Spencer Adair: getting rich slowly with “cockroach” companies
Merryn talks to Spencer Adair of the Monks Investment Trust about how he shuns “glamorous” growth to find solid “cockroach” companies that thrive over the long term while their competitors wither and die.
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Merryn Somerset Webb: Hello and welcome to the MoneyWeek magazine podcast. I am Merryn Somerset Webb, editor-in-chief of the magazine. And with me today is Spencer Adair. Spencer is someone I have been wanting to have on the podcast for quite a while, actually. We're lucky to have him today. Spencer is a partner at Baillie Gifford, a company I know and lots of you know very well, and co-manager of the huge, what? Around 3.4 billion ish market cap now, Spencer?
Spencer Adair: That’s about right, yes.
Merryn: The huge Monks Investment Trust. Incredible performance over the last five years of 170% or so. 17% over the last year. Not as good as some, but not bad either. Spencer, very nice to have you with us today. Thank you for joining us.
Spencer: It's my absolute pleasure. I'm looking forward to this.
Merryn: Are you? It's not what most people say. I'll tell you what? I'll give you an easy start. Tell us a little bit about the trust. I know lots of my readers will have it already, but not everybody will. Tell us about the trust, how it's managed, what you're looking for and how it works.
Spencer: Sure. Monks is an investment trust. It's over 90 years old. And it's really optimised for building and compounding capital growth over the long term. It’s not suitable for income, people who record income. It's not suitable for people who need short-term smooth performance. It's all about long-term capital compounding. We do this by owning a selection of between 100, 120 structural growth businesses from all over the globe.
Why growth? Simply because over the long term, being a shareholder in growth businesses has been the best way to build generational wealth. If you just look at the Forbes list of billionaires or the Sunday Times Rich Lists, most of the people on those lists have got there by owning equity or businesses for a very long period of time. The alternatives appear to be some God-given skill in music or sports or even being a royal or stealing state assets if you're from certain countries.
In the absence of those four alternatives, owning shares or owning a business for a long period of time is the best way to build wealth. We take that growth investing seriously. And by that, I mean we are reward-seeking and we are ambitious. Some companies will go wrong, but the ones that go right, we hope go really right. We search for companies that have the potential to grow to a multiple of their current size.
And it's the growth of the companies rather than ever any clever dealing and wheeling and dealing by me. It's the growth of the companies that builds the wealth for the Monks shareholders. Because we're globally unconstrained, our opportunity set is massive. But very few companies meet our hurdles. I reckon there's between 4,000 and 5,000 companies we could invest in. We select 100 to 120.
We don't just look for good companies. We don't just look for cheap companies. We're looking for the ones with the potential to be the great ones of tomorrow. And we are genuinely long-term. That, I think, is our biggest competitive advantage. We back and we challenge the ambitions of management teams to give the businesses time to grow and let that value compound. We don't attempt to predict short-term share prices.
We don't attempt to predict politics or even short-term economic news. Others do that much better than we do. We wouldn't be very good at it. But we think we're pretty good at spotting really long-term trends. And by trading less, we avoid excessive fees and costs and we make sure that shareholders keep as much of the gains and the growth as possible. Since my team took over running Monks in 2015, we've got the total cost of the trust down from 58 basis points down to 43. And I would like to take that down further over several years.
Merryn: Can I just ask a couple of questions going back?
Spencer: Please do.
Merryn: When you say long term, what do you mean? Because it's all very well saying long term and our readers will all say, I'm a long-term investor as well. But a lot of our readers may be in their 50s or early 60s. Long term can't really be more than ten, 15 years in terms of when they actually need this cash to finance their retirement. What do you mean when you say long term?
Spencer: Between five and ten years. Every company we look at, we are assessing at least over a five-year period, also over a ten-year period. And if you look at the turnover in the trust in terms of what we're actually up to, that’s implying something like a seven-and-a-half-year average holding period. Between five and ten.
Merryn: And then let's go back to what it is that you mean by structural growth. Because I've talked to your colleagues about Monks before and they have this idea that there are four buckets effectively of growth definition. And when I've been told about the four buckets before and I've thought about it now and then, I actually can't think of a single company anywhere that doesn't fit into one of those buckets. Is using these four groups and calling it all growth, what are we actually talking about here?
