James Anderson: the trouble with the fund management industry

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Transcript

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 I have possibly the greatest treat I’ve had for you in the last year, and you’ve had some great names on. Today we have James Anderson of Baillie Gifford, the man behind the phenomenal success of the Scottish Mortgage Investment Trust over the last what, James? 20 years? how long have you been in charge of that trust?

James Anderson: 2000, from one period of angst to another.

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Merryn: So, a long time. Now, if you’ve been holding that trust, and you probably have, because it’s in the MoneyWeek investment trust portfolio, if you’ve been holding it from the very beginning, you would have made what, James? 1,500% or so by now and outperformed any global index you might care to mention by three or four times.

Plus, obviously, the last few months haven’t been so good, and we will get on to that later, but we are going to talk about everything from the specific stocks and portfolio to James’ career, to James’ views, I hope. We will start with James’ views on the fund management industry, as a whole, which, I suspect, we’ll all find interesting. Anyway, James, welcome, thank you so much for joining us today.

James: It’s always a pleasure to be with you.

Merryn: I would love it if we could start by talking about the industry as a whole. You and I both have a huge interest in how the industry works, what it does for society, what it does for finance, what it does for all of us. So, I wonder if we can talk a little bit about how it’s changed in the period that you’ve been at Baillie Gifford and that you’ve been managing so much money.

James: I think, Merryn, that the biggest shock to me, and this has occurred at intervals over the last 40 years, has been that I always assumed that in aggregate, the returns to fund managers would fall and the returns to savers would, hopefully, in compensation, go up. But we’ve gone from questioning where are the customers’ yachts to where are the customers’ superyachts over this period of time. And I think I’m right in saying that nearly half the top 100 wealthiest people in America are hedge fund managers.

And I think that actually carries most of the explanation, that the extraordinary returns for not, usually, much performance, there are exceptions, obviously, in the hedge fund industry, have coloured the whole picture. And so, despite the impact of people like yourself trying to publicise the nature of costs and the hit to performance of our friends at Vanguard doing something in a practical sense, I think it’s very troubling. But I also possibly even, to a greater degree, find the mentality surrounding it deeply troubling.

Because I think we’ve changed the role of finance to something that is important in itself, rather than for its role in aiding the developments of companies and societies. You and I have talked in the past about the origins of financial markets and particularly, the heydays of the 19th century, when we were instrumental in building. And to me, what we can do to help building companies is the key to the task.

It’s not how much wealth we make or even directly what we do for shareholders. As you know, I’ve been hugely influenced by the work of John Kay over the years, indeed, we were chatting about this last night, I think that we are in a really bad position where finance is not about creating industry, and that is problematic.

Merryn: Interesting. But let’s start with that first bit you were mentioning on cost and how the returns are coming to the industry, as opposed to the saver. I accept that a lot of that is the hedge fund management industry, but nonetheless, when you look at the margins of ordinary fund management companies, you’re still seeing some of the highest margins in any sector, looking at 40% or so. And that’s the same whether you look at fund managers, whether you look at platforms, wherever you look and [overtalking] you see the same.

James: Yes. There is extreme profit.

Merryn: It’s also fair to say that the partners of Baillie Gifford have made what the rest of us would consider to be vast fortunes over the last decade or so. So, this is not specific to the hedge fund industry. This is a basic function of the ad valorem model in the fund management industry. If you take a percentage of assets under management and assets under management keep going up, and up, and up and up, as, of course, in the UK, they will continue to do.

Even if markets fall because of pension or to enrolment, the amount of money accruing to fund managers is also going to continue to rise, not exponentially, but hugely.

James: Merryn, I apologise to the listeners, and above all, to you, if I was any way perceived as trying to escape from that issue. Really, by my focus on the hedge fund industry, I was trying to explain what I think has happened to cover up the fundamental issue you are talking about. I hope you will not consider this unreasonable, I think the ad valorem message is wrong, fundamentally wrong and misguided as a methodology.

My own view is you should firstly consider it as a percentage of the profits or profits over the market generated, and then, of course, the figures become even more intimidating if you’re thinking you’re giving away 10% of your return, rather than 10% of the assets under management. How should one respond to that? I hope I would always welcome, but I particularly welcome at this stage of my career at Bailie Gifford, being able to discuss this openly.

My view has been that my, the board’s primary responsibility is to make sure the fees we charge for Scottish Mortgage are, in some form, rational, in a greater form, hopefully, earnt, rather than anything else. And particularly by putting a cap on the assets under management lead directly to lower fees in the way that it is structured for Scottish Mortgage. We think that we’re both in the absolute fee, but also, in terms of giving the benefits of the scale back to the shareholders, we think we’re doing a reasonable job.

And I would also, and I hope this is the last moment when I’m going to say defensive, rather than doing a little bit of a rant about the situation. I would also say that to my mind, we have been honourable in that as we evermore invest, which we’ll probably come on to, into venture capital, whereas you know these are very much higher, we are doing this for, basically, a total expense ratio of under 0.4 on a consistent basis, and often, considerably lower than that.

Now that, to my mind, is a pretty decent bargain for giving people exposure to the biggest unquoted opportunities in the world, as we hope to do over the course of time. And, to a certain extent, I think we can claim to do. the wealth, and I won’t talk just generically about Baillie Gifford or whatever, I’ll be personal about this. Now, I’ve always seen fit that one should eat one’s own cooking.

The vast majority of my own wealth, this in shares in Scottish Mortgage, I’m currently engaged trying to find out at what price in aggregate I bought them to satisfy the revenue, but I assure you, they’ve been there for most of that 20 year period. And I think this is an element on which I would agree with Buffett. As you know, there are certain things that I don’t at all, but I think you should absolutely have that commitment for it to be vital to you, the fortunes.

