This is a fuller version of an interview which first appeared in the Spectator in its May 22nd 2015 issue.
Interviewing James Anderson is a lot more refreshing than grilling your average fund manager, as befits a man who runs one of the country’s most venerable investment trusts in a most unvenerable way. The Scottish Mortgage Trust, established in 1909 by Baillie Gifford, has been taken in a new and more adventurous direction under its latest managerial team, which pairs Mr Anderson, a historian, and Tom Slater, a computer scientist, as co-managers.
The new direction is most evident in the list of names that now make up the trust’s biggest shareholdings. The top ten include no less than three of the biggest US Internet stocks, Amazon, Google and Apple, and two of their newly emerging Chinese rivals, Baidu and Tencent. Further down the list you will find Facebook, LinkedIn and (less happily) Twitter. No other mainstream fund in the UK has made such a large and concentrated commitment to the global digital revolution, or so robustly challenged the conventional wisdom in fund management circles that these stocks are both richly valued and most likely heading for a dramatic fall one day.
Mr Anderson bats away any suggestion that this is an Icarus-style fund flying too close to the sun, as many Internet stocks did 15 years again. His view is that while his concentrated holdings make the performance of his fund more volatile than the norm, it is the rest of the fund management profession which is out of step in failing to recognise the rapid changes and new corporate titans which online technology is now creating on an extraordinarily global scale.
I start by asking him how he benchmarks his approach against that of wily old Warren Buffett, who famously has always refused to buy technology stocks on two grounds – one, that he does not understand what they do, pushing them outside his “circle of competence”, and secondly, that their future earnings potential is so uncertain given the pace at which the digital world is changing that they can never really pass the classic value investor’s “margin of safety” litmus test. If they can rise so quickly, to put it bluntly, can they not also disappear just as fast?
Mr Anderson does not buy that argument. While he has great admiration for aspects of Buffett’s approach, including his preference for putting large bets on a small number of companies with powerful brands and market dominance, and holding them for the longer term, the world has changed. “Buffett grew up with a generation of post-war American companies at a time when growth in the world was linked to what those great American consumer staples were doing” (think Proctor & Gamble, Coca-Cola and so on).
“But I think, to use Buffett’s terms, that your circle of competence needs to be different now. Our observation would also be that many of the new technology companies have proved to be much longer lasting than anyone expected. The run of excess profitability that say Microsoft or Bloomberg has enjoyed makes us wonder whether they not only offer you explosive growth, but are themselves becoming great long term franchises of the kind that Buffett so admires”.
Anderson namechecks the British economist John Kay, who sits on Scottish Mortgage’s board, for encouraging him to think more deeply about what makes a great company, one that can both grow very fast and maintain its dominance for years. Those are the innovative elephants his fund is hunting. “I am actually ambivalent about how well we understand the technology, but I think what my colleague Tom Slater and I have been able to do is appreciate that the technology is more mature in some cases than the common perception”.
A good example is Illumina, his largest holding, which started out as the brainchild of some Cambridge scientists but now, under American ownership, leads the world in genome sequencing. Just as Moore’s law has relentlessly driven down the cost of computer processing for a generation, so something similar is happening with the cost of sequencing, with dramatic potential for practical medical advance. Because of their willingness to think long term, and not just about next quarter’s earnings, it was “not a great push for us”, says Anderson, to see that the price of sequencing would continue to fall very rapidly. That in turn would produce huge earnings power several years ahead” – but still leaving the shares a blind spot for overpaid, short termist, overactive, quarterly earnings-obsessed UK fund managers (a “psychologically impaired” group, in his view).
Despite the youth and inexperience of their founders, some of the new Internet pioneers have also proved to be highly effective at growing market dominant businesses. Anderson cites Mark Zuckerberg as an example of a new breed of owner-entrepreneurs who have been almost Rockefeller-esque in their ability to consolidate their industry. Many analysts pooh-poohed Facebook when it was first floated on the stock market, but since then its dominance has continued to grow, not least because of Zuckerberg’s ability to persuade other social network pioneers, such as Instagram and What’s App, to sell their businesses to him.