Or are we saying you can chew on pretty much anything you like as some growth bucket?
Spencer: We've definitely got the broadest opportunity set of all of the trusts that Baillie Gifford manage. But the thing that underpins it is that we do require structural growth to be there. And by structural growth, it means a minimum of 10% free cash flow on earnings growth over a very long period of time.
Merryn: But going back again, structural growth, when I think about that, I'm thinking when you say structural growth, you must mean that the business itself is growing and expanding. But you can have earnings growth without a business expanding in itself?
Spencer: That’s right.
Merryn: You can take an oil company and say, look at the price of oil going up and we're doing a bit of cost-cutting around the edge. And the earnings are going up, but you might not say that’s structural growth. It’s just earnings growth.
Spencer: Correct. You can absolutely get some growth for a period of time by cutting costs. You can definitely cut your way to glory. But at some point, if you look over… This is where the time horizon is really important. Over long periods of time, companies that only cut costs don't sustain that growth. That they run out of fat to cut and they start cutting into muscle or whatever analogy, unpleasant analogy you want to use.
Merryn: That’s a really horrible analogy.
Spencer: I know.
Merryn: It can tell you used to be a doctor.
Spencer: Exactly. I'll start talking about horrendous surgical procedures. What we're looking for here are companies where the top line is growing. That's the starting point of the structural growth. If a company's top line is flat for a long period of time, but it's only buybacks and margins that they're improving, that’s a lot less of interest to me. There's essentially three ways that we're approaching this growth question. The first is, the power of compounding can be underappreciated.
Roughly a quarter of the portfolio today is in growth-stalwart companies, which are the get-rich-slowly businesses. They're really well established. They're very durable. They've got relatively little economic sensitivity. We think they grow, on average, 10% a year, but for ten or 20 years. Really, really long term. Companies like… I don’t know. There's America's leading funeral company or Estee Lauder, the luxury makeup company.
Whatever happens in the economy, sadly, loved ones will still die and people will still value looking younger. For stalwarts, it's the long-term compounding that people may underappreciate it. The biggest skill I have is doing nothing. It's sitting on my hands, allowing the wealth to compound and just relaxing, always checking that they're not falling foul of society, of course. But that's what we're trying to do there.
On the other side of the portfolio, another quarter of it is our more mature cyclical businesses often run by brilliant, seasoned management teams, capital allocators. An example there would be CRH, the Irish aggregates company, or Martin Marietta, the aggregates company in the US.
Merryn: Sorry, what does that do, that last company you mentioned?
Spencer: Martin Marietta? Essentially, they own quarries in the US. And the wonderful thing about quarries is that nobody wants one next to their home. You can't open very many new ones. And whenever you're building any infrastructure, roads, new houses or whatever, you have to put down this layer of stones. Their pricing power is incredible because there's very limited long-term supply coming on. And yet, despite all our technological advances, we're still in the Stone Age.
We still require basic infrastructure for lots of activities. As you can imagine, the state of US infrastructure is really very tired. And they are in great need of a ten-year programme of serious upgrading. That's before we even think about climate change and higher seawalls and more wind turbines, etc. And we think that actually, what we could have is a nice golden period there of strong volume growth and then strong pricing growth on top of that.
But really, for us, it's the capital allocation and the management skill that's underappreciated. We spend a long time thinking about the people. Do we trust them? How do they behave? And that's where you really spend a lot of time being the amateur psychologist, trying to work out what's really motivating. And then the third big chunk, which is about half the portfolio today, is the rapid growers, the upstarts, the young companies that were only funded in the last two decades, they're still growing at 20, 25% a year.
They're often innovating. They're often creating new markets that weren't there before, like Farfetch selling luxury fashion online. Lots of people thought online fashion would remain a physical boutique. It would never really go online. And Farfetch seem to be proving them wrong. Or Oatly, which is the oat milk company, as dairy consumption’s dropping and alternatives are rising. These are companies that are ahead of structural changes and demand.
