Actual investors are focused. Not frantic.
‘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.
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 2018, using rolling five-year periods, there was a 75 per cent chance that a company in the top fifth of earnings growers would outperform the market. There was only a 20 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.
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 frame of reference. 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 will cover themselves by, for example, investing in a widely-held bank, even if they disdain the prospects for that sector.
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 frantic buying and selling of a large number of index stocks, trying to be slightly different to the next manager while remaining safely within the herd.
That approach increases our chances of discovering the tiny number of very successful companies worth holding for long periods. These are hard to find, hence Baillie Gifford’s focus on researching and understanding emerging technologies and the nature of disruption.
Tomorrow’s rapid growth opportunities are best understood not through the lens of today’s index successes 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. 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.
Below is some of our most recent in-depth writing, which will provide some insight into how Actual Investors see the world.The Rise of ESG.
The logic of long-term investing means that companies harming the planet and its people will ultimately be losers.A View from the Midst of the Pandemic.
Mark Urquhart reflects on 2020, the pandemic’s global impact, and the ways in which it will shape the next decade.Some Suspicions About the Coming Years.
Actions taken in times of crisis will impact society for decades. James Anderson seeks out the great minds who might guide us.