Every investor increasingly must navigate a world of structural headwinds, which requires new strategies to succeed. In the old approach to global equity investing, one could generally rely on a few engines of growth, like the rise of emerging markets (especially China), reasonably steady growth in global GDP, and positive demographic trends such as an emerging middle class.
In a post-COVID and post-Ukraine invasion world, much has changed from that old playbook. First, relying on GDP growth to raise many boats no longer works. Global GDP growth and country-specific growth, such as in certain countries in Europe have slowed a lot. As a result, investors need new sources of return. Second, demographic trends are challenging many countries, both developed and developing, in particular aging (and shrinking) populations are making it more difficult to drive growth. Third, emerging markets, and China in particular, have slowed dramatically as they face structural headwinds that are not easy to resolve or that may require embracing reforms or a change in policy. Fourth, there is an extreme dichotomy in intellectual property (IP) creation, or innovation, across countries, with a select group of countries creating much of the IP while most countries rely on commodities and basic industries. Much of the wealth globally is being created in pockets of innovation, concentrating wealth in select locations. Lastly, there appears to be a growing number of countries embracing autocracy, repressing freedoms, chilling entrepreneurship, and chasing away investors.
We believe an updated approach to global investing may help in navigating through, or around, these headwinds, a strategy we call Macro 2.0. This new global investing approach, which we outline below, embraces two new frameworks: 1) Focusing on Innovation Clusters, and 2) Evaluating Country Governance.
Focusing on Innovation Clusters: Economic Engines of Growth
Across the world, there is a growing number of special geographic areas that academics have called innovation clusters. The concept was largely conceived by Michael Porter in his groundbreaking Harvard Business Review article, “Clusters and the New Economics of Competition.” In it, he stated that “[the] economic map of the world is dominated by what I call clusters: critical masses—in one place—of unusual competitive success in particular fields.” This article was written in 1989, 35 years ago, largely in reflection of the stunning rise of Silicon Valley as the dominant center of innovation for technology.
Decades later, Silicon Valley is still a center of gravity and fountain of innovation, but the big surprise is that there is a growing list of “Silicon Valleys” developing not only within the US, but across the world. These special places have very specific ingredients to generate creative hotbeds where innovation thrives, often with a focus on specific industries. In the table shown, we share the key features that define an innovation cluster.
From these unique clusters arise globally competitive and highly innovative companies. We believe focusing on these special locations—of which there are many more than just the five clusters we profile below—is becoming the new way to do “macro” and identify attractive global opportunities, particularly if you agree that much of future wealth creation will be driven by important new innovations.
Evaluating Country Governance: Focus on Attractiveness Along a Continuum
The second framework we developed takes the concept of “governance,” often used to evaluate how companies are being managed, and applies it to countries. We believe countries can be categorized as investible or uninvestible based on where they are located on what we describe as the country attractiveness continuum (illustrated below).
On one end of this continuum are Supportive Regimes, which have built (or are building) strong rule of law, IP protections, and infrastructure that, together, support a strong startup track record, robust IP creation, high levels of patenting, and an investor-friendly environment. In combination, all of these ingredients tend to spawn innovation clusters and drive national competitiveness. These countries are not only investible but are highly attractive hotbeds for sustainable growth businesses. While the United States is a standout example, we also believe there are a number of countries across Europe, Latin America, Asia, and other regions that are emerging as beacons of good governance and IP creation.
On the other end of the Country Attractiveness Continuum are Repressive Regimes, which we believe should be labeled uninvestible. What are the indicators of poor governance in these types of regimes? Repressive regimes typically trend toward autocratic rule, undermining rule of law, disincentivizing IP creation or startup activity, and often stopping reforms in their tracks, if not backtracking entirely. A mark of repression that is most easily diagnosed is increased censorship and control over information channels. Since investors rely on accurate information in their assessment of investments, it is no surprise that when a country restricts information flow, capital starts to flee. One example of this would be Russia, a country in which we have never invested.
Given this country-governance framework, we seek to assess whether a country offers a supportive or repressive environment and then to understand the direction of the trend. Some countries can move toward openness and reform over many years, and then backtrack on these reforms—usually slowly at first, and then more rapidly if the government becomes truly autocratic.
Below, we share a handful of example companies and associated innovation clusters across current portfolios. There is a growing number of these types of clusters across the US, and the world, that are generating important innovations. Our team and process has been built to systematically identify these promising areas of opportunity.