And we think the power of disruption is often underappreciated there. It's some combination of compounding, disruption and capital allocation. Those are the three really big levers that if our companies are doing that, it’s going to lead to that superior long-term growth that we're looking for of a portfolio level.
Merryn: And how do we pay for that? A lot of people will look at your portfolio and a lot of the other Baillie Gifford portfolios and say, that's a great story and we buy that and we all love growth and we love the idea of growth-stalwarts and we love the idea of these new upstart companies, etc. Although got to say I'm not mad for oat milk. But we get the idea. But surely, there's a price limit here. How do we value this stuff?
Spencer: Just let's be clear, we are looking for underappreciated growth. It's easy to find glamorous growth or obvious growth. What we're trying to find is, do we see something that other people don't see? There's various ways we can go into about how we do that. But one important discipline is that every stock in the Monks portfolio has a strict future return hurdle. It has to have a fighting chance of doubling over five years or trebling over ten years.
That's absolute return. It's in sterling. There's no funnies. And by a fighting chance, I mean a 30% or greater probability. For every single stock, at every point in time, we must be able to sketch out how we could make money over the next five and ten years? And what's the odds of that? And if a company doesn't meet that hurdle, we sell it. And if we actually see the odds falling, either the absolute amount we might make or the probability’s falling, we start to reduce.
I think recently, we have greatly reduced Tesla and Alibaba. We have sold out of SAP and Visa.
Merryn: And is that because they're too expensive, because their price has gone up so much that you feel that it's not possible for them to double?
Spencer: Correct. Or at least in the case of Tesla and Alibaba, because the probabilities of doubling again has fallen a bit. Because the starting valuations, the starting market caps have become really quite large. It is harder to imagine a $2 or $3 trillion company than it is if you're starting point’s 1 trillion. That is a really tough task. You have to be really tapping into very, very large opportunity sets. And that's why we're never going to get the exact timing right in terms of calling the top and suddenly moving out.
What we tend to do is just constantly assess the upside and gradually reduce as the probability reduces.
Merryn: Say, for example, Tesla, are you still fully confident in that as a business, just not confident in it as a doubling stock?
Spencer: I think about the path of Tesla in the portfolio. And others in the firm have absolutely been the leaders in terms of building the relationship there and understanding it. Whenever it was first presented to us as a team, this was even before my team took on the management of Monks, that we thought by far the largest probability was that it was going to go bankrupt. I want to say a 40 to 50% chance that this was going to end up at zero.
But we saw a chance, it was clearly greater than 30%, that they could go on to become something very, very special indeed. And I think a lot of professional managers hate the thought of losing money in one stock. Something going bankrupt is embarrassing. It's terrible. We need to shy away from. There's almost an over-conservatism that creeps in. I am being paid for…
As the manager of Monks, we are being paid for taking thoughtful risks and for occasionally buying something which you know has got a high chance of ending in failure, but a small chance of a huge, huge return. And I can't remember the exact figures, but we've made something like hundredfold our initials of money in Tesla over the years. We have reduced it far too quickly, far too early. And we've been too sceptical, despite owning it all the way up.
But from here, an awful lot in the last 18 months has gone right for this company way faster than we thought. The production bottlenecks have been solved with the Gigafactories in China and I think Germany's opening before the end of the year. The model proliferation or the model line-ups have been materially enhanced. Competition is still pretty slow to react. Honestly, I thought they would have lost quite a lot of market share by now.
But they still appear to be in that leading position. They have a coherent narrative now around the battery and solar businesses that wasn't there in the past. An awful lot has gone right. And I think my ability at this stage to have a really differentiated view on Tesla versus others is a bit smaller. And therefore, we have, on several occasions, been reducing that stock. And despite our best efforts, it's been performing extremely strongly.
And it's therefore still a material holding in the fund, but it's one that we've cut several times. That has been wrong. I would have been better off not worrying and letting it run. But that's probably been both one of our biggest successes, but also one of our biggest mistakes in terms of being a bit too confident in knowing what the valuation could be of this company.
Merryn: Let's talk about some of the holdings that you're not selling down at all, some of the biggest ones in the trust. It’s interesting to me that the biggest holding in the trust is actually effectively a technology investment fund. It’s Naspers. You're delegating some of those choices to somebody else.
