James Anderson is one of the biggest names in the UK fund management industry. As the brains behind the intensely growth-orientated strategy that drives many of Baillie Gifford’s well-known funds, and of course the Scottish Mortgage Investment Trust (SMIT), he has made fortunes for many (Baillie Gifford’s staff and clients both). This month he stood down – but before he did, he and I met at the Baillie Gifford offices in Edinburgh to record one last interview.
We start by talking about the changes in the industry over the past 20 years. One of the problems with the industry is the incentive structure – and the “extreme profit” on offer. Fund management has some of the highest profit margins of any sector, thanks in large part to its ad valorem charging structure (charging a percentage of funds invested). Baillie Gifford has been one of the best-behaved firms in the industry when it comes to this – keeping fees relatively low and slashing them as funds grow. But even so, many of its partners have still made what most of us would consider to be vast piles of cash from the business. And even if all its funds were to massively underperform for decades to come from here, more of them would make more very large piles purely on their percentage take on the assets under management.
Finance has changed as a result of this kind of dynamic, says Anderson: it has become something “that is important in itself”, rather than something that is mainly important for “its role in aiding the development of companies and societies”. Finance should be about creating industry – not about creating more finance. And fund managers should be focused less on thinking of themselves as businesses to be efficiently managed and more on the “greater mission.” However you look at it, the majority of the industry is effectively broken, says Anderson. On the plus side, that leaves opportunity on the table for creative and contrarian thinkers – something of which Baillie Gifford has plenty.
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Scottish Mortgage keeps on rolling
On, then, to Scottish Mortgage, possibly the most popular investment trust in the UK (and until very recently the largest). Look at any list of top buys from any investment platform in the UK and you will very often find it at number one. Until recently this made obvious sense – at the end of last year, it was up 200% over the previous three years and nearly 2,000% over 20 years, making it one of the best-performing investment vehicles ever.
This year, as holders will know, has not been quite so good. Overall, it is now down nearly 50% in the last six months – and it has fallen 12% in the last five days alone. Shares in biotech group and Covid vaccine maker Moderna, the trust’s top holding, are down 43% year to date and those in electric car maker Tesla, possibly the firm Anderson is most famous for backing, are down 33%. SMIT also trades on a 7% discount to its net asset value (NAV – the value of its underlying portfolio), something that would have been genuinely unimaginable a year ago (even with this discount, the average premium over the last year has been 0.14%, a number that reflects previous premiums).
The trust is in the MoneyWeek model investment trust portfolio and I hold it myself (as for that matter does Anderson, who tells me that the “vast majority” of his own wealth is held in SMIT shares). Every time we write about it I remind you that success rarely goes in a straight line (in performance terms at least) in the fund management industry and that you must rebalance your portfolio regularly (in this case selling down SMIT and shifting the money made into the more value-orientated/capital-preservation names). I have done that myself (though this week has sunk most ships so nothing I have shifted into is causing much celebration) and I hope you have, too. But an hour with Anderson and you will want to keep holding what you have left.
Most stocks are disappointing
We start with what went right (until this year at least). It all began, says Anderson, post the great financial crisis (GFC). At the time Baillie Gifford talked a good game about being long-term investors but it wasn’t really so: “much of Baillie Gifford’s process and philosophy was also broken” (think “endless discussions of quarterly performance”). So they stopped, rethought everything and decided to become a “truly global, truly long-term” investment firm. That involved recognising that most investment theory isn’t really valid in the real world – the key truth being that stockmarket performance is not a “perfect bell curve”. Instead, the majority of long-term returns come from a tiny percentage of listed companies (the academics Baillie Gifford works with have it at around 4%). The challenge, then, is to find the brilliant few.
Until recently this went almost too well – the “hit rate” was so high that too much money was attracted to the strategy (there was a “rush to imitate” Baillie Gifford). But the short-term falls in share prices are, he reckons, just that. “I reject the notion that this is all over,” says Anderson. You might say to that: well, he would, wouldn’t he? But he does makes a good case.