Absolutely, whether a downturn, we must try and endure them, but it hurts. Now, the broader wealth, I would hope, and please tell me, guide me on this, that if we’ve provided well above market returns, not consistently, because that’s the wrong word, and as you know, we’ve always been willing to take periods of pain, in order to get long-run returns, but if, over decades, we’ve managed to create those sorts of returns, I think some form of wealth is just fine. I’m an avid you should be rewarded, if you do a good job. You shouldn’t be rewarded, if you’re doing a bad job.

Merryn: But therein lies a problem, which is that with the current model, if you get a percentage of the assets under management, regardless. I don’t want to spend hours talking about fees, but I do think it is relevant, to a degree. Lots of our listeners will now be saying do you know what? I’ve lost 30% over the last six months, or whatever, but Baillie Gifford are still getting 0.4% of the assets under management, whatever it is.

And so, where’s the punishment for the failure, as opposed to the reward for success? And obviously, it’s such a short time period, we’re not really talking about that in this context, but in the context of the industry as a whole, you can create mediocre performance for years and years and still make absolutely fortunes, and Baillie Gifford could. Now, let’s say, for example, that everything we’re going to go on to talk about over the next half hour is nonsense and Baillie Gifford has got it completely wrong as to how long-term good returns should be made.

Nonetheless, your business has so much under management, that fortunes could continue to be made for many decades to come on mildly disappointing performance. And that’s the kind of thing that I find slightly distressing.

James: I didn’t want to escape that issue.

Merryn: Well, you’re very good at confronting this stuff.

James: I was trying to give you a personal account of my own position, which I hope it’s clear and I hope it’s honourable. It’s for others to judge plainly. I think what you’re talking about at the industry level is…

Merryn: That’s what I’m trying to get to [overtalking].

James: Also with the Baillie Gifford one, I think the point you raise is a very real one. But at the industry level, I think this is a huge shock [?]. I remember having a very provocative discussion with Jason Zweig, editor of Ben Graham and columnist in the Wall Street Journal, and the like, about this, and he put it in a slightly different way, and I think a complementary one, which is this is the only industry in the world where you can be a fourth level player, producing bad results, and you will still make this level of returns for yourself and your company.

And I totally agree with that, which is why I was trying to suggest that I, personally, would genuinely feel very embarrassed if I took them over the long-term. I do reject your, since Scottish Mortgage was at its all-time high last November, and I think the timeframes are important in this. I would hope that if I had been, and I hope that Tom and Lawrence, my very good successors, will take a similar attitude, if we had a period of rolling five year underperformance, that we would propose that we would cut our fees.

Now, there, I’m giving you an answer about Scottish Mortgage or what we might do in negotiations with Vanguard, as you say, there is an institutional problem there. And I think that is a very serious problem for all forthcoming generations. 20 years ago, we did a renegotiation of how the profits worked between retiring partners and their subsequent, and how you don’t want people living off what they did ten years ago either. So, it was quite short time period.

But in some ways, I think it would have been an even more intractable problem if what we were doing was still at an all-time high and the rewards were going to a generation who hadn’t, in all cases, been behind the performance it generated.

Merryn: You haven’t been the ones who built those assets in the first place.

James: Yes, that’s right.

Merryn: Let’s not bore ourselves with too much more of my dreams of an…

James: Can I just say, I absolutely agree with your attitude and campaigns on this. And the last thing I would want is to sound as though I’m picking holes in it, because fundamentally, I’m with you. It’s just that there are some nuances of difference.

Merryn: And my dreams of the flat fees across the industry are going to stay dreams, I think, for many decades to come. But that doesn’t mean that I’m going to stop writing about them. Let’s move on to the second, and possible the bigger problem with the industry that you mentioned earlier, which is that it doesn’t seem to work as a supporter of growing companies anymore. It seems to work just as layers upon layers and layers of fee taking and financial fiddling, as opposed to the other.

And I know you’ve complained as well about the UK market being a dividend producer, rather than a growth producer, although I think I would slightly disagree with you on that. I’m all for dividend producers, because some of us need dividend income to retire. So, let’s talk about that where you think the industry…

James: It’s more a general return of capital, which actually applies to people in America these days.

Merryn: So, where has the industry gone wrong on its focus?

James: In line with my promise, at this stage, to be very open, I think a very good example of it is in the book that Richard Burns wrote about Baillie Gifford, which has a chapter entitled becoming a business. And I think it is, primarily, the fund managers themselves have become businesses and are seen in that light, rather than as services to the broader industrial societal issues that we have got involved.

I think, in turn, if I may add, and again, I’m not trying to distract, I see it as an associated problem, I think that leads, inside most fund managers, to a culture of the business being managed, rather than a focus on the investment. And that all too often, it, therefore, turns into a wrongly led organisation, and I think that is terribly, terribly problematic. I think there are, as you well know and you’ve interviewed many of them, fund managers who are absolutely driven by both the task and that greater mission.

I think that gets eroded by many fund managers themselves being quoted businesses, for instance. Some of them cope quite well, T Rowe Price being an example. But I think it is catastrophic, and I think, even for other organisations, unquoted ones, partnerships like Baillie Gifford, it is a real danger that it’s seen as an asset generating money, which fits your earlier comments, rather than something one should be deeply proud of trying to help with and be good at.

Merryn: OK. So, do you think that that’s a change over the last decade? A decade ago, 15 years ago, 20 years ago, were fund managers a different breed? Were they more imaginative, more creative, more interested in business itself, as opposed to being a business? Has there been a change? Is fund management now more of a technical spread sheet kind of business than a thinking business? Is that what you’re getting at?

