Only a few companies will drive long-term shareholder returns – it is the job of active fund managers is to find them.
Addressing delegates at a Sub35 event in London’s Covent Garden, Catharine Flood, a client services director at Baillie Gifford, which runs the global growth trust, used an academic study to illustrate her point.
Professor Hendrik Bessembinder of Arizona State University collected data from every single stock in the US market from 1926 to 2016. The total value these created was just shy of $35 trillion, but of the nearly 26,000 companies on the market, only 90 were responsible for creating half of that value.
“In the long run, it’s actually just a few companies that really matter,” said Flood. “We buy and hold the companies that we think have a reasonable prospect of becoming one of those 90 companies, because that’s where the returns come from.”
Common characteristics of those 90 companies include having a sufficiently large end addressable market to facilitate growth and a management team that is allocating capital to entrench that competitive position.
“You have to be patient; this does not happen overnight,” said Flood. “You have to be a long-term investor to benefit from some of these trends, so we are looking at five, ten, 15 years.
“It won’t happen in a nice smooth line. It’s not going to be easy; there will be setbacks and uncertainties that come along the road. Being prepared to support companies through that, but not being uncritical, is truly valuable.”
Investors should also expect asymmetric returns. Flood quoted Amazon founder Jeff Bezos: “Given a 10% chance of a 100 times payoff, you should take that bet every time.” While some companies that Scottish Mortgage has owned over the last ten years have failed, losing shareholders 100% of their capital, others have made 1,000% or event 5,000%.
“You should have some [holdings] that don’t work; if not, you’re not taking the risk you’re being paid to take by your clients,” said Flood. “The asymmetry means that the balance works in your favour for equities. The point for Jeff Bezos is that the markets that he attaches his capital to are big enough that the ones that work – that become AWS [Amazon Web Services], grocery, healthcare, apparel – make Amazon in aggregate so much money that they pay for the ones that don’t work.”
True leaders
Flood also stressed the importance of listening to ambitious company bosses. “We spend most of our time when we meet companies listening to what these people say. These are some of the people genuinely changing our world today.”
Speaking on the day that Sergio Marchionne, the former Fiat Chrysler chief executive who merged and revived the Italian and US carmakers, died at the age of 66, Flood said: “There are some people in the world who are better, more creative, at running companies, who are prepared to embrace uncertainty and ambition and can take their companies to a height that nobody anticipated.
“At one stage, GM [Motors] paid $2 billion to get out of buying Fiat. The credit for where Fiat and Ferrari and the other companies in that group are today largely rests on that man’s shoulders.
“There are a number of such true leaders where we aim to put our clients’ money because they’re aiming to do something different. We only wish that we could find more of them.”
Big bets for Scottish Mortgage include Chinese tech companies like Alibaba, which has more than 70% share of ecommerce in China, Tencent and Ant Financial.
Size advantage
The investment trust structure with its closed pool of assets and independent board, which acts as a “check and balance” on fund managers, combined with Baillie Gifford’s private partnership structure, is well suited to long-term growth investing.
The trust can also use its size to its advantage. With more than £8 billion of assets, it is by far the largest investment trust in existence.
“We can utilise our size on a number of ways. We are much more liquid – we are a FTSE 100 company – but we can also use our scale to… bring down costs for shareholders. That will always be good for the end returns the investor gets.”
Watch Flood’s full presentation or what she thinks investors can learn from a study that pits humans against chimpanzees