Buy-and-hold investing is effective but fund managers need to beware of becoming too complacent with their stock picks, according to Moritz Sitte, co-manager of the Baillie Gifford European fund. 
The five crown-rated, £217m fund takes a long-term approach to investing having held nine of its 51 holdings for more than a decade and 52 per cent of its portfolio for more than five years.
“We see it as exploiting market inefficiencies,” the fund manager said, adding that they are “durable” and have been around for a number of years.
“I believe that the market is incredibly short-term. I think it’s very much driven by macroeconomic aspects and by having a top-down approach, especially in continental Europe,” he said.
As such, Sitte says the European equity team tries to think like an owner when looking at businesses.
“We don’t see shares as pieces of paper that you trade in and out of at the click of a button, we really regard shares as representing a fractional ownership in a business and that’s how we approach business analysis and investing,” Sitte said.
“What we’re trying to do is find these great businesses that have attractive growth opportunities and that are run by what we think are outstanding people and then we just try to hold them for the long run rather than trying to be too cute.”
Indeed, a bottom-up approach allows the team to cut through some of the macroeconomic, short-term noise surrounding European stocks.
“This inefficiency about being top-down we are addressing by being purely bottom-up and again that comes back to this idea of thinking like an owner,” he said.
“As a result for us the index is not a good starting point it’s just a collection of big businesses that are not necessarily great businesses.”
As the below graph shows, while short term blips of the financial crisis in 2008 and the eurozone crisis in 2011 have done little to slow the long-term growth of the MSCI Europe ex UK, which is up 64.14 per cent over the last decade.
Performance of index over 10yrs
Source: FE Analytics
The third inefficiency, following on from short-termism and using a bottom-up approach is compounding – famously described by Albert Einstein as the ‘eighth wonder of the world’.
Sitte explained: “I think the market can underestimate the power of compounding within a business and we are trying to exploit these inefficiencies by being long-term. We are placing a lot of emphasis on growth, on businesses that can compound their intrinsic value.
“So the idea is not for us to make money by exploiting the mood swings of the market – it is a perfectly viable strategy but is not what we are trying to do. We are trying to make money from the progress of the business in the long run.”
As such the fund looks to buy-and-hold positions for the long-term, focusing on management, growth prospects and company edge when analysing businesses.
“We focus on alignment which is the focus of management: are they trustworthy and are their interests aligned with ours? Then we have the question of growth: can this company be larger in 10 years’ time? Which then leads to the third question on edge – does it have a sustainable advantage which means it can provide attractive returns on capital in the long run?” Sitte said.
A recent addition that outlines this strategy is Zalando, a leading European online fashion retailer founded and based in Berlin.
“The company is being run and controlled by its founders and by a Swedish holding company and we think they have done a tremendous job scaling this business,” the manager said.
“We think they are very much focused on growing this and making it a much more valuable company over the next 10-20 years.
“The growth question with a business like this is relatively straightforward. You have a big market that is still predominantly offline and online penetration rates in continental Europe are relatively small compared to Britain.
“The much more difficult question is: what is their edge? My take is that they are agnostic about fashion trends, they see their core expertise as a technology company and I think that investment in building the right systems depresses earnings in the short term but in the long run could be quite valuable.”
This analysis model has worked for the team over the longer term, with the fund in the top quartile of the IA Europe ex UK sector over one, three, five and 10 years.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
However, despite nine companies lasting more than a decade in the portfolio, Sitte says there are no “holy cows”, meaning all companies come under constant scrutiny.
But this he says is the biggest challenge for long-term investors – not performing backward-looking analysis or holding biases for companies that have been proven winners.
“The risk with these names is you become complacent and you perform rear view mirror research,” the manager said.
“You can say ‘this has been doing great in the past so let’s just extrapolate it and say it will continue to be great in the future’ and that’s a risk.
“We do ask ourselves about the future because that’s the only thing that matters whether you’ve held a stock for 10 years or three months.”
An example of this is Colruyt a Belgian grocery retailer and that was one of the fund’s 10-year holdings until last year when it was sold.
“Last year I took a look at this because we said we would revisit the case. That doesn’t mean that we completely forget about these businesses but we said that we thought it was due a proper research project not just keeping on top of quarterly news flow and seeing management every few months,” he said.
“My outcome from that was I think it remains a good business but what I came away with was that the growth opportunity really wasn’t that exciting anymore.
“This was a case where the business had grown within its market very successfully for a long time but it was a big fish in a small pond and it’s hard to still grow meaningfully over the next 5-10 years.”