James: Yes. I personally would take it back further than that. After all, by the time Charles or I joined, Baillie Gifford was barely profit making, and again, I’m talking about the individual examples, but there weren’t many fortunes out there being made in fund management. Some of the great businesses to do with that chain of either value or lack of value had not yet been created.

And I think it’s been a fairly ineluctable process, Merryn, over the past 30 years, where it has got greater and greater as a pressure. Now, I’m not sure that that necessarily has to be connected with when it became less imaginative, less creative, but I think it probably has been, so I’m not going to push that too far. I think a lot of that has become part of the other side of professionalisation, there is thought to be a way to go about this. So, to try and explain what I mean.

I had an intriguing conversation with myself and Bill Miller, who I deeply, deeply admire – we happen to be fellow members of Johns Hopkins Investment Committee, so I know him reasonably well from that and other aspects, with, I don’t know whether you remember Charlie Ellis who was the leader of the CFA, a trustee of many of the big organisations that we’re talking about here, an advocate of efficient markets.

And what Charlie was trying to say, and has written many, many times, was that you cannot outperform because the markets have become professionalised. What Bill and I, and him with more predictable success than myself, were trying to say, is that it’s precisely the flaws in the professionalisation of the industry that give you the chance of doing this. Most of my family are doctors, and on the whole, if a doctor tells you something, there’s pretty good odds that they are right and there is a commonality to it.

In fund management, if you do the same as everybody, then you’re almost certainly going to be wrong, as you know. But I think this has been redoubled by both the internal professionalisation, and if I may take a real go at it, the whole notion of the CFA, which teaches you things that are demonstrably wrong about the world. And so, I think there is a culpability, as well as a professionalisation, which wasn’t meant to lead here.

So, I absolutely would agree that at whatever point in the last 30 years was the critical tipping point, we are in a world where it’s much, much more difficult to be creative nowadays.

Merryn: OK. So, the majority of the industry is broken, to a degree, but that leaves huge opportunities for creative and contrarian thinkers, such as yourself.

James: Exactly.

Merryn: So, if you look back at the success of Scottish Mortgage, you see the real outperformance happening, 2010, 2012, 13, etc., and then you see the lies start to really, really soar. You’ve obviously been with Scottish Mortgage for much longer than that and with Baillie Gifford for much longer than that, what changed? What sparked this massive outperformance? Is that when your strategy started to work or is that when you began to formulate your ideas more internally?

James: There are two different parts of this, and please, Merryn, I’d be very comfortable if you want to cut after the first internal part. But it’s important to me, and I think it’s important to understanding Scottish Mortgage, if I can put it that way. So, around 2004 to 2006, we decided that under the pressure of just what we’ve been talking about, much of Baillie Gifford’s process and philosophy was broken, although we said we were long-term, we were not.

There were endless discussions of quarterly performance. We were built on geographical building blocks, some of them, like what Sarah did in the Japanese department were fantastic, but intrinsically, in limited knowledge and limited ability to make bets in the right way. So, we tried to become truly global, truly long-term, and that was philosophically a big change. Now, some of the good investments, for instance, Amazon, do bake back to exactly that period of time.

But I think it was particularly concentrated post 2008, 2009, where partly some of the old models just didn’t work anymore, or partly because I think the combination of what I might call the [unclear] Arthur hypothesis about the world, came to be dominant in what was happening in the real economy and not just in stock markets. So, it became evident that stock market performance wasn’t, again, as the CFA would take you a perfect bell curve of distribution, it was dominated by the right ending [?] streams.

I know this could be rather caricatured these days, but it’s a profound truth about what’s going on. And Brian Arthur and colleagues, particularly around Santa Fe, explained why that was so, because you had increasing returns to scale. And I think that under the influence of people like them of much greater brains than our own, we began to see companies in that light and that did lead on. So, it was a period where those companies were doing incredibly well, but I also think we had a different philosophical understand of why that should be so.

Merryn: Now, that phenomenal success, can it now be repeated in that what you did initially was very thoughtful, different to other people, reflected a philosophy that other mangers didn’t have, but the ideas that you’ve just talked about are now fairly mainstream, thanks, in large part, to you. The idea that you should be in private companies, as well as public, that you should constantly seek outgrowth, that the market behaves in the way you’ve just described, is no longer an outlier view.

So, is it possible for Scottish Mortgage, or businesses like that, funds like that, to have the same level of success they’ve had under you? And the second part of that question, of course, will be in this very different environment of inflation and interest, etc.

James: Let’s take the parts as parts.

Merryn: Do the first bit first, yes.

James: Because I think they are different ones. I was expressing this to a client before this meeting, a client in Korea, which is how far, in a sense, the ideas have spread, as you say. I think there was a period when the hit rate was too high, and hence, it did attract what you’re talking about. And I think, to a certain extent, that is what we are working through, but for two reasons, I reject the notion that this is all over.

So, the first one is that I think that there was, if you like, a gathering rush to imitate this style of approach for the year or so after the pandemic first started, and I think we can understand the reasons, whether we agree with them or not. So, I think there were quite worrying signs and I don’t know if we’ll have time, but I’m more than happy to talk through what I think we got wrong and what we got right in responding to that.

I think there were too many people trying to play this at the beginning of last year, and we saw all the SPACs and all the premiums for new companies, and the like, of that classic symptoms of over exaggeration. But I don’t think that beyond a very small number of investors that there is much evidence that people are having the strength to endure.

And to be frank, and please don’t take this as not feeling sorry forth fact that we’ve recently lost people money in any way at all, it was always inherent to my set of beliefs, and I absolutely believe in Tom and Lawrence’s as well, that one of the virtues of this is enduring. It was like this in 2008, 2009, for heaven’s sake, as well. I think, very often, these periods actually turn up huge opportunities.