Spencer: There's two things. Firstly, we think Naspers is absolutely an advantaged investor around the world. We've actually got two holdings here. We've got Naspers and Prosus shares. They are essentially the same company, it's just if you own the shares in South Africa or in Amsterdam. But that's a new one, you don’t want to be [?] digging into too much. If I look at their long-term track record of investment, it must be the best in the world over the last quarter of a century.
They identify a number of leading companies extremely early in their lifecycle when they're still private in areas that we would find difficult to get real high-level corporate access to. And they have built a series of fantastic businesses. At the same time… That's one attraction. It’s just that we expect the NAV of this business to compound away at a very, very material rate. But given their track record, these guys should be…
I think if they were American, they would be lauded as top of on every piece of media there is and absolutely celebrated for their success. The shares trade, depending on which share you're buying, had roughly 30 or 50%, five-zero percent, discount to net asset values. Here, we get a chance to access one of the most thoughtful long-term management teams and company builders in the world at a 50% discount to net assets.
And their largest holding is Tencent, the Chinese social media company. And it's the equivalent of us buying Tencent on ten times earnings, which I know there's lots of fear about China at the moment. But that really is pretty daft as a valuation. That's why Prosus-Naspers is one of our largest holdings. And it's been a very long-term holding. And I think it'll be a very long-term holding for the foreseeable future.
Merryn: What else is in the top ten that's interesting or that you would be building on rather than reducing?
Spencer: I think there's broadly three big themes that we're getting excited about. The first is technology getting into new areas. The second big thing would be underappreciated growth. Not everything's a tech business, which we’re finding actually lots of underappreciated growth of things that don't look sexy from the outside. And then the third theme is we're seeing lots of competition giving up in certain areas.
And that appears to be clearing the way for our growth companies. If I think about some of the stuff, not necessarily top ten, but we're certainly having to get excited about, one would be… We’ll take each of these in terms of technology getting into new areas. The last 20 years really saw technology disrupting media, of course, that this podcast is an example of that, shopping and entertainment. All important areas.
But the next 20 years will be about disrupting healthcare, energy, property, finance, law and order, education, much more larger areas, not so much more politically sensitive and probably more important for mankind type stuff. One example here would be Certara, which has probably got the longest growth opportunity runway that I've come across. This has developed software that can predict how a drug will interact with the body.
So far, it's got ten biosimulation models. Biosimulation is computer-aided model of all the biological processes and systems that go on in, say, the brain or the liver or the kidneys. It's taken 20 years to build this up. And last time I checked, did almost ten million lines of code in order to think about all of these different organs. What's really exciting is that it makes the research process for R&D. It moves it from having to always be in the lab or in the clinic to something you can run on a computer.
Much, much cheaper, much faster and it stops really nasty drug interactions early. I think we spend $190 or $200 billion in drug research every year. And that this biosimulation piece is less than one eighth of 1% of that. It is minuscule and yet it's got all of these advantages of being cheaper, faster, safer and better at predicting.
Merryn: Does that mean that you can use that technology to cut down the length of, say, drug trials?
Spencer: Correct, exactly. And in fact, you can also, rather than… I think for any one drug that makes it to market, it costs on average $2 billion today. Rather than putting all of your eggs in that basket, as well as cutting the speed of trials, also because they become much cheaper, you can… Let’s run 100 different compounds and let's see which one works better. It allows you to both accelerate and have a broader approach to drug development.
Of course, at some point, you have to try on humans. This is about overcoming those first couple of phases of drug research. But those are often… It's allowing drug companies to run faster, to try things, to really get a little bit more Silicon Valley disruption into that initial stage. And what's exciting us is that we're seeing a tipping point here. All ten of the largest drug companies in Japan, in Europe and in North America are customers.
And that's really fascinating. And in terms of regulators, last time I checked, 17 different global regulatory bodies have now approved this approach, say it's absolutely fine to have that as part of the drug development process. This Certara, it’s pretty small today in terms of revenues, but this could become one of the technology suppliers to an industry which is notoriously reliant on good luck and serendipity.
