate and low inflation environment. The pandemic disrupted that, though deflationary forces including ageing demographics, growing tech automation, weaker secular demand growth and high debt levels, mean a return to that pre-Covid low growth environment seems likely. Interestingly, he infers that we could be headed back to sub-2% interest rates too. Obviously, that would be favourable for long duration assets, like the growth and tech companies that Hyperion prefers.

Orthman explains that his firm is really trying the capture the tail of the market. In Australia, just 1% of companies, or 20-30 of them, have accounted for all the gains of the ASX. In the US, that figure is 4%. Hyperion tries to find these wealth creating companies.

In Australia, the wealth creators of the past were the likes of BHP and the major banks. Now, and in the future, Orthman says that’s likely to change. His firm has little interest in investing in miners or the banks, which in aggregate comprise more than half of the ASX 300.

Instead, it looks elsewhere. Hyperion likes to own monopolies – disruptors which are almost creating industries unto themselves. It’s famously been early investors in companies such as WiseTech (ASX:WTC), REA (ASX:REA), and Afterpay.

One of its biggest investments now is Block (ASX:SQ2). Afterpay got rolled into Square which then became Block. And Afterpay is about 10% of Block’s business.

Orthman acknowledges that Block is a controversial stock though he thinks it’s misunderstood, as WiseTech and REA were in their formative years. About 50% of Block’s earnings come from its Cash app. It’s a peer-to-peer product that’s gone from having the sixth largest market share in the US to number one. The product allows you to do things such as easily transferring money to a friend. Block has offered this as a free service but has added services on top, like being able to invest in Bitcoin, owning fractional interests in shares, and so on. Block also has another business with its well-known payments and point of sales system for small businesses.

Orthman believes that the younger generation are often starting off with the cash apps and not with banks, and that gives Block the potential to disrupt the traditional banking system. He says recent earnings issues at the company should be behind Block as it remains a dominant business, yet it lost control of its cost base, which is now being addressed. That should result in much higher earnings over the next few years.

The Schroders view of the world

Schroders has a very different take on markets. Conlon thinks inflation could remain a problem. He says deglobalization, remilitarization, green energy, demographics resulting in increased government spend to support the ageing, is likely to lead to more inflationary pressure.

Conlon says prices of markets are high versus history, driven by growth stocks, especially in tech. He expects a shakeout, and valuation mean reversion, at some point.

He believes long duration stocks aren’t without risk. They can operate in cyclical industries rather than be structural growth stories. Also, he finds it hard to look 10 or 20 years ahead to figure out what a company’s earnings might be then.

Conlon’s prefers to look at sectors and stocks that investors are running from, rather than towards. He cites resource stocks as attractive given his inflation outlook. He also favours pathology and radiology shares. He says they are not only solid businesses, but may also benefit from artificial intelligence potentially replacing people performing scans etc. Conlon also likes that they are preventative healthcare businesses, which are less reliant on government spending than companies that treat people after they become ill.

Both may be right

Hyperion and Schroders are both fabulous investment managers. Right now, growth is the flavour of the month. If it was a kid in a classroom, it would be the cool, hip one that’s endlessly attracting attention and followers. Meanwhile, the value investor is akin to the nerdy outcast sitting at the back of the classroom, envious of the attention the cool kid is getting and waiting for them to soon trip up!

There are obvious risks to Hyperion’s view of the world. Short-term tech valuations do look excessive. In the 32 trading days to the end of last week, Nvidia (NYSE:NVDA) gained more than US$1 trillion in market value – a six week gain that’s greater than the total market capitalisation of Berkshire Hathaway (NYSE:BRKA), which Warren Buffett spent six decades building. That seems far from normal.

There’s also the risk that we don’t return to the low inflation and interest rate world that Hyperion envisages. If it doesn’t happen, the valuations of long duration assets should come under pressure.

There are question marks about how revolutionary AI will be too. Yes, it will almost certainly help with productivity and cut costs, but will it have the effect that the Internet had? It seems highly doubtful at this point.

While Martin Conlon may prove right in the near term, the long-term might be another matter. There are a few issues that value investors must grapple with, and it’s not just recent underperformance. First, technology is here to stay and understanding it will be critical to evaluating all companies, not just those in the tech sector. In my experience, a lot of value investors are sceptical of tech, if not tech averse, driven by the experience of large drawdowns in tech stocks in 2000, 2008, and 2022. Yet, a thorough knowledge of technology will be critical to future stock picking.

Second, younger generations will be the customers of tomorrow’s businesses and understanding them will be crucial as well. For instance, they seem to value convenience and technology that enables this. It’s why Block’s Cash App is proving popular. It’s why online investment platforms are taking off. It’s why ETFs and active ETFs are attracting money at the expense of managed funds. And the list goes on.

Disruption of traditional industries because of our tech-savvy younger generations is likely to continue and grow, whether value investors like it or not.