I think I’ve talked to you about this before, we ended up buying Apple on three to four times, what, 18 months on its [?] earnings. And sometimes, you get extraordinary opportunities. In a world where people are worried and short-term time horizons happen to get covered up. So, that’s on set of reasons. I don’t believe that fundamentally, it has. To be honest, I think the media reflects that as well, it’s all back to value of Muffin [?].

But the second part, which is what absolutely intrigues me, and what I would very much like to make the case to shareholders that there is an opportunity for Scottish Mortgage to build on this in the future, is that I think the number of areas where you have the opportunity for exceptional growth and progress is expanding. If you think about this over the last 30 years, I was having a chat with Dennis Lynch [?], a fund manager I much admire, in America about this.

And we ended up talking about how if we just know that Moore’s law would continue for the next 30 years, really, it was quite easy, from that point. You still have to get to the right companies, but the bulk of it was covered. Now, I think whether it be what Moore’s law extends to, or whether putting genomics, synthetic biology, energy transition on top of this, the number of areas of opportunity for that extraordinary sense of returns.

Of course, there will be many companies that fail within that. We’ll have to make the right decisions, my colleagues will have to make the right decisions, financially. But I think the hypothesis that backs the notion of exponential growth as an opportunity set in exponential terms, returns to the companies that benefit from that and exploit that fully is absolutely intact. And we can talk about the shorter-term obstacles, but on a ten or 20 year view, I think the case is stronger, rather than weaker.

Merryn: So, anyone who thinks that this is just suffering from what you’ve previously called the difficulty of imagining.

James: Thank you. I don’t know, some of the psychological studies around difficulty of imagining and difficulty of thinking about exponentials have recently been debunked. But to put it in context, I trust I’m going to give you the right figure here, so just to describe what you have to imagine and the impact of this. So, ASML trace back Moore’s law of the doubling of semiconductor [unclear] in two years, not to when Gordon Moore first wrote the article in the 1960s, but they said they could trace it back to 1900.

Given one has to look forward at least five years from here, so you have 128 years of doubling in progress, what does that compound into? It takes you from one to nine million trillion. Now, that’s a difficult enough number to imagine, as well as all the consequences of it, and applying that to human biology and the like is an extraordinary task.

We currently have [unclear] going back to, after this, a forum on long-term thinking, one of the gentlemen there talking to us is Noubar Afeyan, both chair of Moderna and of a flagship pioneering healthcare company. And his constant phraseology about this, which I find incredibly challenging, but really important, is that actually, it almost goes beyond imagining. Because anything else that may not go quite as far needs to be excluded, because it is, effectively, discounted.

Any imminent innovation does not matter. And as he would say, this means you go in a very different direction from the point of view of the cultures and teams you need. But of course, he endlessly and rightly says, you cannot expect ordinary people to attain extraordinary tasks. And to expect them to behave as ordinary people in trying to do this is also misguided. So, I think it is imaginings. Having green spreadsheet out working out ratios is not going to help you greatly about that, to be honest.

Merryn: Let’s talk a little bit about the shorter-term dynamic. There is much conversation about how the great growth boom of the last decade has been driven by super low interest rates, by very easy money, and by very low inflation. Obviously, that means that the discount rate is different and suggests that profits in the future are worth significantly more than they would be under a different monetary regime.

Now, the generally accepted view is that rising inflation, and hence, the expectation of continued rising interest rates, have changed the dynamic of how you value growth, and that is the explanation for the fall off in Scottish Mortgage and any other growth related trusts or funds over the last six to eight months. Is that a short-term dynamic, I suspect you’re going to say yes, or is it a fundamental change in the way that we value growth?

James: I nearly said, in light of the previous question, I hate the undue certainty that people tend to have about all of this, it applies both to the top down and to the bottom up, just as much as I hate people sending me a diagram of precisely what Tesla should be valued at when there are only unknowns out there. So, I don’t think it’s right to be too dogmatic, but let me try a few comments about this. Firstly, I don’t think it’s really consistent with everything that’s been happening in the markets.

I mentioned, a couple of minutes ago, Moderna. Now, there is no company, at which, the extreme of current profitability is higher. And it’s trading on approximately five times earnings, if we take the short-cut, of near-terms, and it’s huge cashflow positions, yet its share price has fallen from 490 to 140. So, I think there is something odd going on here, and I’d also extend that…

Merryn: Does that make it practically a value stock, at this point?

James: I should ask you that question. You’re far more trained in it. But I find it absolutely intriguing. I don’t actually think the prospects of whether an RNA revolutionised medicine has changed a great deal in one direction or the other over the last 12 months. Equally, I’m not sure most of the behemoths, actually, their near-term profits are both high, and here, we enter a more conceptual framework, but I think an important one.

I think the companies that suffer most under inflation are those that do not have the strength of business to have pricing power. I think it’s quite unlikely that that applies to most of these companies. Also, Merryn, and I don’t want to get into the weeds of this, but I think we would mostly argue that it’s real interest rates that matter, and you could make the argument that those are at all-time highs on certain metrics at the moment.

Merryn: All-time lows.

James: But I don’t know, I don’t think it’s my role to say how long inflation will be or whether you define it as transitory. What I can say is I think this debate has a peculiarly short-term bias and a peculiarly American, perhaps Anglo American bias, in what’s going on. I’ve found it very puzzling for a long period of time, and that’s even before we got into accelerated Fed and perhaps other central banks tightening, to think that this isn’t all going to turn into a severe recession at some point.

And I think that changes, very strongly, what you think is likely. I think it is quite conceivable that by the end of this year, we’re worrying about recession, rather than worrying about inflation, which is troubling in certain ways.

Merryn: My fear is we’ll be worrying about both things at the same time.