Example Innovation Cluster: Copenhagen, Denmark
Ascendis Pharma is headquartered in Hellerup, Denmark, part of the increasingly important Copenhagen innovation cluster—and just one of a growing number of innovative clusters or cities in Europe benefitting from world-class academic research that supports breakthroughs in biotechnology. Copenhagen is home to top medical universities such as the University of Copenhagen medical school, which has become a key talent hub from which neighboring biotech and pharmaceutical companies attract employees. In fact, the University of Copenhagen is the most common school attended by Ascendis Pharma employees, according to LinkedIn. Importantly, the Copenhagen cluster is home to many other biotech and pharmaceutical companies, including Novo Nordisk, that represent potential collaborators for Ascendis and further bolster the Copenhagen cluster as a true talent magnet.
Ascendis Pharma has developed a leading and unique drug delivery technology platform, called TransCon, that enables sustained and targeted release of clinically validated and unmodified parent drugs that result in favorable dosing regimens (e.g., extended release) that improve compliance and, in turn, result in improved treatment outcomes compared to existing drugs on the market. The TransCon technology platform has been clinically validated by the FDA approval of Skytrofa, Ascendis’ once-weekly human growth hormone (hGH) injection (improving upon older-generation once-daily injections), as well as by the recent FDA approval of Yorvipath, a treatment for patients with hypoparathyroidism (HP).
Ascendis has proven its ability to commercialize pipeline candidates with the rapid launch of Skytrofa, for which we believe the company can continue to take meaningful share of the $4+ billion (and expanding) global hGH market. This has given us confidence in Ascendis’ ability to launch Yorvipath following its FDA approval in August. Our conversations with endocrinologists have helped to confirm not only the high unmet clinical need among HP patients for a new effective therapy, but also the potential for a relatively quick adoption of Yorvipath. We believe a successful launch of the treatment in the US could support a multi-billion-dollar global market, as the drug has already been approved in the EU. Furthermore, we believe the company has a strong balance sheet with ample funding to continue to build its commercial infrastructure and develop its broad pipeline over the long term.
Example Innovation Cluster: Minneapolis’ “Medical Alley”
Inspire Medical is headquartered in Golden Valley, Minnesota, which is part of the renowned “Medical Alley” innovation cluster. Medical Alley initially spawned from large amounts of government-funded medical research (with a primary focus on heart health) at the University of Minnesota and the Mayo Clinic during and after World War II, which helped attract the best and brightest minds to the region. Ultimately, this heavy investment in medical research led to the formation of Medtronic and, eventually, the invention of the pacemaker. This revolutionary innovation drove the success of Medtronic, which further bolstered Medical Alley as a talent magnet and ultimately led to the birth of many other medical device companies in the area, including St. Jude Medical (acquired by Abbott), Inspire Medical, and many more. Interestingly, Inspire Medical is a spin-out from Medtronic, and was founded after long-time Medtronic employee, Tim Herbert (Inspire’s CEO), discovered that Medtronic’s neurostimulation technology could potentially be applied as a treatment for obstructive sleep apnea (OSA).
Since receiving FDA approval for its hypoglossal nerve stimulation (HGNS) treatment for moderate to severe OSA in 2014, Inspire Medical has treated over 75,000 patients, and we believe the company is still in the early innings of treatment adoption. HGNS uses an implanted neurostimulator to gently stimulate the hypoglossal nerve to move the tongue forward to open a patient’s airway during sleep, which significantly reduces sleep apnea events at night. There are around 17 million patients with moderate to severe OSA in the US alone, with about two million of those patients being prescribed CPAP mask therapy each year. With CPAP non-compliance historically ranging from 35% to 65%, many patients go untreated or face highly invasive, irreversible, and painful surgical procedures that often have low success rates. With a clear unmet medical need, Inspire’s HGNS implant represents a true paradigm shift in treatment for these patients, supporting a potential $10 billion US market opportunity, over time. Importantly, while we believe we are still in the early innings of the Inspire story, the company has already flipped to sustainable profitability and continues to grow revenues at above-average rates, which we expect to be strengthened by the recent approval of the company’s next-generation HGNS device, the Inspire V.
Example Innovation Cluster: Oxford, UK
Oxford Nanopore is another standout example of groundbreaking innovation arising within innovation clusters. As its name suggests, Oxford Nanopore is a spin-out from the University of Oxford, an innovation hub in many areas, including life sciences and genetics. Oxford Nanopore is a pioneer in the development of next-generation gene sequencing technology, based on its nanopore single molecule sensing platform. Nanopore technology was being developed at the University of Oxford as a potentially superior way to sequence genes. The nanopore sequencing technology utilizes electronic base calling (reading the individual ACGT bases) versus current optical-based platforms. By passing gene strands through a microscopic pore within a membrane, this platform can uniquely conduct direct and real-time reading of the genome (known as “long reads”), including capturing epigenetic information such as methylation (which regulates genes). This contrasts with current SBS chemistry and short-read optical platforms, such as Illumina’s, where genetic samples are cut into much smaller pieces, read, and then reassembled indirectly, losing critical epigenetic information and structural variants. Oxford’s nanopore platform uniquely sequences long and ultra-long sequences directly and in high-throughput processes that are offering scientists a deeper look at the genome and its relation to disease. Lastly, Oxford Nanopore systems can be purchased as lower-cost kits that often don’t require expensive capital equipment, offering a more cost-effective and accessible way to conduct genetic research.
