One of the most underrated traits of successful fund managers is being able to accept when they have got an investment wrong. Selling out of a perennial underperformer crystallises any losses and shines the spotlight on a poor decision by someone who is paid to know better – but it often saves them from heavier losses and additional embarrassment further down the line.
To help them override any emotional attachment that may prevent them from pulling the plug at a later date, many managers have a rigid sell discipline in place that will see them dump a stock as soon as it disappoints in some way – such as issuing a profit warning or cutting its dividend.
Yet Tom Slater (pictured), deputy manager of the Scottish Mortgage Investment Trust, believes it is just as important to prepare yourself for the consequences of making a successful investment, as a failure to do so can be even more detrimental over the long term.
“If you invest in a company and it does well,” he said, “what are the challenges that that presents? At the time the stock price has gone up and the news flow is positive, you potentially encounter other behavioural challenges around being complacent about that success.
“So at the start, why not write down what you think your challenges will be that will come with success? Then you can be a bit more dispassionate when you reach that point about saying, ‘what will this company have to do to generate returns from here?’
“Then you can evaluate that in a colder way.”
Slater and lead manager James Anderson have spoken numerous times in the past about their investment process, which revolves around trying to unearth the small handful of companies that are responsible for the majority of stock market gains over the long term.
Yet while this has been an incredibly lucrative strategy – the trust has made more than three times the gains of its FTSE All World benchmark and IT Global sector over the past 10 years – its success has brought its own set of problems. When companies grow to a size large enough to be included in this small group, they not only profit from societal shifts, but begin to shape them. Slater said he and Anderson have had to adapt their process to reflect this.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
“Businesses like Facebook, like Google, like Amazon, as the western examples, but also Alibaba, Tencent and Baidu in China and Asia have been able to grow and become extremely dominant actors in their respective industries.
“They’ve got really quite remarkable characteristics: they’ve been able to grow faster as they’ve got larger, they’ve required very little capital to support that growth and they’ve sucked in economic activity, not just from across the internet, but from across the real economy. And it has been very hard for other companies to compete with them.
“I think today we’re in an interesting phase where these companies are now dealing with the consequences of that success. They have become major, major actors in society, major actors in our economy, and that attracts a far greater degree of scrutiny from all kinds of sources. And it’s only right that that is the case.
“As we look forward, we have to be more selective in the way we think about these companies.”
The main way this enhanced scrutiny manifests itself as a threat to these companies is in governmental interference, whether that is through higher taxes or more stringent controls on their business practices. However, Slater said it is pointless trying to second-guess the actions of the government – instead, it is more useful to analyse the view in society or any issues that regulators or politicians are likely to respond to. The best example of this is Facebook, which was previously one of the trust’s largest holdings.
“Facebook has become an extremely dominant social platform,” said Slater. “But the way that platform is used at such scale is now causing pause and challenge as we as a society think about the impact of its tools.
“For example, Facebook was being used as a platform to influence the electoral process. As soon as you get into that type of territory, it becomes almost guaranteed that there is going to be regulatory scrutiny and there are going to be restrictions on what you do.
“From an antitrust perspective, it’s a big media platform, but it is also providing the infrastructure and tools that companies need to advertise and that brings conflict.
“As a result, from a product development standpoint, it has largely been firefighting for the past two years. We have a small residual holding in Facebook today, but it is no longer an important part of the trust’s asset base.”
This would all seem to tie in with a focus on ESG (environmental, social and governance), the latest buzzword to which every fund manager seems desperate to attach themselves. However, Slater has some scepticism towards this trend, pointing out it often leads to a one-size-fits-all set of standards and a tick-box approach to governance, which the “exceptional” companies he aims to invest in often fail to meet.
Instead, he said that if you want to weigh up the importance of ESG issues to a fund manager, you should look at the length of time they are willing to hold on to a stock.
“If you’re going to own a share for a day, a week, a month or a year, you’re not really that interested in governance and sustainability because those types of factors don’t have an impact over that type of time horizon,” he explained.
“The reason these factors are important to us is because we aim to own stocks for five or 10 years and our longest-standing holding at this point is over 20 years. Over those types of time horizons, we think sustainability and governance are crucial.”
Slater said another consequence of being a long-term investor is it allows him to have “grown up dialogue” with companies.
“If you are seen as a long-term, constructive and supportive investor, then if you want to raise questions, those concerns are taken seriously.
“Take something like Amazon, where we have had concerns about whether the company was paying appropriate rates of tax, or concerns about conditions in its warehouses.
“Because we’re looking at long-term investment outcomes, we believe it is crucial to Amazon’s appeal to consumers that it is seen as a good corporate citizen, both in its employment practices and in its approach to taxation. And we can have those conversations.”
Scottish Mortgage is up 26.57 per cent this year, compared with losses of 2.88 per cent from its benchmark and 6.32 per cent from the sector.
Performance of trust vs sector and index in 2020
Source: FE Analytics
It is trading at a discount of 0.59 per cent to net asset value (NAV) compared with 0.43 per cent from its one-year average and a premium of 1.36 per cent from its three-year average. It is 8 per cent geared and has ongoing charges of 0.36 per cent.