James: I don’t know. I personally would be part of the belief that particularly rising energy prices are usually harbingers of recession, and that that’s been the great problem over the last 40 years, rather than anything else. But I think the squeeze on consumption is very much there, and of course, that affects some technology companies, Netflix being the current example du jour. So, I think it’s at least likely, I’m not going to be dogmatic, that we’re talking about collapsing activity and collapsing interest rates at some point out there in the future.

That’s not what the philosophy is built on, but that is how I would see it. I think, if you look around the globe, we already see this happening. There are plainly, and I’d love to talk about it, but we probably won’t have the time, but the major, at least transitional problems, in the Chinese economy. They may be more structural ones. I think it’s pretty unlikely you won’t have a recession in Europe, for the obvious geopolitical reasons and knock-ons at the moment.

But we both know that the squeeze on incomes in the UK is pretty intense. So, I think the global picture suggests that we’re dealing with weakening and that the dialogue may be dominating people’s mentality by Fed pronouncements every day and the headlines, but I’m not sure that that’s where we’re heading. But the contentions around Scottish Mortgage rest much more on what I was saying about the structural than they do about these, but I am peculiarly tempted, at the moment, to be slightly questioning of the narrative in the background.

Merryn: Let me ask you briefly about China, given that you’ve mentioned it. There are transition problems inside the Chinese economy, and obviously, right now, there are horrendous short-term problems with the lockdowns causing supply chaos everywhere.

James: My poor colleagues in our Shanghai office.

Merryn: Yes, your poor colleagues in your Shanghai office, exactly. And this is strange, but it also highlights, perhaps, one of the criticisms of your Chinese investments, which is that you don’t necessarily consider political risk enough.

James: I would agree with that, Merryn, but from a different perspective. You’re going to get a real [unclear], but it’s possibly not going to be the one you expected.

Merryn: I don’t expect anything when I’m talking to you, James. My mind is open.

James: I do not feel that we were naïve in general in what we did in China. I can assure you, there were many, many conversations, both within, directly with the Scottish Mortgage team, and more broadly, with people like [Unclear], Richard Sellen [?] and departed [?] about these attitudes. And whilst one will always have a consumer [?] position on these matters, we absolutely believe that ultimately, one is always going to be at the mercy of the Chinese Communist Party.

I think that Baillie Gifford, if I may be specific and include one or two mandates, for which I had some responsibility, were wrong to own the education stocks. Because I think everything from Chinese literature to the published accounts of how Xi Jinping and others thought about this area and would have guided you away from that. But I don’t think we were profoundly wrong for the Tencents, Alibabas, and even Meituans of the world, which we’re talking about.

I think there is a relevant conversation about how far the complete upside, that as you know, is important to us, matters there. But what I really feel guilty about, and I had every opportunity, and that’s an I, even more than a we, was to misinterpret the signals coming out of America around China. And I have many, perhaps too many, connections one way or another with the American foreign security establishments.

And the moment I ought to have taken more seriously was, in particular, when hearing, as a representative of the Trumpian world, Mike Pompeo, talk. And in the audience was Chuck Schumer, who said, Secretary, you are getting this completely wrong. We are not complaining, from the Democratic perspective, that you are being too tough on China. we’re complaining you’re not being tough enough.

And I think the vigour with which that has been pursued, I’m not making a judgement as to whether it’s right or wrong, and that hence, you indebt [?] not just a lower possible share price, which was the Chinese reaction, but that this could go to nought as the whole Russian crisis has had, is something that I should have reflected on really, and I feel guilty about.

Because as we’ve talked about both in this discussion and before, I think there are certain elements of unpredictability, which you simply have to acknowledge. You can’t make judgements about. I think I was in a relatively privileged position to make a judgement about this and I got it wrong.

Merryn: It’s interesting, isn’t it, in that it highlights the G and ESG to a degree, and that maybe we should think not just about corporate governance but of the governments of where we invest. Possibly, when we talk about ESG, G is the bit that’s not quite mentioned enough. And S, actually.

James: That may well be right, and it may also, we’ve been talking, I think, rightly about quite a lot of 30 and 40 year trends. I’ve lived all my career, until recently, in an era where globalisation was increasing, which inevitably, de-emphasises what you’re talking about here. And I think it’s certainly a very valid question as to whether that was continuing. And if that is a domineering part of what goes on, then yes, that’s right.

Up until recently, I suppose I thought these tensions merely resulted in a change from there eventually being a fight, say, between Amazon and Alibaba for global dominance to you reach domination in your whole entire world. But if it’s now that you can even destroy your franchise in your own markets, then it becomes a lot more complicated, I agree with you.

Merryn: It’s interesting, isn’t it, the retreat of globalisation must surely make a huge difference as to how you manage a global fund.

James: Yes. Here, I get quite questioning, and please, it must be one of those issues, from which I should try and govern from the grave. It’s got to be up for my successors to decide where Scottish Mortgage goes. And I’m sure that they will all take it extremely seriously. I think there are certain forms of globalisation that are retreating, and I think we are directly in the hair of this, because it is about financial integration than primarily that this is happening.

I’m not sure, Merryn, that it’s completely going on in two other ways. Firstly, and we’ve been quite influenced here by talking to Branko Milanović about the process, but labour markets are getting more integrated, because you can do at distance. This isn’t an argument about the value of Zoom or anything else, at this juncture, it is simply physically possible not to have to go to Silicon Valley. You can be in India or whatever to do this.

But I don’t see any evidence of what that is doing, other than progressing, and I think Branko is absolutely right about that. The second part of it, and this is a real [inaudible], I don’t really see much evidence that commercial value chains and supply chains are retreating from globalisation. Just to give you one figure that I have [unclear] today, which I haven’t examined in detail, but what struck me as strange, China has announced its first quarter figures on inward investment and it's up 25%. That’s not really a retreat, is it?

