All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
Modern art comprises many movements. Impressionism led to expressionism, then cubism. Banal objects were turned into pop art by Warhol and Lichtenstein. Banksy made the streets his canvas.
The art world and the investment world have much in common. Entrepreneurial business leaders are like artists: driven visionaries creating long-term value out of nothing. The team at Long Term Global Growth see ourselves as curators, hand-picking the companies we judge likely to be widely admired over time. Like the artists themselves, the curators appreciate the colours, composition and form of a canvas, or the materials and textures of a sculpture. However behind every choice is a myriad of influences which produce the end result.
For the ‘artist’ business leader, these influences determine the type of enterprise they pursue and the values they adhere to. For the investment ‘curator’, what matters most is the choice of works to put on display, when, and for how long. We call this the art of ‘portfolio construction’, and it is more art than science. There’s no formula, any more than there’s a single number that captures a valuation or a degree of risk.
© Getty Images Europe.
Like the art world, the investment world sees ‘movements’ come and go. In 2004, Long Term Global Growth led Baillie Gifford’s charge to transformational growth. The aspiration was to create a concentrated portfolio of companies, managed by a decision-making team that saw the whole picture, ultimately producing compelling returns for clients. This was in sharp contrast to the benchmark-clinging, stalwart-seeking portfolios then in vogue.
Our belief was that the industry could no longer deal with the behavioural and emotional challenges of today’s capital markets. Why? Noise and lots of it. We are besieged by news, data and opinion, spurring rapid, usually pointless, action. The average holding period for companies on the NYSE is around eight months. In the 1950s and 60s it was eight years. We wanted to ensure we stayed patient, ready to benefit from the outsized returns of extraordinary company progress.
Rather than risk being hypnotised by the incessant noise, it’s more useful to think about the underlying changes impacting our world in the next decades. Knowing that most information doesn’t matter in the long-term, we try to escape the markets’ echo chamber and seek other sources of insight. Far more valuable, we think, than regurgitating Bloomberg clickbait.
Then there’s optimism. You might think a Scottish firm would struggle with this, given our ‘dreich’ cultural environment. But the attraction of equities is that the upside is theoretically unconstrained. Returns will always be driven by the handful of investments where things have gone right. At LTGG we were certain that long-term success required risk-taking and ambition, not caution and focus on the downside.
Rather than risk being hypnotised by the incessant noise, it’s more useful to think about the underlying changes impacting our world in the next decades.
From the short, quick brushstrokes of Monet and the impressionists, to the abstract geometry of cubists such as Picasso, each artist gives subtle clues to their inspiration. Creativity can roam free, but movements are defined by their own principles and guidelines.
When Mark Urquhart and James Anderson conceived Long Term Global Growth 16 years ago, they saw an opportunity to invest with total freedom. But they believed passionately in following a few principles from day one.
These principles led them to:
1. Identify revenue and earnings growth (as share prices follow fundamentals)
2. Ignore large chunks of the index (most companies don’t matter)
3. Stop apologising for short-term underperformance (it’s inevitable, and volatility doesn’t equal risk)
4. Avoid trading a lot (it’s expensive and erodes returns)
5. Stop worrying about economic and market forecasting (it’s meaningless)
Since that time, academic work has strengthened our beliefs. Portfolios that differ from the index, most commonly measured as those with a high ‘active share’, combined with long holding periods, achieve consistent outperformance. The recent work of Professor Hendrik Bessembinder inclines us to ignore large chunks of the index. Why worry about broad coverage when most companies are unambitious and vulnerable to disruption?
Our guidelines determine concentration. We must always have 30-60 stocks in the portfolio, though we’ve been at the lower end of this range throughout LTGG’s history. The required exposure to at least six countries and six sectors ensures further sensible diversification. When new companies enter the portfolio, their starting position tends to be between 1-2 per cent. We can add as our conviction rises, but we passionately believe in running our winners, especially after Prof Bessembinder confirmed our hunch that outsized returns have always been driven by the few, not the many. Inertia is the long-term investor’s friend.
© Getty Images Europe.
Source: Cremers and Pareek, 2014, Patient Capital Outperformance.
A good curator is inspired by an artist’s body of work, and knows how to select pieces that will please the public. If it’s still admired, it stays on show.
Over the years, a few LTGG companies have received such acclaim. This means that the stock is held for an extended period, and that our maximum 10 per cent in any one company is reached. The success of these companies has often been extraordinary, but we feel we can congratulate ourselves for not trimming holdings during their ascent. The indirect benefit of reaching the 10 per cent limit is that we can redistribute capital to fund newer positions. Our holdings in Cloudflare and Carvana, potentially the next generation of top holdings, were funded by one such redistribution. As a result, our portfolio weightings never precisely match our convictions and are more an organic expression of companies’ past progress, twinned with our current enthusiasms.
A common trait of wealth-creating companies is their entrepreneurial spirit and adaptability in adversity. We added the question ‘is it adaptable?’ to our 10 Questions (10Q) framework a few years ago to reflect this. This adaptability gives us confidence in letting our winners run. A company exhibiting extraordinary operational progress, along with a growing opportunity set, improves the probability of an extreme payoff.
Hence our puzzlement at the industry’s preoccupation with ‘reversion to the mean’ and why we don’t muse much over price/earnings (P/E) ratios. Instead, we continue to spend our time dwelling in the future.
