“The central principle of investment,” said John Maynard Keynes, a highly successful fund manager as well as an economist, “is to go contrary to the general opinion, on the grounds that if everyone agreed about its merit, the investment is inevitably too dear and therefore unattractive.” In October, the contrarian trade was to switch out of the technology stocks that had outperformed in the pandemic and buy lockdown-hit value stocks. The announcement of vaccines in November duly led to a dramatic rebound in value stocks as an end to restrictions was factored in. The consensus view has now turned in favour of value over growth and against the tech-heavy US market.
Another good year for growth stocks?
Advocates of such a strategy are urging investors to take profits in Scottish Mortgage Trust (LSE: SMT), the £17.6bn flagship of Baillie Gifford and the FTSE 100’s best performer of 2020 with a return of 110%. The same advice would apply to SMT’s sister trust, the £940m Baillie Gifford US Growth Trust (LSE: USA), which returned 133%. But do these trusts now have contrarian appeal? They will not repeat their 2020 returns, but could still do well in 2021.
The case against the Baillie Gifford style is that growth stocks, especially in the technology sector, are overvalued and need to derate. This is possible, but derating could come through earnings growth rather than share prices sliding. For these stocks to plunge, as many tech stocks did when the tech bubble burst in 2000, their business models would have to be seriously flawed owing to a lack of competitive advantage, limited pricing power, or inability to dominate a durable market. That is much harder to argue now than it was in 2000. Growth valuations may be ahead of profits, but the same applies to most of the recovery stocks, where investors are looking ahead to results in 2022 rather than 2021.
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Baillie Gifford’s managers have not been sitting complacently on their winners. Although Tesla is still SMT’s largest holding at 8.9% of the portfolio, “we sold over 40% of our shares” last year. Betting that established companies, such as Toyota and Volkswagen, will see off the threat of an insurgent with new technology has rarely succeeded in other fields, and Tesla’s leadership in battery technology gives it a huge advantage. To spread its exposure, SMT has devoted 4.5% of the portfolio to Nio (see page 7), a Chinese electric-car company with a focus on autonomous driving and battery exchange. This allows drivers in China to refuel at 143 battery-swap stations rather than settle for the much slower process of recharging.
Seeking new opportunities
SMT has also made the first reduction to its Amazon holding (now 6.6%) “that was not driven by diversification concerns”, arguing that “the starting capitalisation of over $1.5trn makes the path to large future returns more challenging”. It has also sold out of Facebook. New opportunities for investment “remain plentiful”, not least in the private-equity segment of the portfolio consisting of 50 companies and 17% of holdings.
According to the Financial Times, the number of “unicorns” (technology-related private companies valued at over $1bn) has risen from 40 to 500 in the last seven years, with a combined value of $1.5trn; 35 of the top 50 are in the US. These 500 will be the main hunting ground for new investment, although SMT continues to add to existing holdings and explore new listed stocks.
The steady evolution of the portfolio reduces the need for investors to worry and the vague feeling that “Buggins’ turn” dictates that value stocks must now outperform is no basis for ditching a winning strategy. Stick with Baillie Gifford and be patient.
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