Merryn: I find that a very surprising number.

James: Yes. But if you think about what some of the big companies are doing, and this is where the narrative doesn’t fit with what’s going on in the markets, after all, the two biggest American presidencies in China and deeply integrated in both companies would be Apple and Tesla. I don’t think, in either of those cases, there’s plan to retreat, from that perspective.

So, I absolutely agree, and I don’t want to dismiss in any way what you’re saying, but I think it may be a big problem for financial investors. I’m not sure it describes wholly perfectly what’s going on in the global economy, away from finance.

Merryn: Interesting. Can we go back a little bit to we were talking earlier about the huge opportunities thrown up in 2008 and you said that it’s probably the wrong narratives take hold in the market, that one being an obvious one. Are there opportunities right now that are very obvious to you, be it they are stock specific of sector specific, which may not be obvious for everyone else.

James: Actually, I will try two different hypotheses very quickly. The first one is, and I hope George Soros will regard this as entirely predictable, but it’s really interesting what’s going on in markets. And I think, in many cases, the inability to raise finance to back projects that are ten years away from profitability at the moment is actually tugging forward profitability. And I think one of the major areas where that is happening is in the old delivery [?] spectrum.

Where even 12 months ago, 15 minutes delivery is probably funded all over the place in extreme rations. I think now even in the food and delivery era, profitability is going to be earlier and structurally, we’ll find out who the leaders are earlier. So, it’s an area that intrigues me. More generally, though, I think my answer would actually be cautious in a different way from 2008, 2009. I think back then, you could see that the Googles, and Apples, and Amazons were actually doing very well as businesses and their share prices were simply demonstrations of people having to raise cash. So, there was a very obvious…

I think now what we’ve got is terribly complicated, but really important for how we think about the world and whether we will be successful in the future. Which is that I think the correlations, particularly in new companies, and smaller companies, and innovative companies, in non-profit companies, become so strong that some of the eventual, they will be worth the entire portfolio. In ten years, companies must be down 80%, 90%.

Now, I think trying to work out which specific ones at the moment is both our task and extremely difficult. But I’m pretty sure that there will be some, and I could give you candidates from Ginkgo to recursion, which I think we have to believe there are greater than normal chances of them being in that distribution, but I think I’m less certain about knowing what it is that’s going to provide that real long-term return structure. That, I think, was the case in 2008, 2009, where I think there was a batch of very established, very fast-rising, dominant companies.

Merryn: More obvious. I want to ask you some of the questions that our readers have sent in for you. But before that, I wanted to ask you about the conflict, or the possibility of conflict, between the private investments and public investments in the portfolio. So, most of the Baillie Gifford funds now hold a mixture of listed investments and non-listed investments.

And one of the things I wonder, when I look at that is, and particularly Baillie Gifford, because you have these incredibly close relationships with private companies, and you’re known to be a great and incredibly supportive investor in non-listed companies, and then, of course, they become listed. Do you ever feel that perhaps having both of these types of company inside one fund leads you into a type of conflict?

Whereby you are obliged to continue to hold the shares after they’ve been listed for the long-term, on the basis that new private companies looking for money are going to want to see that long-term commitment to private investments. And that may lead you to a point where possibly you’re holding large stakes in companies for longer than you might otherwise.

James: Every policy is bound to have its complications. I’m not sure that I’m going to go as far to say drawbacks, but complications, for sure. Can I just say, before going into the weeds of it, I’ve always felt uneasy, and I hope my colleagues would say the same, that I should, in any way, try and impose views and mentalities on Baillie Gifford at large. I deeply treasure the fact that there shouldn’t be a mindset that dominates everything, and it worries me when people try to dominate.

So, I will speak absolutely for Scottish Mortgage and a few other things. So, the relationships are incredibly important and valuable to us. And we have been able to do worthwhile investments. I think a lot of it is to do with that combination of corporate and academic relationships, so I’m not walking away from them. I do not believe that the transition is fundamentally something that is a drawback to Baillie Gifford.

Indeed, I would claim it is an advantage over many of the other investment management first that try to straddle it, in that because it is the same people, the understanding is there already, the knowledge base is there, and the relationships are there. Rather than you having to hand over to a group of people who may not sympathise and may have a different investment policy. But whilst I’m saying that, is it possible that sometimes our mentalities are in the direction you [inaudible]?

Yes, it is theoretically possible. I don’t mean theoretically in the condemnatory sense, I think that, and I hope I’ve been open to this, I think that people like you asking us tough questions on these lines matters, so that we can keep trying to factor in this matter to all the conversations. My own experience, and if you want, this is something that may or may not be directly to do with the question, but it’s something really on my mind, as you approach leaving, actually, most of my mistakes have been the other way around.

That I have not, whether it be public or private companies, have actually endured enough. So, why did I sell Apple? I know what I wrote at the time, and it was me, I’m not trying to cast blame anywhere else.

Merryn: It was in the wrong direction.

James: And it was a bad decision. Why have I ever sold a share in Tesla? I think, if anything, I would argue for even greater loyalty to our companies, even though they will inevitably [?] include some mistakes, because I think you’re giving up on the extraordinary upside potential.

Merryn: One or two more questions I want to ask you from me, but before we do that, we’ll just ask some of the readers’ questions. I’m not sure we want to go political. Number one, does he really think breaking up the UK is a good idea? We’ll come back to that, if we have time, perhaps. Will there be any significant changes to the funds’ holdings and, or strategy, in light of recent performance macroeconomic shifts? Now, we’ve slightly covered that, haven’t we? Unless there’s anything else you want to add, I think I’ll just answer for you. No, probably not.

James: But we need to be absolutely openminded and honest. Sometimes, we will be wrong, and if the world has changed, we have to adapt.