We recently took a research trip to the UK and Oxford and had the opportunity to meet with Oxford Nanopore’s CEO, Gordan Sanghera. He shared his views on the progress the company is making in significantly improving the accuracy and cost of its sequencing platform, as well as updates on sales of products beyond research into applied markets, such as pharmaceutical manufacturing quality control, infectious disease surveillance, and clinical diagnostics. Overall, our confidence increased that long read genetic sequencing technology has a strong future and is poised to take market share within the larger market, with Oxford’s nanopore platform offering unique advantages relative to the competition.
Example Innovation Cluster: Silicon Valley (US)
Intuitive Surgical, a pioneer and leader in the field of surgical robotic technology, is headquartered in Sunnyvale, California, part of the important Silicon Valley innovation cluster. The original idea for robotic surgery was born from the Department of Defense’s desire to decrease battlefield casualties through the development of telesurgery. Ultimately this turned into a pivotal collaboration between the Defense Advanced Research Projects Agency (DARPA), and the Stanford Research Institute (SRI is located in Menlo Park, California, 20 minutes from Intuitive Surgical’s HQ) in the 1990s that led to the development of the first prototype and core intellectual property (IP) for a robotic surgery platform. Intuitive Surgical was founded in 1995 after its founders, Fred Moll and John Freud, were able to successfully negotiate licensing for SRI’s core IP, and later develop and receive FDA approval for its Da Vinci robotic surgical system in 1997. After years of IP disputes with its key competitor, Computer Motion, the two businesses merged in 2003 and the combination of the two technologies led to meaningful improvements in the robotic surgical system, and broader adoption of the technology. Fast-forward to today, and Silicon Valley remains a hotbed for robotic surgical innovation, with Intuitive on its fifth-generation platform alongside emerging innovators such as portfolio holding Procept BioRobotics, whose current board member and former Chairman happens to be Intuitive Surgical founder Fred Moll.
As previously mentioned, Intuitive Surgical recently received approval for its next-generation robotic surgical platform, da Vinci 5 (DV5). The launch of the DV5 next-gen platform will start a multi-year replacement cycle (the previous platform, the Da Vinci Xi, was launched a decade ago). After a 10-year development cycle, Intuitive has packed the DV5 with over 150 new features. The most notable new features of the DV5 include force feedback, advanced high-resolution imaging, enhanced ergonomics, integrated instruments, and new software and AI capabilities. Potentially the most important of these new features is the first-of-its-kind force-sensing technology, which enables the system to measure subtle forces exerted on tissue during surgery, helping to inform surgeons about the amount of force being applied. Data shows this force feedback capability can reduce applied forces by over 40%, limiting tissue trauma or injury and ultimately reducing complications during robotic surgical procedures. Overall, the new DV5 robotic platform further widens the moat relative to potential competitors, whose systems lack DV5’s breadth of capabilities, approved procedures, and clinical data. The adoption of robotic surgery has also expanded globally, with broadening adoption across Europe and other advanced economies as well as early adoption in emerging markets. Following multiple years of heightened investment in this new platform and expansion of its commercial infrastructure, Intuitive Surgical is now entering a period of sustained margin expansion. We believe Intuitive Surgical can sustain durable high-teens earnings growth, driven by a multi-year replacement cycle, expansion into new procedures, international growth, and margin expansion.
Procept BioRobotics, headquartered in San Jose, California within the Silicon Valley cluster, is the pioneer of the first and only robotic-assisted system (branded HYDROS) and heat-free, water-based procedure (branded aquablation) for the treatment of benign prostatic hyperplasia (BPH). BPH (enlarged prostate) is the number one reason why men visit a urologist, with an estimated 8.2 million men in the US being actively treated for BPH with either medications or surgical options. Our research shows that some urologists have begun to standardize most of their surgical procedures on aquablation due to its ease of use, reduced and predictable procedure time, and applicability across prostate sizes, all without sacrificing durability of treatment or increasing the potential for negative sexual health side effects. A number of the core technologies that support the HYDROS robotic system are products of the expertise in software, robotics, and computer-assisted surgical equipment found within the Silicon Valley innovation cluster in which Procept operates. Procept’s former Chairman of the Board and current Board member, Frederic Moll, was the co-founder of Intuitive Surgical, the industry leader in surgical robotics (previously mentioned), which has its headquarters just 20 minutes down the road from Procept.