And this is introducing a whole level of better data and better analysis into that. It's an early stage. It's three times the size of its nearest competitor, but that could grow at, I don’t know, 20% a year for the next 20 years. I'm hoping to just tuck that away and never have to sell it again and because it just slowly compounds its way to glory.
Merryn: Sounds fantastic. That’s a great one in the real new technology growth. But I'm quite interested in this idea of non-tech companies hiding brilliant growth, because at the moment, we tend to think of all growth as coming from tech, don't we, one way or another?
Spencer: Yes, we do. I'm going to get a bit morbid. America’s largest…
Merryn: Oh God, do you have to?
Spencer: I know.
Merryn: You’re going back to the funeral company, aren’t you?
Spencer: I'm going back to the funeral company, exactly.
Merryn: Go on.
Spencer: I get genuinely excited and probably quite oddly excited about finding underappreciated long-term growth in what appears to be at first glance quite a dull industry and quite an unglamorous industry. SCI is the largest death care company. 16% of all deaths in America go through SCI. It helps almost half a million families every year. And 80% of deaths go through small, independent, local funeral directors.
Roughly half of SCI’s revenue comes from at-need customers. Someone in the family’s died, they need to be looked after. And roughly half come through customers who many years ago have prepaid for their own funeral and plans. How does this grow? I think it's three things. There's the death rate, there's the market share and there’s profitability. I hope the promise of Certara and better, cheaper drugs means that this particular case won't work out.
But I like holding two separate things in my head at the same time. We’ve tried to model a death rate, and you can be as complex as you like. But the chief determinant to growth is the number of people over 80 in society. And the chief determinant of how many people are over 80 in society is the birth rate 80 years ago. The birth rate in 1941 was very, very close to the absolute nadir. It was obviously during the darkest times of the war.
The baby boom was just starting. And we think that volumes at SCI very naturally will be higher in five years’ time, higher again in ten, higher again in 15, higher in 20. And on top of that, they've also locked in future higher market shares because they've been pre-selling these needs to people in their 50s, 60s and 70s. SCI’s market share should grow organically towards 25%, because they've got this secured backlog.
And as a little aside, the mix gets richer because you tend to spend more on your own funeral than if someone else is paying for it. Having a company whose structural growth accelerates rather than fades, breaks almost every traditional valuation model. Every traditional finance model thinks that growth starts off at 100 and then falls to 90 and then 80 and then 70 and slowly fades towards a GDP. This is one company where we actually see the structural growth accelerating for at least a couple of decades ahead of us.
Merryn: This is one for people who'd like to make a bet on the baby boomers dying, basically?
Spencer: Yes. There are many things in life that we want to try to avoid. But sadly, gently over the next quarter of a century, the baby boomers will pass. And this is a company which is going to celebrate life and make sure that those events are happy family reunions and celebratory events. And people want to increasingly spend a bit more money on these things. We actually had… This is all pretty morbid stuff, but…
Merryn: I'm trying to think of a way to move you on and I'm like, I'm just going to have to let you finish. You actually had one what?
Spencer: We had this test. Obviously, during COVID, lots of the smaller mom-and-pop funeral directors just really couldn't cope in certain parts of America. And SCI, because it’s so large, managed to cope. And then actually, I think it really changed the whole culture of the company towards much more of almost a first responder caregiving culture. And I think that's really underappreciated by… That degree of cultural change that's happened very, very quickly, I think, is totally missed by the market today.
I think this is a much more interesting, kinder culture than it was in the past.
Merryn: That's interesting. And I don't know if we liked the story or not, but we get the investment case. I appreciate that. Thank you.
Spencer: Nobody likes talking about it. And that’s why [overtalking].
Merryn: Nobody likes hearing about this stuff, particularly since the baby boomers have been such an amazing driver of the global economy for the last 40, 50 years. Thinking about them vanishing is a bit of a transformational moment for global economy, isn't it? But let's move on from that to the last point you made, because that’d be fascinating. There's competition dropping out of sectors and leaving some of the companies in your portfolio a clear run ahead.
What sectors are you thinking about there? I don't like the sound of competition dropping out of any sector, by the way.
