Capital at risk

Actual investors are focused, not frantic.

  • Active investing doesn’t necessarily mean frequent trading. For us it means taking independent views to hold the small subset of the investment universe that we favour
  • Baillie Gifford’s portfolio turnover is typically less than 20 per cent per annum

The trouble with the term ‘active management’ is that it confuses more than it clarifies.

‘Active’ naturally suggests ‘activity’. Share traders in red braces barking ‘buy this!’ or ‘sell that!’ down the phone no longer prevail, but active managers are still expected to act fast and often. Busyness is a badge of professional excellence, reflecting superior sources of company information, familiarity with market cycles and whiplash commercial reflexes.

But this is based on a misunderstanding of how an investment manager adds value for clients: not by trading stock markets but by seeking companies that can outperform their peers over the long term. Frantic day-to-day activity is distracting and unrewarding.

The earnings-share price link

For equities, over five years and longer, there’s a strong correlation between growth in earnings per share and share price performance. From 1992 to 2022, using rolling five-year periods, there was a 69 per cent chance that a company in the top fifth of earnings growers would outperform the median stock. There was only a 19 per cent chance that a company in the bottom fifth of earnings growth would outperform.

Crucially, this relationship over the longer term is robust, regardless of companies’ starting valuations. In the three-to-five-year timeframe there is less correlation, and for periods of less than three years it’s statistically insignificant. In short: most investors don’t look five years ahead. If we can find more of the rare companies that will thrive over this longer period, we needn’t worry about share prices at all.

Overrated indexes

The other, deeper confusion around the ‘active’ word stems from it being the opposite of ‘passive’. That suggests the primary aim of an active portfolio is to be different from the index. On those terms Baillie Gifford is an ‘active investor’, and proudly so. But we think the definition is limited.

Invented as useful benchmarks and illustrations, stock indexes have proliferated over the decades, their complexity promoting a phoney sophistication. Computing power has accelerated the bewildering variety with which global stocks can be sliced and diced. It may just be a matter of time before it’s proved that companies whose names start with, say, the letter ‘T’ outperform others and the ‘Letter T Index’ is launched. Some smart marketer would find a plausible reason for it, and people would buy it.

In an increasingly short-term world, indexes are often based on investors’ crude extrapolations of present values into the future. They take no account of foreseeable disruption, for example from the impact of declining demand for fossil fuels on big oil companies.

Active investors can decide not to own – or own less of – a company but an index portfolio is not a sensible starting point. It makes even less sense to pay managers a premium just to be different.

Investment choices based on their degree of variation from an index are often more about business risk management than the real task of investment, leading to perverse outcomes. Managers who expect to be rated against an index may cover themselves by, for example, investing in a widely-held bank, even if they disdain the prospects for that sector.

Focusing on what matters

Baillie Gifford doesn’t so much seek to differ from ‘the index’ as to ignore it. As Actual investors, our focus is on deploying capital into the growth companies we think likeliest to generate outsized investment returns. We therefore ask the questions that actually matter: ‘What are the long-term prospects for this company? What do I think it’s worth? How risky is it? How much should I invest?’ Focusing on these absolutes serves clients better than frequent buying and selling of stocks based on news flow.

Tomorrow’s rapid growth opportunities are best understood not through the lens of today’s index incumbents but through the nascent technologies and business models that could answer future needs and wants.

By linking with academics, entrepreneurs, thinkers and authors, by talking to companies about emerging competition, we stay alert to what’s changing to increase our chances of discovering the tiny number of companies that are worth holding for long periods. The academic research we sponsor may or may not lead directly to investments, but it opens us up to new thinking. Even obliquely, this helps us understand the long-term change on which Actual investing is based.

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Important information

The content of this website is intended exclusively for professional investors in accordance with MiFID legislation. ’Professional investors’ are potential investors who are deemed to have the status of “professional clients”, within the meaning of MiFID (2004/39/EC), as transposed in Ireland. It is not intended for retail investors.

Baillie Gifford Investment Management (Europe) Limited is authorised and regulated by the Central Bank of Ireland (Reference number C182354) as an Alternative Investment Fund Manager and UCITS Manager to Baillie Gifford Worldwide Funds plc. Its registered office is 4/5 School House Lane East, Dublin 2, D02 N279, Ireland.

This website is informative only and the information provided should not be considered as investment or other advice or a recommendation to buy, sell or hold a particular investment. Read our Legal and regulatory information for further details.