James Anderson explains why he’s relaxed about the future – and how he plans to make money from it.
James Anderson is a hero to lots of MoneyWeek readers. That’s because the Scottish Mortgage Investment Trust (LSE: SMT), of which he is the lead manager, is one of the core holdings in our investment trust portfolio – and also one of the best performers. Over the last three years he has almost doubled his investors’ money. Which is nice.
I meet him in our Edinburgh office (you can see what this is like by watching the video of the interview and kick off by asking him (as unsycophantically as possible) what he considers to be the secret of his success.
It comes down to the “pretty distinct approach” used at Baillie Gifford. The managers there “don’t really believe that the progress of share prices has much to do with the generalised economy”.
The “debate about – what’s the influence of monetary easing? What’s going to happen to inflation?” and so on leave them “rather cold”. What doesn’t is thinking about the “process of exponential change” that drives the underlying businesses of genuinely successful companies.
A classic example is Google (Nasdaq: GOOG). When it went public in 2004, its earnings per share (EPS) were 20c. Investing in the company at its initial public offering (IPO) price seemed nuts. But the shares are up tenfold since. The fact is, says Anderson, that it’s really hard for investors in periods of change to see just “how great a company can be”, and how concentrated returns can be in the greatest of them.
As investors, we are all taught endlessly to “go back to the figures”. But the more we do that, the more we fail to grasp “the fabulous process of deep change that is going on”. Everyone talks about investing in growth at a reasonable price (GARP), but the key to success is buying “growth at an unreasonable price”.
Not many people noticed in 2004, but given its potential, Google was “unreasonably cheap”. The same was true of Apple in 2008. Anderson reckons there is too much worry about the downside in investing, when the “great joy of equity is that your downside is only 100%”, whereas your upside is unlimited. That should make the “first task of an investor” to “understand and think creatively about the upside”.
Value isn’t everything
So valuations are irrelevant? Sort of. You don’t necessarily want to ask: “what is the price today?” Instead, you want to ask “what are the chances of success, and what should we pay for that success?” I ask for an example – a stock that a value investor might dismiss out of hand on grounds of price, but that Anderson is embracing wholeheartedly.
It is the trust’s largest holding, gene-sequencing firm Illumina (Nasdaq: ILMN). By the time Scottish Mortgage bought it, a trend had already been established: the price of sequencing a human genome had fallen from $3bn to a $100,000 and it was clear that $100,000 “was merely a stopping point and the process of change was going to be faster than it is in Moore’s Law”.
That has happened – and is still happening. Right now Illumina is “certainly on a very high multiple of earnings”, one that a value investor simply wouldn’t tolerate. But we know that “the price of sequencing will fall below $1,000” and at the same time the chances of Illumina being the main beneficiary of that has gone up.
“Approximately 90% of all the human gene nodes that are being sequenced are to be done on Illumina equipment. That’s a pretty serious competitive advantage… and… probably all the coming generation will be sequenced at birth. And if you have serious illnesses, cancer being a very clear early example of this, you will be sequencing in detail many times.
“This kind of thing is all part of the way in which the process of change is broadening out to areas that are hugely important to humanity.” Apple founder Steve Jobs always used to say that it is “when data hits biological sciences” that things will get really interesting.
He’s right, says Anderson: the opportunities in health care in the next decade are “absolutely enormous… almost incomprehensible”. So the fact that Illumina is on a hugely high multiple of current earnings “is not really the issue”.
The hottest cities in Europe
We move on to geography. Are there particular areas where the innovation Anderson is talking about is taking root faster than in others? There are. But “we don’t really think that countries matter that much. We think that innovation comes from specific cities and regions.”
Some wealthy cities and regions never produce a great company. Take London: “it’s good at circulating wealth, but creation of wealth seems to be a very different issue”. So what are the great areas for innovation?
There’s the west coast of America. Scottish Mortgage has “close to zero investments” on the east coast, but some 30% of the portfolio is on the west coast. There’s China. Despite all the misery talked about the Chinese economy, “one of the most sensational developments of the last three or five years is that China has proved its ability to create really large-scale innovative companies with dominance of areas. I think the fact that Tencent and Alibaba and Baidu can exist at a scale that outside of America is just not being challenged by any non-west-coast companies is truly remarkable.”
