What is ‘innovation intensity’ and how can it boost returns?

There is a direct correlation between innovation and outperformance according to new research

What is ‘innovation intensity’ and how can it boost returns?
Steve Randall

Historical outperformance of companies can be directly linked to innovation, but this is widely ignored by investors according to a new study.

It found that most investors recognize the correlation, but few allocate directly to innovation and most lack a dedicated framework for measuring innovation in their investment process, even though it can improve long-term risk-adjusted returns.

Using the ratio of annual R&D investment to revenue to measure innovation, over the past 45 years, companies in the top quintile in R&D/revenue outperformed bottom quintile companies by 100 basis points (bps) per annum. But this has surged in the last 10 years years to a 560bps outperformance for those heavily investing in innovation.

The study was conducted by Greenwich Associates in partnership with investment manager Alger. It polled institutional investors, financial advisors, intermediaries, and consultants looking after more than US$18 trillion.

“Most investors do not target innovation directly because they simply do not know how or where to start,” says Davis Walmsley, head of client relationships at Coalition Greenwich and author of The Innovation Advantage? Harnessing the Power of the New Factor.

Innovation intensity

The study highlights the concept of ‘innovation intensity’ where a metric, such as R&D as a share of revenue, is used to assess impact of innovation in investment portfolios.

However, a deeper focus on innovation intensity is advised.

“Capturing the full return premium associated with innovation requires a more comprehensive investment framework that identifies companies with proven, repeatable processes for cultivating and monetizing innovation,” says Brad Neuman, director of market strategy at Alger. “We believe that investors may be well served by evaluating the Innovation Intensity of their portfolios and allocating to managers with proven track records in order to harness the power of innovation.”