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How to pick inflation-proof innovators

By Bevan Duncan and Ken Wotton, Gresham House Baronsmead VCTs

Inflation has been firmly in the headlines this year, as the pandemic aftershocks are finally being felt by markets. Supply chain disruption and labour shortages are feeding through to cost inflation, with the UK inflation rate reaching a 30-year high in December. Alongside new strains of Covid-19, this is causing share prices to fluctuate considerably.

We have been anticipating this market turbulence for some time, avidly awaiting the opportunity to invest in exciting early-stage businesses that we believe will outperform in this market context and beyond. However, it will be important to ensure these young businesses, which have not experienced an inflationary environment, are well equipped to navigate the uncertainty ahead.

Pricing power prevails

Due to the pressure cost inflation places on profit margins, companies must explore ways of enhancing pricing models to maximise revenue. Smaller firms run by ambitious management teams are in fact best positioned to do this, as they can be more agile in their decision making versus larger and more entrenched incumbents.

We also look for companies in a market leading position or with a defendable competitive advantage that affords them a high degree of pricing power. We invested in Cerillion, an Alternative Investment Market (AIM) listed software specialist that provides leading billing, charging and customer management systems to the telecommunications, finance, utilities and transport sectors.

Due to the company’s reliance on highly skilled software developers and service roles, the wage inflation and ‘war for talent’ ongoing in the UK was a major concern. To combat this, the company has focused on boosting productivity and utilising lower-cost labour in other geographical regions.

Additionally, the business has evolved its strategy to generate greater revenue. Instead of simply increasing prices, Cerillion was able to target larger clients and take on longer projects – which require roughly the same resources – thereby increasing margins to offset the rise in wages.

Money in momentum

Another important aspect to protecting a portfolio from inflation is to search for companies operating in sectors supported by positive long-term, structural growth trends.

With public healthcare systems struggling to cope with Covid-19, the private healthcare space is witnessing a wave of innovation, from advances in drug development to digital treatment. The phenomenon of ageing populations means this trend is here to stay, and we are seeing a number of compelling investment opportunities in companies benefiting from these shifts in the market.

At the end of last year, we invested in the initial public offering of York-based biotechnology firm Aptamer Group on the AIM. The leading tech platform produces aptamers, or synthetic antibodies, for use in processing, therapeutics and diagnostics, and has forged partnerships with most of the top 20 global pharmaceutical firms. The production of synthetic antibodies is a fast-growing market, taking share from traditional antibodies due to their ease and low cost of production, yield consistency, binding affinity and specificity.

Aptamer Group is experiencing rapid growth with a high-quality customer base and has significant upside potential from IP licensing and royalties, in addition to fee-for-service revenues.

Know your network

In private markets, we are continuing to see strong levels of deal flow in high growth areas including healthcare and tech. These are parts of the economy where we have a strong talent network and in-depth sector knowledge.

By leveraging the scale of our team, we are able to double down on high potential prospects and move quickly to try and put ourselves in a preferred position to win deals. In addition, our track record and expertise is attractive to private companies, which choose to partner with us based on the value-add advice we can offer and our access to resources and specialist skills.

This recently allowed us to invest in a company at the crossroads between two structurally growing spaces – e-commerce and personalisation. The innovative photobook app Popsa harnesses machine-learning to enable users to digitally design customised photo albums in minutes.

We recently invested £6.5m in the company, motivated by its promising growth trajectory and ambitious, high quality management team. Founded in 2016, Popsa already boasts about two million users across two continents and expects significant further growth. Our investment, which will increase funding to the data science and technology team at Popsa, will enable the company to meet increased demand as it scales despite a possible softening of overall consumer demand.

By playing to their strengths and being selective, investors can not only navigate the current market turbulence but also ensure consistent returns over the long term without fear of inflation erosion.

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