The first thing to note is that, short term at least, valuation does matter: a world of worried people with short-term horizons can throw up huge opportunities. Post-GFC “we ended up buying Apple on three to four times earnings” for example. There may have been a rush to the Baillie Gifford strategy during the pandemic but only a small number of investors will “have the strength to endure”. But there is something else that makes him hugely confident: “I think the number of areas where you have the opportunity for exceptional growth and progress is expanding.”
Think about what the idea of Moore’s Law (that the number of transistors in a dense integrated circuit doubles about every two years) can be extended to. That sort of speed of change is now possible in genomics, in synthetic biology and in energy transition. Many of the things that will make the best companies the best are still unimaginable. To a degree everything you can think of is already in the price – the real long-term value is not in “imminent innovations” but in the culture of extraordinary companies – that go “beyond imagining”. Look at it like that and while there are obviously short-term obstacles for growth, that makes the case “stronger rather than weaker”.
Has inflation changed everything?
Let’s look, I say, at these short-term obstacles (the ones that have lost those who got in at the top not far off 50% of their money). The mainstream view is that rising inflation and the prospect of rising interest rates has been the main driver behind the collapse of global growth stocks. Does he agree? Is this, I ask, a fundamental change in the way growth is valued? Or perhaps just a short-term dynamic?
Anderson makes a few good points here. The first is that if it is interest rates that matter, we should be looking at real (after-inflation), not nominal rates – and these remain at all-time lows. Second, the companies that should suffer most from inflation, says Anderson, are those “that do not have the strength of pricing power”. That is something that is “quite unlikely” to apply to say, Moderna. Third, worrying too much about inflation might be a waste of energy given that, with the squeeze on consumption under way, we may soon be worrying (again) about “collapsing activity and collapsing interest rates”.
Finally he stresses that “none of this is what the philosophy is built on”. Think too much about these dynamics and you risk missing the brilliance of individual companies. Does that hold good when it comes to China? One of the things Baillie Gifford is criticised for is not thinking enough about political risk in China. That is sort-of fair, says Anderson. Baillie Gifford was wrong, for example, to own China’s education stocks. But the real fault was to “misinterpret the signals coming out of America around China” – and to take into account that missteps in this relationship could lead not just to lower share prices but “this could go to nought”, as investments in Russia have.
James Anderson’s top stock pick
Does he have a view on crypto, I wonder (bitcoin has been falling pretty much in line with growth stocks). There is an awful lot that one might not be able to imagine about its future – I find it easy to imagine ongoing collapse of today’s popular currencies, but not much else; this is really one for the next generation, says Anderson. But one thing he would say is that while many would disagree (not me by the way…) he does not “fundamentally see that crypto is an innovation remotely akin to the internet”. The use cases will be far fewer – if you want exposure you are much better off looking for business models that can exploit it. Don’t buy crypto, buy a “great company”.
OK. What looks like the greatest of companies right now? If he could take one company from the SMIT portfolio and hold it for 20 years, which would it be? He picks Ginkgo Bioworks (NYSE: DNA). It is risky – “the likelihood of success is lower” than is the case with many others in the portfolio – but also has extraordinary potential upside (“what you can do is unlimited”). The company is effectively “the Intel of synthetic biology”. Baillie Gifford was first drawn to it by an early project that worked to make plants produce their own nitrogen (so cutting out the need to use fertiliser) but what this technology does “could disrupt everything”. If you are interested, now might be the time to take a look – the share price is down 82% in the past six months. Disruption is cheaper than it was.
That is of course the case with lots of the stocks. I can’t quite get Anderson to redefine any of the SMIT holdings as “value” stocks (despite the huge cashflows at the likes of Moderna) but he does say that in valuation terms “there is something odd going on here”. That said, says Anderson, “sometimes we will be wrong, and if the world has changed we have to adapt”. And the fees? There should be no reward for failure, says Anderson. Had he seen a period of rolling five-year underperformance on his watch, he would have proposed a cut in the firm’s fees. He hopes that his “very good successors will take a similar attitude”. Investors will hope they don’t have to.
• Listen to the whole of Merryn's interview with James on the MoneyWeek Podcast now
Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
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