I ask – more in hope than expectation – if there are many regions in the UK that fit the bill. There is (hooray!): Cambridge. But even that isn’t perfect. The core technologies behind Illumina were “invented by people talking in a pub in Cambridge”, but they, “of course didn’t really manage to commercialise it”.
But Europe is more “difficult to map than the west coast or China”. Inditex (Spain: ITX), another core holding for the trust and “almost certainly the world’s greatest clothing retailer”, is based off the Galician coast of Spain. That isn’t an innovation hub. So the success there is down to a “selection of individuals”.
Otherwise the most intriguing place in Europe is Berlin, somewhere Anderson recently spent six months. He went out of an interest in politics, but found something else to be the real draw of the city: “an enormous, creative, ideologically quite anti-capitalist” process of innovation, being driven hugely by young people, immigration, and cheap property. This is starting to create firms that are different to traditional German ones.
What has he found to buy there? Online retailer Zalando (Xetra: ZAL) and internet incubator Rocket Internet (Xetra: RKET). The latter is “fascinating” because it is “industrialising the process of innovation” in a very Germanic way. They aren’t looking for geniuses: they are looking for business models they can replicate in different countries.
The chaos of innovation
This is all rather thrilling – but I’m still worried. Does Anderson really have no worries about the macro environment? The potential failure of monetary policy perhaps, or the very high valuations in the US market, or the levels of debt in developed countries? We do, after all, live in rather unusual times.
Anderson says, quite rightly, that this isn’t the kind of portfolio you should put all your wealth into. The key is just to have exposure. But it then turns out that there is something he worries about – he’s worried that the change we are seeing across the world at the moment is “too powerful and too important” and that the “process of change will be so dramatic that we can’t cope with it”.
What on earth does he mean? “We’re going to be facing more change in the next 30 years than in all of accumulated history put together… how long do companies’ real competitive advantage periods last against that?” It may “induce chaos”. Or perhaps “artificial intelligence will take over the world”. Anderson doesn’t bother with “traditional worries”, he says: the real thing to fret about is the results of innovation extended to extremes.
We move to safer ground. The fund-management industry faces a period of huge change as we move towards pensions freedom day (and if it doesn’t, it should do). How does he see it evolving? What the industry needs to focus on, he says, is “ultimate value to savers”. That’s about a variety of things. It is “important for us to focus on how we make companies better at a strategic level”.
One of the most satisfying parts of Anderson’s involvement with Illumina so far has been helping to stop it from being taken over by Roche, for example. Had it happened it would have “done huge damage, not just in shareholder terms, but in terms of human health and the prospects of it”.
I like the idea of good fund managers stepping up their level of engagement. That’s good. But I can’t let him go without asking about cost – which has to be part of value. Can fees in the business fall? They can.
You need to structure this correctly, so that you can get fund managers “who are not concerned about whether they’re going to be sacked at the end of a year, but have the ability to think what’s good for the corporate environment and about what’s good for savers over ten years or 15 years, because they know they’ll still be taking responsibility then”. But that’s possible – “heck, you
can cut our fees quite a lot and still have that security”.
Who is James Anderson?
After graduating from Oxford, and then doing an MA in International Affairs at Johns Hopkins University in Baltimore, James Anderson joined Baillie Gifford in 1983. Two years later he became the manager of Baillie Gifford’s European fund, a position he held for two decades until 2006.
In 2000 he also took over management of the Scottish Mortgage Investment Trust. Barring a six-month sabbatical in 2013 to write a book on investing, he continues to run the trust, which has returned 358% over the past ten years, compared to less than 130% for similar funds.
Sceptical of macroeconomic forecasting, Anderson believes in “identifying transformative companies at a very early stage and owning them all the way through to maturity”. He is also a prominent member of the Institutional Investor Forum, which aims to encourage fund managers to take a longer-term approach to investing.