Investment managers have an important role in finding and supporting enduring businesses that can change the world.
- Investment managers have a vital role in helping the best companies thrive
- Much of the market remains structurally ‘anti-growth’, avoiding companies making significant investment
- The real vulnerability is among those businesses that haven’t been forced to innovate
On waking in the morning, a doctor will have a reasonably clear vision of their tasks for the day ahead: they may be mending a broken leg, or performing heart surgery, but their purpose is to make people better. The purpose of an investment manager is not always as obvious: Is it to beat their peer group? The benchmark? Or do they have a wider role?
James Anderson, manager of the £4.1 billion Scottish Mortgage Investment Trust at Baillie Gifford, is clear that an effective investment manager should do more than simply move money from place to place. They have a role in helping the best companies grow and endure.
“Many haven’t realised just how major a structural change to capitalism was wrought by the evolution of fund management as a business” he says. “It can be a self-regarding business. Investment managers often respond to their agency issues rather than the needs of the business in which they invest. What investment managers do for the good of their own business is not necessarily what’s important. Our job is to help create great, enduring businesses that wouldn’t otherwise exist.”
"Our job is to help create great, enduring businesses that wouldn’t otherwise exist."
He argues that this has been lost in an industry fond of debating the marginal accuracy of share prices. This is as nothing relative to the creation and maintenance of good businesses, he believes.
Much of the market remains structurally ‘anti-growth’. Anderson gives the example of electric car manufacturer Tesla Motors, a holding in his portfolio. While investors may like or dislike founder Elon Musk, he says, few could argue that this is a business seeking to change the world and using investment from capital markets to do so. Yet the company is subject to significant short-selling pressure and many investors seem enthusiastic for its failure. Instead, investors are often more inclined to give capital to companies that have no need of it; that are already large and well-established. Company management is told to prioritise cash flow, dividends and stability. This has been particularly evident since the credit crisis and is worst in those countries with large institutional pension funds, such as the UK. Is it surprising that there is widespread poor productivity?
There are other problems associated with investing in this way, says Anderson. While no business starts out as definably ‘evil’, they can be pushed into poor behaviour by investors: “There is self-justifying behaviour within any company and it interlocks with what happens in fund management firms,” he adds.
It may also create fewer and fewer opportunities, but there can be a genuine arbitrage opportunity in backing those companies that do not conform. Those companies that are investing to grow have an enduring competitive advantage over those who don’t, he says. Companies that invest can achieve things other businesses cannot. Anderson continues: “From our point of view, it may be a competitive advantage, but from society’s point of view it is a problem. Why are the dreams not bigger?”
Partly, the problem can be explained by a desire for certainty among investors, particularly at times of political and economic turmoil. However, Anderson says investors need to learn to live with uncertainty for long-term rewards: “The outcome of future investment can’t be certain. It is less the certainty of return than the probability of return. If you have a 10 per cent chance of making a return of 1,000 per cent you should take that chance, while in no way denying that it still means you have a 90 per cent chance of failure.
“Businesses will fail. We’re not trying to say we won’t ever lose money in an investment. It is important to be prepared to lose money, but to take a portfolio approach, where there is a probability-adjusted chance that these risks will pay off and will move society onwards. We think in terms of aggregate returns and accepting loss.”
Equally, he believes, risk has been misconstrued: “There is an assumption that because technology companies are living with innovation, they are more vulnerable to the downside.” However, competition keeps these companies on their toes. The real vulnerability is among those businesses that haven’t been forced to innovate. This has been seen in the retailers and is now being seen in the motor, energy and utilities companies: “If Musk is right, these companies are dead,” Anderson adds.
It does require backing the right people, and again, the outcome will not always be clear ahead of time. Anderson says: “With really clever people, we don’t know what’s in their mind. It’s a game of chess. With Tencent, our research was very thorough and we still got nowhere near understanding how great a business it would be.”
Anderson is clear that a judgement needs to be made about individuals and their motivation. But is it so difficult to tell a Jeff Bezos (founder and chief executive officer of Amazon) or an Elon Musk from the average guy? That said, it is not a guarantee of success and it is more difficult in some industries than others: In healthcare, for example, even highly motivated people may not be able to get a drug through stage three clinical trials.
There is a valid question over whether companies can continue to generate strong growth after their founders have left. This is an issue facing companies such as Apple, where investors worry that the engine of creativity has begun to stutter.
At the extreme, the biggest companies – BP or HSBC – are too big, complex and institutionalised to be managed, Anderson says, but it is not simply a question of size. He points to Inditex, owner of clothing group Zara. The company was started in a small Galician village and is now the largest fashion group in the world. Its continued growth has much to do with the ongoing commitment of its founder, Amancio Ortega, whose position among the world’s richest people has not dented his enthusiasm for the business.
What can fund managers do to encourage this type of business? For Anderson, it is about showing long-term commitment that puts companies in control of their own destiny. He says: “We are trying to be consistent shareholders for the long term. For example, we are holders in Illumina and were instrumental in not allowing Roche to take it over in the early stages. We don’t want to tell companies how to do it. We want to help people be revolutionary.”
James Anderson is manager of the $4.1 billion Scottish Mortgage Investment Trust
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