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Scottish Mortgage interview: backing exponential change

James Anderson and Tom Slater tell Mary McDougall where they think the best opportunities are, and how they access them
Scottish Mortgage interview: backing exponential change
  • Scottish Mortgage seeks the world’s most exciting growth opportunities
  • The managers’ reputation makes its strategy possible

Over the past decade, Scottish Mortgage Investment Trust (SMT) has had one of the most remarkable runs of success that any mainstream investment trust has ever had. Its assets have grown to over £18bn, several multiples bigger than its largest rival. It’s an extraordinary achievement.

Much of the trust's recent asset growth has been fuelled by Tesla (US:TSLA), its largest holding, which appears to have defied traditional valuation metrics and shot up more than 780 per cent over the year to 11 December. While many investors worry the stock is far too expensive, James Anderson and Tom Slater, co-managers of Scottish Mortgage, see it quite differently.   

“Tesla is not just about electric vehicles," says Mr Slater. "If you look at some of their other efforts around autonomy, software, robo taxis and the like, I don’t think there is anyone else close to challenging that.” He isn’t concerned about other carmakers catching up, either, because Tesla delivered under half a million cars in a global new car market of about 100m last year; there is little evidence of demand constraint any time soon. 

The managers’ conviction in Tesla feeds into how they think about investing more broadly. “The rise of Tesla is a symbol of a revolution in energy," says Mr Anderson. "It’s basically the ability to use energy in large forms without malign consequences at very low cost that underwrites economic progress. We’ve had such revolutions only three or four times in human history, and are having one at the moment. And I’m pleased to say it’s driven by economics even more than by climate change as we are now in a position where solar power plus storage is cheaper than any other element or energy provision.”

They believe long-term equity returns are concentrated in very few companies, and these are the firms they look to own. While many of their holdings are considered ‘tech stocks’, they say a crucial part of their progress is not having thought about holdings such as Amazon (US:AMZN) or Alphabet (US:GOOGL) as part of a 'tech sector'. 

“We’ve been fortunate to see significant success in advertising, through the likes of Alphabet and Facebook (US:FB), and in the retail industry through what's been achieved at Alibaba (HKG:9988) and Amazon," explains Mr Slater. "A lot of the opportunities over the next 10 years will come from the application of Moore's law in ubiquitous mobile communications to other sectors, whether logistics, real estate, insurance..."

Gordon Moore’s law estimates that the speed and capability of computers can be expected to double every two years, as a result of increases in the number of transistors a microchip can contain. A sector Mr Anderson is particularly excited about is healthcare. “In the last three or four months we have seen the first evidence that healthcare is starting to be transformed by big data,” he says, citing Illumina’s (US:ILMN) acquisition of Grail, and its progress in using artificial intelligence for early cancer detection. 

This is the first year that they have trimmed their holding in Amazon for reasons other than portfolio concentration. “We’re not saying it’s the end of Amazon, but that the process to maturity is getting closer,” explains Mr Anderson, adding that the entry of Alphabet into cloud computing with a willingness to cut prices matters quite a lot for the economics of Amazon’s cloud computing branch AWS.

They believe more specialised consumer companies are starting to have the edge over their giant competitors. They think e-commerce platforms Shopify (CAN:SHOP) and Zalando (GER:ZALX), and furniture retailer Wayfair (US:W) can do a better job in their respective areas than Amazon and that Spotify (US:SPOT) has an edge over Apple (US:AAPL), offering a real transfer of opportunity.

Scottish Mortgage holds a notable number of delivery companies, from Meituan Dianping (HKG:3690), to Delivery Hero (GER:DHERX), Hello Fresh (GER:HFGX), Wayfair and a recent addition, Ocado (OCDO). “What attracts us is that these industries are being recreated by technological developments, and you get not a national but a very strong local presence," says Mr Anderson. "If you can identify the likely winners early on in those areas the prospects for growth are immense." He adds that people are often put off by apparent lack of profitability in the early stages and underestimate their potential.

He also says that inspired leadership makes a big difference. “We regard Jeff Bezos as absolutely critical to our thinking, not just in terms of owning Amazon, but because he has provided the best anti-Warren Buffett philosophy about how you ought to think about the opportunities.”    

They are not concerned by the surge in demand this year for streaming services such as Netflix (US:NFLX) and Spotify, which others worry are on lofty valuations and at risk of a pullback as things normalise. “I don’t think it will be a surprise if they grow more slowly, but I don’t think it’s relevant to the investment case,” says Mr Slater.

He says Netflix has a content budget that is “absolutely unprecedented”, and its structural advantage in distribution scale and ability to attract talent puts the company in a very powerful position. On Spotify, Mr Anderson says if it reports next year that user growth has shrunk or gone negative, they would see it as an opportunity to add. 