After connecting with multiple urologists and reviewing clinical data, we have increasing conviction that the technology may become the standard of care for the treatment of BPH within our investment time horizon. Procept has an attractive razor-razorblade business model for which system placements have grown meaningfully, leading to rapid growth in procedures in recent quarters. We believe this business model supports high gross margins that can help drive profitable growth over time as aquablation potentially evolves to become standard-of-care.
Example Innovation Cluster: Boston, US
Sarepta is another great example of the power of innovation clusters. The company recently received FDA approval for its groundbreaking gene therapy for the treatment of Duchene muscular dystrophy (DMD). As we describe below, Sarepta straddles at least two innovation clusters, including the Greater Boston area and Columbus, Ohio, in developing treatments for neuromuscular disease. Sarepta has developed four FDA-approved therapies, generating over $1 billion in revenues, for the treatment of DMD including three exon-skippers and a gene therapy treatment, all addressing the underlying cause of the disease.
Sarepta is headquartered in the Cambridge area of Greater Boston, a well-known innovation cluster for medical research driven by local academic institutions (Harvard, MIT, UMass, Boston University, etc.) and a prominent biotechnology hub for biotech and pharmaceutical companies. Sarepta is one of the larger biotech companies in the area and, in fact, connects with other innovation clusters in other parts of the country. The company leverages an open innovation approach for pipeline development by accessing next-generation biotechnologies for the treatment of neuromuscular disease from outside innovators (complementing its in-house R&D capability). The most impactful example of this is Sarepta’s external collaboration with Nationwide Children’s Hospital based in Columbus, Ohio, a great example of collaboration between two clusters of innovation.
Nationwide Children’s Hospital is a world-renowned leader in medical research for degenerative neuromuscular diseases and is where Sarepta’s gene therapy program first originated, from research conducted by Dr. Jerry Mendell and Dr. Louise Rodino-Klapac (who is currently Sarepta’s Chief Scientific Officer and Head of R&D). That program was licensed by Sarepta and recently received full FDA approval across a broad spectrum of DMD patients, creating a multi-billion-dollar opportunity for the company. Interestingly, the connection to the Columbus innovation cluster still remains strong, with the most commonly attended university by Sarepta employees (according to LinkedIn) being The Ohio State University, located in Columbus.
HubSpot is also headquartered in Boston, which is emerging as the most important innovation cluster on the East Coast. Boston has a unique blend of world-class academic institutions in MIT and Harvard, coupled with a rich history of venture capitalists that have helped the city become a hotbed for biotech and technology innovators. HubSpot, a company we’ve owned in our portfolios since 2018, is a leading provider of cloud-based marketing automation and customer relationship management (CRM) software for over 225,000 small to medium-sized businesses (SMBs). The company was founded in 2006 by two entrepreneurs, Brian Halligan and Dharmesh Shah, who both attended MIT’s Sloan Business School where the concept for HubSpot was developed. In fact, the majority of the initial team at HubSpot (around 10 of its first 15 employees) attended MIT’s Sloan School of Management. With its vibrant ecosystem of academia and researchers, Boston provides HubSpot with access to a deep pool of highly skilled software developers, engineers, and other tech talent.
HubSpot started off as a single-product company, developing a leading marketing automation tool, but the company’s vision was much larger. Over time, HubSpot has expanded its platform to multiple “hubs” including sales, service, content, operations, and commerce hubs. Today, over 50% of its customers are using three or more hubs, which demonstrates the company’s ability to cross-sell its broader platform. Additionally, all five of its largest hubs continue to grow revenue at a double-digit pace. The company has developed a robust ecosystem of customers, partners, and developers who all get together at the company’s annual INBOUND user conference in Boston (our team also attends). The event attracts tens of thousands of attendees each year, which is impressive for an SMB-focused software company and a testament to the strong product and community HubSpot has built. We believe HubSpot has significantly benefited from leveraging the resources and opportunities available in the Boston innovation cluster. We believe HubSpot is well-positioned for continued growth and expansion, particularly as it moves upmarket to serve larger enterprise clients and as its recent pricing adjustments flow through to the business.
Outlook: Markets Are Reconnecting To—and Rewarding—Strong Business Fundamentals and Growth
While the market remains volatile, we believe there is reason to be optimistic about the future. The Federal Reserve’s (and other central banks’) shift to an easing cycle—after one of the fastest rate hike cycles in a generation—is of profound importance for stabilizing the markets. We focus less on the number of rate cuts and more on the direction. The continued decline in inflation, and continued stabilization or reduction in interest rates, has created a market environment that is less macro-obsessed and beginning to refocus on the underlying growth and fundamentals of individual companies.
As the equity markets begin to broaden out beyond the Magnificent 7, we believe the companies with the strongest underlying fundamentals will be rewarded over time.
Overall, we believe we own a collection of high-quality, innovative businesses that tend to lead their industries and represent attractive leaders emerging from various innovation clusters in the US and abroad.
