“Reach for the moon if you wish to get to the top of the tree” was once taught to aspiring young men. In more recent years, this has become vulgarised into Gordon Gecko’s credo in the film Wall Street: “Greed is good”.
But it is not good, at least as far as investors are concerned. Very few private investors can expect to do better than the market as a whole, and those who say they have are mostly lying or fooling themselves.
Passive versus active
Jeremy Grantham GMO is a very successful investor indeed, but nearly 50 years ago he realised that index trackers made more financial sense than actively managed funds. As he put it then, and many times since: “market returns less low costs of index linkers beat market returns less the high costs and transaction fees of active managers.”
Active managers counter this by saying that passive management is akin to driving using the rear view mirror only, so actively managed funds sell more than nine times better than passive ones. And even if active managers mostly invest conventionally through “closet indexing”, and their hidden costs have a disproportionate effect on results, very few investors ever bother to check how well their savings have performed. So, for most of us who cannot be bothered with investment matters, the better credo is low-cost index trackers or ETFs combined with caution, patience and compound interest.
Nevertheless, investment thinking needs to be combined with a sense of history, as well as the rhythms that flow out of that history. Financial repression was last used in the 1940s, when the Attlee government attempted to keep borrowing costs to under 3 per cent. That had two effects on investment thinking: a bear market of nearly 40 years in gilts that destroyed the wealth of those who refused to accept that the world had changed, and the birth of ‘the cult of the equity’ as well as Britons’ love of bricks and mortar investing.
Much the same happened in America. Then the S&P stopped rising in the mid-1960s and did not resume until 1982, but at that stage, in both countries, inflation was coming under control, and government bond prices began to recover.
So despite conventional wisdom that shares do better – and their miraculous rise that lasted until prices blew out with the TMT bubble of 2000 – over the past 30 years or so US bond markets have produced better returns than the S&P. It has been the cautious investor with a 40:60 split between bonds and equities that has fared best.
End of another era?
It may be that we are coming to the end of another investment era. To investors in their 50s it is strange to hear central bankers worrying about inflation being too low; for the 300 years or so of their existence, their main task has been the preservation of trust in their respective nations’ currencies, and that required above all a belief in the stability of the purchasing power of an intrinsically worthless piece of paper. This reversal of central banking behaviour partly reflects the unwillingness or inability of western governments to impose the supply side reforms necessary if their economies are to function effectively, of which reform of the banks and of labour markets are the two most important.
But it also shows the pervasiveness of a formerly unknown economic idea, the ‘trickle down theory of wealth’ (or, keep the really rich happy, and the rest of us will benefit from what drops off their table). Certainly by Alan Greenspan’s time as head of the Fed, the health of Wall Street – and specifically the level of the equity market – concerned US authorities.
A belief that national wealth is created by trading bits of paper rather than people inventing things, then making them and improving them, and all the while trading the necessities of life among themselves, seems odd on the face of it but, without much evidence, appears to have become official dogma. It does not seem to have worked.
Quantitative easing [QE] has failed to inject cash into the real economy because banking balance sheets are too weak to allow them to lend to SMEs – the providers of employment and innovation in any real economy – and recovery from 2008 is either stunted or blocked. Businesses are fearful of investing, and workers [aka consumers] have no money to spend. The ECB is now worried that the eurozone is heading for a Japanese style deflationary spiral.
Further technological change
The American futurist Ray Kurzweil predicts an exponential increase in technologies like computers, genetics, nanotechnology, robotics and artificial intelligence. Without going so far as to believe in his prediction that this will lead to a technological singularity in the year 2045, a point where progress is so rapid it outstrips humans’ ability to comprehend it, it is clear that change is affecting all existing business.
This is where investment managers, who can think independently and outside of the herd mentality, can be advantageous to the forward-looking and patient investor. The world has changed, and is still changing but even faster.
Back in the 1970s and the world of Top of the Pops, personal computers did not exist, nor mobile telephones, nor the internet, no one had heard of social media, nor dreamed of identifying the human genome. It is not only the profitability of the music industry that has been destroyed by those developments, and there are more to come.
Baillie Gifford on the case
Scottish Mortgage Investment Trust [one of the Baillie Gifford stable] was commented on in March’s Investment Spotlight, when it was compared to Personal Assets Trust. Now Charles Cade, head of research at Numis Securities, has written of a recent meeting with Baillie Gifford in Edinburgh. The full report is available on the Numis website and should be read by all concerned with finding a core manager to lead them through the difficult years ahead.
Mr Cade writes that it is “crystal clear” that the focus on disruptive technologies is pervasive, with Scottish Mortgage and Edinburgh Worldwide the “purest” plays on this theme. Baillie Gifford has always focused on a stock’s growth potential, but the emphasis has shifted towards high growth, and particularly the power of technology to disrupt traditional industries, and allow others in.
There is a bottom-up stock picking method and no in-house view or model portfolio, although there is a collegiate approach, with ideas shared across investment teams where appropriate. There are 95 investment professionals, primarily focused on equities, and the average tenure of an investment trust manager is 18 years. Most of the partners are recruited through the group’s graduate trainee programme.
Baillie Gifford defines its portfolio holdings via themes such as cloud computing; online retail; technology obsolescence; transformational healthcare; consumption in growing economies; and great western brands. This approach is
very different from the traditional fund management industry. Baillie Gifford’s investment trust portfolios have little in common with market indices.
The firm’s partnership structure enables the group to focus on delivering long-term investment performance without concerns over their own profitability and has been a leader in cutting management fees with no investment trusts charging performance fees.
If Mr Cade has worries, they are more to do with portfolio concentration, and an inclination to run profits and ignore valuations.
But investors do not have to buy all of Baillie Gifford’s stable, only those which appeal to them and, as the March article suggested, these should be hedged against other investment trust managerial styles.
