Rules and Regulations: Investors Can Benefit
Get out your crystal ball and tell us what’s going to happen. Is there going to be a recession? Are we already in a recession? Is Congress going to play its game of chicken until it forces the U.S. into default on debt payments? The questions posed have binary answers: yes or no. They are either going to happen or they aren’t. They also are relatively short-term in nature. The recession question will be answered (in hindsight, of course) within a year or two, maybe in a matter of months. Regardless, two years is not a “long-term” horizon. The U.S.-default question will be answered within weeks. Also, not a “long-term” horizon. As Yogi Berra sagely put it, “it’s tough to make predictions, especially about the future.” So if you can’t predict the future with any certainty, how can investors take a long-term view? With history as a guide, identifying certain trends helps focus our portfolio construction and security selection. One such area of concentration is the steady march of rules and regulations dictating business practices around the globe. This one-way street, or noose as some prefer to label it, has been tightening for over a hundred years and is accelerating, creating a growth industry that investors can align themselves with.
With an arbitrary starting point in 1906 and the publication of Upton Sinclair’s The Jungle, U.S. regulation has seen dramatic growth. Public outcry over The Jungle led to the passage of the Meat Inspection Act, The Pure Food and Drug Act and ultimately to the creation of the Food and Drug Administration (FDA). What we have today in the U.S. is a wide array of government agencies that oversee consumer products (Consumer Product Safety Commission); automobiles, trucks, motorcycles, tires and car seats (National Highway Traffic Safety Administration); food, drugs and cosmetics (Food and Drug Administration); aircraft (Federal Aviation Administration); etc., etc. The theme of consumer and public safety plays out around the world. Virtually every country has a similar framework for regulating products and (ostensibly) protecting its citizens. Because every jurisdiction creates its own body of law, a vast global patchwork of rules and regulations has arisen.
Investors can latch onto this growth industry by identifying companies that facilitate and enable the expansion of regulation. Of particular interest to ACM’s International and Global strategies is the TIC, or Testing, Inspection, and Certification industry. These companies play a critical role in ensuring safety, reliability, quality and compliance with standards across all geographies and industries. Testing usually deals with physical products, their makeup, adherence to standards, mechanical properties, electrical safety, composition and interoperability. Inspection can expand on testing to include site assessments, supply chain audits and further compliance. Certification verifies that systems and procedures are in place that meet specific standards and requirements and offers evaluation and accreditation.
A handful of examples will illustrate how the TIC market is booming. Unheard of a few years ago, these are real topics and product areas that create growth in the TIC realm: sustainable chocolate, genetically modified bananas, sustainable finance, environmental protection, sustainable development, data protection, ethical labor practices, emissions reduction, supply chain verification, green energy, net zero commitments, cryptocurrencies, and on and on. New monickers seem to crop up daily.
Investment merits to TIC companies are plentiful. Product manufacturers typically maintain a single TIC vendor for the entire life cycle of a product, making for a very sticky and long-lasting relationship. For a given product, say a mobile phone, for example, if a single component is changed, the entire testing and certification cycle must be repeated. If a seemingly simple change is made, like moving the antenna from one side to the other, a cascade effect of follow-on tests is required. This can happen even when something as innocuous as paint color changes. The physical qualities of the paint or coatings can alter the electrical and radio signals, requiring full testing and recertification. The bottom line is, a tiny change in product makeup means recurring revenue to TIC vendors.
As mentioned above, TIC is no longer limited to physical goods. The European Union has taken a more comprehensive approach to data privacy and protection than other jurisdictions with the implementation of the General Data Protection Regulation (GDPR). The GDPR establishes strict requirements for the collection, processing, and transfer of personal data. ESG (Environmental, Social, Governance) investing is a much more prevalent phenomenon in Europe as well, with reporting requirements being mandated to virtually all publicly traded companies. Additionally, labor practices are scrutinized, not just at a company level, but at the company’s suppliers. Verification of adherence to rigorous labor and workplace practices is provided by TICs.
Regardless of intent, effectiveness, or final outcome, regulation is the driving power behind the growth in the TIC industry. Firms that make products require testing and certification. Trusted third parties provide the verification. These TIC companies get paid for their services and these are the types of companies that provide visible, long-term investment horizons. These are the types of companies ACM selects for its portfolios with regard to investing in rules and regulations.
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