Merryn: This is quite interesting, actually, and there are several on China, but we’ve covered that. Colour on the valuation basis methodology of Scottish Mortgage private investments. How is that done? Several people have asked me this before, and by the way, I know the answer to this, because as I’m sure listeners known, I sit on the board of another Baillie Gifford trust, so I know how this is done. But I think it might be useful for readers to understand the difference in valuation methodology there.

James: When I first committed to private investing, we made it absolutely clear that the central feature of it, I think the central feature, was that we could still apply the same investment process, and indeed, the valuation philosophy. And I think whether it be about private companies or more general, there are few things, to be honest, that have irritated me more over the years than the idea that we don’t take valuation seriously.

We don’t think valuation is short-term PEs, and we cannot be dogmatic about the value of a company. But in the same way as with public companies, we have different scenarios and we try and focus on the likelihood adjusted returns from those scenarios, and that will usually go from nought to a very high figure, which goes back to the previous question, you try and be honest about what is happening the world and the direction of those companies towards the different scenarios.

Merryn: Netflix. There are quite a few questions on that. Share price fall, does that mean that you’ll build on the position? Or the fact that subscription is going down makes you nervous about its future. It’s not a big holding in the portfolio, is it? It’s 1.5% or something.

James: I do think it’s a very interesting one, and it’s past the time when I commit us to a certain policy anyhow, or a certain action. But I think it’s a really interesting one, Merryn, in that I think it is one of the earliest examples at scale, you might say Facebook Meta as well, but I’m not sure that’s really what’s going on there, where actually, the operating conditions are worse than we would have thought three years ago.

It may, to some extent, be to do with the pandemic, but I think it is much more to do with the level of competition that has happened there. And I think the likelihood that they are going to be dominant and they will wipe other people out has surely altered, according to this, but equally, the valuation of those prospects has changed very acutely as well.

Merryn: Energy crisis. Quite a bit on this, but not so much about the energy transition, as you might expect, but about the mining sector. Any thoughts on nuclear energy. If we’re at the beginning of a huge bill run for, say, uranium, is that somewhere where you can see, not on your watch, I know, but you might be able to see Scottish Mortgage investing?

James: Whilst there are never precautions in anything that can be defined as [unclear], that doesn’t mean that there aren’t commodity cycles within this that can last quite a long time. There is no rule that Scottish Mortgage doesn’t invest. You will remember about the time, 2006, say, where we had quite substantial exposures. The nuclear one, specifically, I have always been sceptical about, because based on some more work that fundamentally has mostly been done at the Santa Fe institute.

The best guide to the price of different energy technologies is what has happened in the past. Now, we all know, and there are many, many reasons behind this, that the price of nuclear energy has not got cheaper over the past. Therefore, I am much more comfortable with those technologies, such as solar and wind, where those price declines have been radical and look for all the complications of the commodities to remain over the course of time.

Merryn: Nuclear is very reliable and we might be prepared to pay a premium for that.

James: Gosh, there are many very different arguments about this, but I think the models that say that a combination of solar, plus wind, plus batteries is actually pretty resilient are quite convincing. So, that’s the way round I meant it, but I don’t want to come across, any more than I would in discussions of politics, of having the answer.

Merryn: Fair enough. Cars, everyone’s talking about cars. Do you think that it is likely that Tesla will be overtaken by some of the incumbents over the next decade or so. So, VW, in particular, working in this area. Are the old car brands going to claim back their shares, as they build up their technology?

James: I think that it is doubtful. And I also think it is, in a sense, the wrong question. We’ve endlessly had commentary from our friends at Tesla that people should worry less about market share within the EV sector, and much more about the percentage of the aggregate market taken by electric vehicles. So, having other people making progress as well is not necessarily a bad thing.

But if that answer is thought to be too soft, I will harden it quite dramatically by saying, and in a way that surprises me, even as a great support over the years of Tesla, I think the scale, speed, and efficiency of their buildout, excepting factors, such as Shanghai, which is not really their responsibility at the moment, has been truly remarkable. And I think their leadership, whether counted in market share or in terms of years, is getting greater, rather than less, at the moment.

I do accept that one or two of the companies, the VW corporates at large, being quite an interesting example, have shown more of an ability to react. So, ex-China, I would add in, and I think this is an important point, that Tesla always said to us that they thought their mostly rivals, and they aren’t complacent about this, would be from new car companies, new EV companies, rather than traditional OEM ICE companies.

I personally think that the balance of that may have changed slightly and that from VW to Ford, there are some of the original companies, Hyundai, which are making more progress than you thought. But on the other hand, the competitors for Tesla, as new EV companies, per se, ex-China, seem to be people who are doing very disappointingly, so it’s a bit of a mixed picture on that score. But no, I think Tesla is in an extremely strong position.

Merryn: And you’re still a huge supporter of Elon Musk personally?

James: We’ve had our differences, but I would class that in that I don’t think you should expect somebody, doing what he has done, to be entirely a placid character, if I can put it that way. So, my admiration way outweighs my concerns.

Merryn: Will you open a Twitter account, if he takes it over?

James: I find Twitter quite a valuable tool, not, I think, for many of the reasons that he is concerned about doing it. There is a wealth of financial information, if one can just win [unclear] on Twitter.

Merryn: I am getting so many questions. They’re still coming in. I asked this morning if anyone had any questions, and they’re still piling in. A lot of people would like to know how you feel about cryptocurrencies and how you feel about companies that are exploiting that technology. And if there is anything in there that you feel might be important for the trust. I’m guessing you’re not a crypto investor yourself.

James: No. The first thing that I would say is that from a couple of years ago, I thought crypto was the quintessential one, where I should opt out earliest of taking decisions. This is going to play out in 15 or 20 years, and I really thought it was better for the next generation to have their views, and I’ve stuck to that fairly thoroughly. But at this juncture, I can address some noughts [?].