While much of their success has come from Silicon Valley, they think the region may be starting to lose its shine. “We think there is less evidence now of real innovation,” says Mr Anderson. “I do worry you’ve got such strong advantages for the dominant companies in America that it starts to undermine the exercise of truly entrepreneurial capitalism.”

This contrasts with China, where innovation is proceeding much more quickly. “The scale and importance of what is happening in economic development are now on a completely different level from in the US,” says Mr Slater. He gives the example of meeting recently with the chief executive officer of Shopify in Silicon Valley and asking if he was there in search of new ideas. He was met with the response: “No, no. I stopped coming to Silicon Valley for ideas years ago. If I want inspiration, I head to China.”  

Although some investors worry about poor reporting standards and corruption, Mr Anderson stresses "from Alibaba to Meituan, Tencent (HKG:700) and ByteDance, we’ve been delighted at the reception we’ve had. We feel the access and the information we get is very high quality and, when you analyse company by company, you have the same number of structural problems in China as you do in the US or UK.”

He accepts that there are pressures to conform to a national system in China, however, and says they have a certain nervousness in the case of Alibaba and Ant Financial, where Jack Ma is so influential and admired, the communist party is particularly wary of him. He expects that we will not fully know what happened with Ant's failed IPO, nor the consequences of it, for many months to come. 


Scottish Mortgage's advantage

A key distinction of Scottish Mortgage from other mainstream investment trusts is the number of private companies it holds. In the last five years, 51 out of 61 new investments have been made in unlisted firms, 15 of which have since come to market. “It’s about getting access to some of the most attractive growth companies in the world and owning them through their lifecycle,” explains Mr Slater. 

The types of companies they have accessed in recent years is almost unheard of for a UK-based asset manager, given top entrepreneurs can be very selective about who they partner with. Starting with Alibaba in 2012, they have owned Spotify, Hello Fresh, Airbnb (US:ABNB), NIO (US:NIO), Lyft (US:LYFT), Ant Financial and ByteDance all as private companies – to name a few.

“It matters that we have been a top 10 holder of Amazon for over 15 years and that we have stuck with Tesla as the largest outside shareholder through the challenges it has faced," explains Mr Slater. "When we meet private company entrepreneurs, they recognise that we would behave as a proper partner for a decade – regardless of whether they are private or public."

While some investors are nervous about investing in private companies for transparency reasons, Mr Anderson finds that they are much more open. “The single most refreshing part about investing in private rather than public companies is that they will be more open about the challenges that they face. You know they can't do that in public markets because the next day Goldman Sachs will write a sell recommendation and the short community will come in. It's incredibly rewarding and helps your understanding of what these companies and industries can bring, if you can discuss what’s the hard stuff.”

They don’t concern themselves with fluctuations in share prices, or worry about stretched valuations in 'tech' stocks. “Some may look expensive on immediate metrics, but where we are right they become absurdly cheap on long-term estimates,” explains Mr Anderson. “We do not believe that it is possible – even in the simplest company – to have one secure long-run estimation of its valuation. The world is much more complex.” 

Rather than using exam board valuation techniques, they model multiple different scenarios and attempt to adjust them for likelihood. “We do not know when many of the big transitions that we are talking about either at the societal or corporate level will happen, but we are very confident they will happen at some point, and to have a time frame that enables not to have to worry about when is very important.”

Mr Slater adds that they are in the fortunate position of being able to forecast some of the drivers of change fairly accurately. “The cost of generating energy from solar panels has fallen 20 per cent a year for the past 10 years," he says. "An almost perfect exponential decline. The cost of storing energy in a battery has fallen 16 per cent with every doubling of global battery capacity.”


Tesla has made you loads of money: what’s the next one?

Mr Anderson: “I am incredibly excited by the application of big data to healthcare. So I would go for the newly merging entity of Illumina plus Grail.”

Mr Slater: “Zipline in drone delivery, Lililum and Joby in flying cars, Full Truck Alliance and Convoy in freight scheduling, or Space X and Relativity Space in space rockets. It’s a lot more than one company, but there is the potential for enormous change in the transport industry over the next 10 or 20 years, and I honestly don't know which one of this collection is going to be the one. But that’s the nature of things, you can’t predict.”

Cumulative total returns (%)
Scottish Mortgage Investment Trust share price 119157331802
Scottish Mortgage Investment Trust NAV119170352740
FTSE World index1636104191
Sector: Global investment trust share price average2041122305*
Sector: Global investment trust NAV average2344123276*
Source: Winterflood, *Refinitiv Eikon, as at 11/12/20