“Facebook” says Anderson “is now the owner of four of the five most prominent social media platforms in the world, with over three billion people on their platform – that is quite a judgement on the longevity of the social network”. In other words, for all his wisdom Buffett may have missed a trick in failing to see how well-managed and how Buffett-like in practice these new globally dominant companies could be. What then about Apple, I ask, currently by far the most valuable company in the world?
Anderson sees Steve Jobs as a rare example of a great leader who has shown the ability to pass on a unique way of doing business to his successors, in Apple’s case that unique culture being manifested in the “the primacy of the engineering design task”. But having made a lot of money from the shares, he has recently been finding it harder to reconcile the company’s future earnings capacity with its current $700 billion market capitalisation and has been cutting back on his holding. Twitter meanwhile, he thinks, looks more vulnerable and may be going down the wrong path.
The reality however is that the biggest Internet companies are now “quite close to being monopolies, while spending their time trying to pretend that they are not”. Market dominance is a big issue for the decade ahead, good for shareholders but an issue for governments, regulators and public opinion. He thinks institutional shareholders should be pressing the Googles and Amazons of this world to show more concern about becoming “respected members of society” (read, paying more tax) while simultaneously fighting back against governments about security of personal information. Regulators will always be behind the curve however in remedies and enforcement, as the industry continues to evolve so quickly.
The rise of the big Chinese internet companies raises different questions. The founders of all three big companies in China have close links to the Communist party, but are notable for the way that they admire, study and copy their peers in Silicon Valley. (The founder of Softbank in Japan, Anderson notes in passing, also likes to compare Steve Jobs to Leonardo da Vinci, as a true giant of civilisation). Yet the rapid growth and reach of the Internet clearly poses a future threat to the future of the communist regime. “Serious revolution” in China is a real possibility over the course of the next decade. A big risk then? “We try to think through all the possibilities, but it is much more difficult to say where it ends and whether it is good or bad for the companies”.
A self-confessed optimist and vocal critic of the shortcomings and myopia of traditional fund managers, Mr Anderson says that he is just as excited about developments in a third field of technology, which is solar power, where the economics are “pretty much there” and new capacity is being add at an exponential rate. The impact of clean energy on society, once the process is complete, could be just as transformational as the Internet and genomics. He concedes however that his trust was too early in making its big bet on solar, so the big rewards still lie ahead.
Despite what looks to some like a high risk strategy, the Scottish Mortgage formula is working well. Although they dipped badly during the crisis, the trust’s shares are up 135%% over five years and 388% over ten, a handsome reward for patient investors – and a useful source of diversification for those with other funds, given the very different makeup of its portfolio. To its credit the board keeps the management fee, at 0.3% per annum, low by industry standards.
It would be a mistake to think that the trust is only about technology stocks. Among an eclectic list of 70 holdings, Anderson also likes two reviving car manufacturers, Porsche and Fiat (“a remarkable turnaround”), a German business-seeding firm, the Spanish retailer Inditex and Whole Foods, the upmarket American purveyor of heath foods. You would be amazed, he says, how even Americans are now taking to heathier food in a big way – an early sign perhaps that the skids may be under McDonald’s, another iconic heavyweight in the global stock market, just as they are, in Anderson’s view, for Big Oil and the drugs companies, two sectors which he is happy to avoid completely.
Just as refreshing as his disregard for consensus thinking is Mr Anderson’s refusal to waste time debating the pros and cons of QE and its impact on global growth and stock market performance. “There are so many people thinking and talking about this all the time that the markets have become obsessed by it, which creates opportunities for those with a different narrative”. He merely says that the consensus view which assigns the behaviour of global markets almost entirely to monetary policy is overlooking “much deeper, more fundamental issues”. The technology that has made him so much money, to name but one, is inherently deflationary.
“Do I really believe the GDP numbers? I am not sure I do. If Illumina attain their ambition of making cancer manageable, that will probably depress the GDP figures because a whole batch of healthcare costs which are counted in the figure no longer occur. Is that better for us? Yes. I would say that human welfare indices probably tell us more about the stock market (than GDP data)”. So is there a QE-inspired bubble in markets? “Is the structure of low long term interest rates important for valuations? Yes, but I am not sure it is the QE mechanism that is the critical element”. This is a fair – if rarely heard – perspective.