Despite many people, back to Bill Miller, who I admire greatly, believing in this very directly, despite the number of people building businesses in it, I do not fundamentally see that crypto is an innovation remotely akin to the internet and all the parallels drawn with that. And I think the use cases will be much smaller. I think what we should do, though, and I’m pretty certain my colleagues are doing this, is try and discern whether there are any business models constrained as they may be, by that overall take, which are sufficiently strong business models.

And instead of buying an asset, you’re buying a great company, and I think it’s our duty to do that and I think my colleagues will do that.

Merryn: I’ve used up so much of your time, how are you for time? Another couple of minutes?

James: Yes, I’m OK. If you are.

Merryn: Yes. All the time in the world, James, obviously. On the basis that there’s a lot of exciting things happening at the moment. As you discussed earlier, there are so many things happening, so many exciting sectors, so many possible opportunities, and as one of my readers has pointed out in the great scheme of fund management, you’re really still very young. Is there a part of you that wants to stay longer? The reason we’re having this conversation is because you are retiring, but you’re leaving behind what looks like several exciting decades ahead.

James: Could I invert that? It certainly oughtn’t to be taken that I am leaving because I am negative.

Merryn: No one is thinking that for a second.

James: Good. I think I can have a career in, what shall we call it? Like you, I’m worried about the terminology associated with that, but can one do something in broadly defined investing, which is of utility and which needs to be done or is best done in a different setting? I think can. Now, I’ve taken on a role in Sweden already, but you will well know that in Sweden, there are many entrepreneurs with very distinctive takes on what is possible in the world.

On my connection with Northvolt and with [Unclear]… I think these people are making some of the best efforts to serious, not gesture, decarbonisation in the world. And I think, for many reasons, that is an important thing to back. The other element, which I’ve always felt very strongly about, is that we have a failure of European capitalism relative to its potential. And I think, for this context, I’d probably include Britain in Europe. I don’t want to get into that too much.

Merryn: Let’s not get into that.

James: But, Merryn, there are basically, still, both entirely independent national systems, which don’t beat each other. So, you don’t get that sense of networking community, which actually, I think is outside how most people think about America, but absolutely exists. In some ways, I think of Silicon Valley as a giant keiretsu [?], rather than a competing series of entities. And also, I think that there is a lack of an ability to translate all the deep scientific and technologies, particularly in universities in Europe, into something that is valuable in a commercial sense.

I was really interested in last year, there was an event put on Illumina where Jennifer Doudna was talking, a Nobel Prize winner. And she was asked why she was involved in so many companies, and she paused and then said, companies are great for getting things done. And I think that is right. And perhaps it takes us full circle. I don’t quite know how I’m going to address this stream of consciousness that I’m giving you, but these are tasks that I feel very seriously about and I’m not sure they are really about what equity markets do from month to month.

Merryn: James, if you can solve those problems, I think we’ll be even more impressed than we’ve been over the last 20 years of your career.

James: I’m not going to be able to solve problems, but I might be able to have a little bit of a role in helping some of them. So, I agree with you. My gold game is sufficiently bad and I would be tempted to do that.

Merryn: One last question, which you will refuse to answer, but I’m going to ask it anyway. If you could reach into the Scottish Mortgage portfolio and take one stock away with you for 20 years, which one would it be?

James: I was once asked, Merryn… I’m not playing for time here…

Merryn: Yes, you are. That’s definitely playing for time.

James: I was once asked what would you own forever? And at that juncture, my actual answer was Baidu, which would be mainly ups and downs since that period of time. If we say that it’s for the next 20 years.

Merryn: Yes, let’s say 20 years or ten, if that would be easier.

James: And assuming, for the moment, actually, I think it becomes easier the longer you give yourself.

Merryn: Well, it takes us longer to be able to check in.

James: Assuming that one has some disposable worth, and hence, it’s for upside you’re focusing, I think I would opt for Ginkgo. The likelihood of success is, of course, lower than many of the other ones that you or I…

Merryn: Tell us briefly about the company, because a lot of people won’t know it.

James: Ginkgo is, effectively, how shall I put this, the intel of synthetic biology, in that it’s providing the foundry capacity to make various chains [?]. For instance, one of their earlier projects that interested us a lot was a joint venture with Bayer to make plants product their own nitrogen, rather than having to put on fertiliser. But what you can do is so unlimited, so perhaps it’s a good ending point. I was having a conversation with the ever enthusiastic, but extremely articulate, Jason Kelly, who’s the CEO of Ginkgo.

And it was the end of the Sun Valley conference, and we’d spent the previous three days hearing from these giant behemoths. And Jason looked across at the leaders of many of these companies, sitting at adjoining tables, and said to me, you know, from Facebook to Google, and I think he included Amazon as well, and probably the Chinese companies, these companies have become enormous beyond dreaming, just by disrupting one small stagnant sector of the economy, advertising.

What synthetic biology does could disrupt everything. All of manufacturing, certainly, but all of product development and the like. And I think it is those sorts of possibilities and dreams, which we can’t be certain about, which we need, to go back to what we were talking about, I had to do the imaginings that really mattered. And wouldn’t it be better if we could just close the valuation book at any quarter, and I’m not saying it because [unclear] has collapsed recently, and just see where that takes us over 20 years. And I’ll try and remember this.

Merryn: I’ll be back to you in 20 years. That’s a great place to end it. James, thank you so much for giving us so much of your time. It’s hugely appreciated and good luck in all of these goals you’ve set yourself in retirement.

James: Thanks very much. I’ve enjoyed your very thoughtful and provocative challenges from you directly and from shareholders over the years, so thank you.