Spencer: There’s quite a lot here. And actually, the most recent example would be Farfetch, which is headquartered down in London. It's emerged as the global technology platform of luxury fashion. Whenever we first built this, I thought this was one of several contenders. I thought it was really interesting, but it had a small chance of becoming the really big winner. And in the last 12 months, you've seen Alibaba in China partnering with them because Alibaba couldn't outcompete them.
And I never thought that this plucky business from Europe could outcompete a giant like Alibaba. And then this week or maybe just last week, one of their chief competitors is owned by Richemont, the Rupert vehicle for luxury goods that owns Cartier, etc. But they own two website, the Yutz and Net-a-Porter. And Richemont announced they're in talks to allow Farfetch to essentially use their technology to run Yutz and Net-a-Porter.
And if you read the statement around there, the chairman of Richemont is extremely complimentary about, this technology is just superior. We can't compete. Alibaba tried to copy it, they couldn't do it. And whenever you start to see really close competitors… And Monks, we've owned Alibaba and Richemont for many, many years. We admire them greatly. Whenever they are saying, we can't do this, these guys are special and we're just going to essentially let them run the show, that's really intriguing. Really, really intriguing.
The valuation of Farfetch is, I think, $15 or $17 billion. That equates to about five times revenue. That's nuts. That's far, far too low. If we're right and they've really been ordained as the global, as the tact provider that's going to help luxury slowly go online in the next ten years, that's a magnitude too low. That's a pretty recent story of where our competition has just fallen away. But there are other things, Ryanair, for example, in airlines, or what have you.
I love watching other people retreat and withdraw because that tells you something about the competitive position, but also the growth potential of the guys who are remaining. We love the cockroach businesses that survive and everyone else retreats.
Merryn: And that sounds like one of them. I think we're actually going to have to stop there. We've been talking for rather longer than I thought. We're not supposed to go over 25 minutes or so, but we've already hit 32.
Spencer: I’m sorry.
Merryn: And that's how interesting you are, Spencer. Is there anything we've missed that you'd like to add at this point?
Spencer: The thing that I've been wrestling with is that rapid growth has become 50% of the portfolio. And I've been wrestling with, firstly, is this a concentration of risk with having 50% in one area? And the conclusion I've reached is slightly counterintuitive. And it's that five or six years ago, we had only 30% in rapid growth. But it was really two big bets. It was the continued emerging middle classes in Asia, which has progressed.
And secondly, the tech platform, the likes of Google or Amazon. I've come to reach the conclusion that although we've got 50% today, the holdings that we have in here are much, much more diverse. They are a much broader opportunity set than we had in the past. It's everything from drugs that may cure Alzheimer's or prevent Alzheimer's. It's law and order, body cameras for police officers. It's tools to help teachers in classrooms.
I think there's 30 individual growth drivers behind rapid growth. And although the proportion of the portfolio is larger, I think that the individual growth drivers are much more diversified. And in the short term, of course, rapid growth stocks tend to go up and down together in the very short term. But over the long run, would you let the fundamentals come through, I think we've actually made the portfolio safer.
And that's a counterintuitive point that I'm still wrestling with. I just wanted to share with your listeners, but also our shareholders that are listening in as well.
Merryn: That's interesting. We can see how that works out, won’t we, about the next five or ten years? Spencer, thank you so much for joining us today. I really, really appreciate it. I'm very keen for you to come back. And we've heard three fantastically interesting stock ideas from you today and I'd love you to come back at some point in the next six months to a year and give us more. Although, as you say, your turnover isn't very high. You may not have more, but we'll see.
Spencer: We’ve got another 97% of the portfolio. There’s a big built-up seam there to be contained.
Spencer: My pleasure.
Merryn: Thank you so much. And listeners, thank you so much for listening. If you'd like to hear more from MoneyWeek, you can go to moneyweek.com as usual. And do not forget that the MoneyWeek Wealth Summit is next week on the 25th. You can go to our website to get tickets there. It is online. There are still some available. Otherwise, sign up for our daily newsletter, Money Morning, written by the brilliant John Stepek. Thank you very much indeed.