Admittedly it’s hard to comprehend what a company can truly become. Most investors fail miserably to imagine this. We beat ourselves up most when we’ve failed to grasp a company’s potential. We did this with Netflix, passing up the opportunity to invest in 2011, but we realised our mistake four years later. These failings are inevitable, as we struggle to comprehend the impact of growth rates faster than 10-15 per cent p.a. In the realm of exponential growth, outstanding progress over short periods is regularly underestimated.
Despite the lessons learned, we continue to underestimate company progress. Our optimistic research predictions for Apple undershot the company’s actual progress by a couple of hundred billion dollars. In our initial research on Tesla (2013), we felt that it becoming a $50 billion company by 2028 would represent significant success. More recently, our long-term, blue sky scenario for Chinese commerce moving online was reached within just two years. The lesson here is not to lambast ourselves for failure of imagination in these rare cases, or to blindly construct wild company scenarios, it’s more to acknowledge evidence that supports the case for inertia.
Curators are judged on the artworks they select. Some timeless pieces should be permanently on show. Others deserve a short period in the spotlight. Some will never find favour.
A company with a rising share price, a growing opportunity set, a deepening competitive ‘moat’ keeping challengers at bay – all resulting in a favourable probability-adjusted payoff profile – will be supported as it climbs the portfolio rankings. These types of companies comprise the ‘top 10’ portfolio weightings. These are companies that have exhibited exceptional growth and have ‘earned their spurs’, but still inspire optimism about their long-term growth prospects.
The ‘middle 10’ have likely been owned for a shorter period, but conviction about them could be growing, even with competitive advantages that are not fully developed. Glucose monitoring equipment maker Dexcom was purchased in 2016 with a favourable market position, but the competitive dynamics of that sector were still in flux. Established players like Medtronic and Abbott Laboratories were worthy competitors and younger companies in private markets were employing innovative techniques to treat type 2 diabetes as well. Since our first purchase, the case for continuous glucose monitoring and the dynamics of the market have become clearer, making our optimistic scenario more believable.
The ‘bottom 15’ showcases our newer ideas – the seeds of future growth if you will. These companies don’t warrant a large initial position and it would be arrogant of us to have such conviction at the start of our ownership journey. As we learn more, our conviction can increase.
Hermès, the French luxury goods company, has been a holding since LTGG day one. Our attraction to Hermès stems from the longevity and durability of its brand, as compelling today as it was in 2004. With an insatiable demand for its products, twinned with founding family involvement going back to 1837, Hermes' revenues have ticked up with metronomic regularity over long periods. Other holdings like L’Oréal, HDFC and AIA have similar profiles.
A continual review of holdings is vital as a company’s future returns potential can quickly dissipate. Eroding competitive advantages, atrophying cultures, even technical progress elsewhere can all render extreme returns unlikely. We invested in Baidu in 2009, and it became the largest holding in 2012, but from 2017 we trimmed the holding several times, eventually selling in 2019. Our diminishing conviction came from the rapidly evolving Chinese internet landscape, with Tencent’s WeChat app as well as ByteDance’s Toutiao and Douyin/TikTok apps bypassing traditional search. We felt that Baidu founder Robin Li could have been more adaptable, especially as the founding engineers of ByteDance came from within his own company.
Our near decade-long holding in eBay ended similarly. Initially purchased in 2005, we were excited by the potential of PayPal to disrupt the payments industry. However, instead of being a disruptive force, PayPal priced similarly to incumbents like Visa and Mastercard, even hiring a former American Express executive after CEO David Marcus moved to Facebook. We sold in 2014 disappointed, knowing that the payments industry offered vast opportunities to disruptors. Fast forward to 2020 and new portfolio holding Adyen is attempting to do just what PayPal failed to: untying payments from the legacy banking infrastructure and, ironically, replacing PayPal as eBay’s primary payments provider.
Atlas Copco was another of our largest holdings back in 2007, but we reduced the holding in subsequent years, eventually selling in 2019. We still admired the operational excellence of Atlas, but with continued competition for capital, there were more compelling ideas elsewhere. Inditex, another recent sale in 2020 was a similar story. A company with a legacy bricks-and-mortar store network will struggle to compete with ecommerce growth rates.
Although we are by no means frequent traders, the ability to add and reduce holdings remains an important tool in our toolkit. NVIDIA has seen both since our initial purchase in 2016. More recently, we added twice to the digital fitness company Peloton, shortly after its IPO in 2019. At the time, the market was treating all new listings with disdain, not helped by the failed IPO of WeWork. Peloton's cause wasn't helped by a poorly received Christmas advert. Regardless, we were enthused by Peloton's potential to disrupt the traditional fitness industry providing `fitness as a service' to a growing customer base, despite market short-termism.
For Long Term Global Growth, portfolio construction will always remain an artistic endeavour rather than a science, subject to a set of systematic laws. Each of the companies discussed above tells its own unique story and our portfolio decisions will always be driven by the progress of each individual company, while considering the broader portfolio and the current enthusiasms of the team. Avoiding ‘best practice’ formulae for calculating the size of an investment has served us well for the past 16 years. We continue to believe that creativity and imagination are the long-term investor’s most useful attributes.
The views expressed in this article are those of the authors and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved in September 2020 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
Changes in the investment strategies, contributions or withdrawals may materially alter the performance and results of the portfolio.
Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.
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The images used in this article are for illustrative purposes only.
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