James Anderson takes Merryn Somerset Webb to task for advising MoneyWeek readers to sell some shares in his investment trust.
A few weeks ago, we updated the MoneyWeek investment portfolio. This is never particularly difficult: we’ve done well so far by more or less ignoring it. But this time we agonised more than usual. Why? It’s all down to one holding, Scottish Mortgage Investment Trust (LSE: SMT). The Baillie Gifford-managed trust has been the main driver of our performance. Its share price has risen by 200% in the last five years and 38% in the last year alone; it hasn’t traded at a discount to its net asset value for years (there was once a time when most investment trusts traded at a discount); and it is one of the most popular trusts in the market.
That’s not a scenario that works for those with a contrarian mindset. Show me or John Stepek something that has shown a decade of sustained outperformance and our instinct is to sell – particularly when its portfolio is packed with pricey-looking global technology stocks. Think 9% in Amazon, 7% in Alibaba and 6% in Tesla. Regular readers will know that after a little bickering we kept the trust (see issue 874). But nonetheless, given that our Edinburgh office is a mere five minutes away from the Baillie Gifford one, I went to talk to SMIT’s co-manager James Anderson (he runs it with Tom Slater) – just to be sure.
To rebalance or not to rebalance?
The team don’t have too much time for wobblers. Anderson isn’t impressed by the “passion for multi-asset” investing of the type done by most of the other big UK trusts, and he isn’t mad for my talk of how, while we didn’t drop SMIT, we did suggest to readers that they rebalance (because if you have never sold any SMIT, it will make up a very large proportion of your assets by now). There was a time, he says, when investors didn’t sell funds that had done well. Instead, they thought, “there must be some skill, and they must have identified something in the markets. And you got more money.” Now “you get money taken away”. The skill bit might have been overdone as an idea before, but this change “may be dangerous too”.
What of the possibility, asks Anderson, “and it is no more than a possibility… That Tom and I… might be right”? If we are about to enter a period of “even more profound and rapid change” than before, and if that is to be reflected by a small set of firms, isn’t there a chance that the real risk is in rebalancing from them into the things to which they are a “serious threat”? Look at it like that, says Anderson, and what SMIT really does is act as a “form of insurance” against the chance of very rapid change. If you keep rebalancing, will you have enough insurance? This brings us on to a study by Professor Hendrik Bessembinder, of the WP Carey School of Business at Arizona State University. According to him, most stocks aren’t good investments at all (you’d be better off with short-term bonds). But a few are absolutely outstanding investments: a mere 86 stocks have generated half of the $32trn in net wealth created on the US stockmarket between 1926 and 2015. This jars with conventional investing theory – and if verified suggests a lot of rewriting of business-school courses to come.
Picking winners is tough – but lucrative
However, there are two very different ways to respond to the study. You could see it as a fabulous argument for diversification: given how hard it is to pick winners in advance, you should hold everything, to cut your risk of leaving out the big winners. You could also see it as an argument for skipping diversification and only holding the stocks most likely to be the big winners – the ones with whatever you consider to be the characteristics of sustained success. Anderson (obviously) goes for the latter (SMIT has 77 holdings, but the top 30 make up 80% of the portfolio). With this in mind, he says, it is interesting that the greatest problem for SMIT over the last decade has not been that it has been too excited about the future, but that in fact it has been unable to “grasp just how great the prospects for some of our companies were”. That’s partly down to the fact that optimistic big thinking isn’t what fund managers do: their default position is “profound risk aversion”. So is that of clients: the majority of questions Anderson gets are about why holdings have gone wrong, rather then stunningly right.
But if Bessembinder is right “that life is lived in the positive extremes, we’ve got to get much better
at understanding what the positive extreme is”. That makes sense. It also brings us neatly to electric-car manufacturer Tesla, the holding that SMIT gets the most criticism for. Does he worry? No. Tesla’s chances of being one of our generation’s 86 rest with founder Elon Musk. Talk to anyone who has worked with him and they will say he is “incredible” in his motivation, grasp of detail and strategic vision. He is also trying to do “what capitalism is supposed to do” – raising significant risk capital to pursue uncertain but important economic and social objectives. In this context, SMIT is doing exactly what it is supposed to do: providing that capital.
Amazon’s awesome power
On to the big platform companies. The team reckon that Amazon is not “anywhere close to the end of its period of increasing dominance” and that investors have barely begun to “grapple with” the “awesome” power of “Alibaba and Tencent”. That these three are as big as they are and still growing as fast as they are has very little historical precedent. But there is no reason for it to end. Anderson met Alibaba founder Jack Ma just before Singles Day (a huge shopping event) in China. That night Alibaba did 357,000 transactions a second – in 30 seconds, what Amazon did all day on Prime Monday and nine months’ worth of normal orders. That was a good test of its systems – how much business it can cope with, and how much it could grow as China keeps gets richer. It was also a reminder that the amount of valuable data it is generating is extraordinary. China, says Anderson, thanks largely to its huge population, is much more of a data-driven society than we are: everything is done by app – from queueing for a table in a restaurant to paying for the meal at the end. The difficulties of running your life in a big society (“small” cities can easily be ten times the size of Edinburgh) suggest that “China is probably going to be the dominant data-driven society”.
I wonder if he worries (as we do) if any of the big platforms will be held back by regulation? He reckons we are just in a period of adjustment – comparable to the introduction of printing in the West, when there was huge social upheaval around all the new information available. If he has concerns about any holdings it is the likes of Facebook and Google, which need to show they have the “maturity and seriousness” to deal with cultural concerns. But the key point about regulation of this kind of company is that it can make them stronger. Facebook could afford to hire another 10,000 people to check content if it needed to. New entrants could not. That “freezes the competitive landscape” – and given the size of the current incumbents rather suggests that it is “too late” for regulation.
The risks of being pessimistic
Still, the portfolio isn’t just about the giants. We move on to some of SMIT’s smaller holdings. Anderson is excited about a firm called Bolt Threads, which has “effectively made an artificial silk” that could be used by the luxury brands owned by one of his top holdings, Kering. He’s very interested in synthetic biology (this is all about rearranging and editing DNA), as being developed by another holding – Ginkgo Bioworks – and its interaction with agriculture. Gingko has a deal with Bayer to “get the three main crops of this world to generate their own fertiliser. So you don’t need all the cost, pollution and environmental degradation” associated with traditional ones. He’s also “really quite excited” about healthcare. He’s interested in Denali – which SMIT bought as a private company, but is now listed. The management reckons that the science of things such as Alzheimer’s “is somewhat akin to where oncology was 20 or so years ago”. There’s huge scope for SMIT’s determination to display “resolute optimism” here.
You could talk through this type of firm with Anderson for hours (or read more here), but after our hour-and-a-half chat, Anderson’s point is made. For long-term investors, the risks of not being hugely optimistic about all these things may well be higher than those of being optimistic. MoneyWeek investment trust portfolio holders: the last review was the first since launch in which I really nagged you to rebalance. I’ll wait a few years before I mention it again.