An increase in large tech names and the rise of Chinese A Shares will likely dominate the Scottish American Investment Company’s portfolio in 20 years’ time, according to manager Toby Ross.
However, many of the stocks that are currently held by the trust should still be there – if the managers have chosen correctly.
“I would hope and expect the stocks that we own to be the same or very similar,” he explained. “We are looking for sustainable business models, businesses that we think can sustain their growth for many years that will continue to generate new growth opportunities in the years to come.”
However, for every stock in the portfolio there are 10 listed and another 10 unlisted companies that are “trying to eat their lunch”.
As such, the Baillie Gifford manager said he is constantly testing business models for signs of disruption and to see how they might react to new entrants coming into their markets.
“How businesses think about growth and respond to that risk of disruption is going to be increasingly important over the next 10 or 20 years,” he said.
One example of a stock that is already considering issues further down the road is insurer Admiral, whose chief executive has started discussing the potential disruption from autonomous vehicles and what that might mean for its car insurance business.
Performance of stock vs index over 10yrs
Source: FE Analytics
“That is the kind of slightly paranoid attitude that we want to see from the management teams of our companies we invest in,” said Ross.
Another good example is American truck broking business CH Robinson, which is dealing with a new market entrant – Convoy – and are concerned about the potential for a company like Uber to enter the space.
Ross said: “We are hopeful that the management teams we are backing will get these calls right and therefore we will still be able to own these great, growing businesses in 10, 15 or even 20 years’ time.”
So, what will be different in 20 years? Firstly, there will likely be more opportunities for income-focused trusts such as Scottish American – also known as SAINTS – to invest in the large-cap technology names.
Todays’ technology giants such as Facebook, Amazon.com, Apple, Netflix and Google (FAANGs) currently distribute very little of their earnings as dividends.
However, over time they will start to wrestle with the question of capital deployment which become increasingly difficult to spend on research & development due to the sheer sizes of the cash pools.
“Today Google (or Alphabet as it now is) sits on something north of $100bn in net cash on its balance sheet and that is not for want of investment,” said Ross.
“They are investing as hard as they can but they have established a position of dominance that is incredibly cash-generative and the cash continues to mount up.”
At some stage businesses such as US giants Google and Netflix or even Asian powerhouses Alibaba and Tencent are going to be thinking what the natural thing to do with the proceeds of this position of dominance is.
“We will be interested to see whether dividends make up part of the answer for some of these businesses and we will want to be ahead of the curve if we see some of the signals that they are,” the manager said.
One example where this has already taken place is Apple, which was brought into the portfolio five years ago, before it started paying out dividends.
“We could see exactly this problem of cash building up more than the company knew what to do with and we though the company was likely to be part of the answer. That has been a terrific investment for the company,” he noted.
Alphabet could be the next one to follow suit and is already in the Scottish American portfolio as the problem of increasing cash is becoming increasingly pressing and dividends are likely to come soon.
Ross said: “We are seeking to be ahead of the game in identifying the next generation of big dividend-payers that will be coming through the tracks over the years to come.”
The second opportunity surrounds China, with the inclusion of A-Shares into the MSCI Emerging Markets index the first step to the market really opening to foreign investors.
“Today we think we have got an investible universe of around 2,500 dividend-paying companies if you apply around a £1bn market cap cut-off,” Ross said.
“Over time the Chinese domestic stock market is increasingly opening to Western investors such as SAINTS and our rough estimate is that including that Shanghai/Shenzhen stock exchanges within our opportunity-set would add something like 20 per cent to our investible universe overnight.”
Many of these companies are poorly-researched and are younger that their Western counterparts but have also shown a willingness to return cash through dividends.
This is because many are still founder-managed businesses, who typically like to both invest for growth and have cash coming out of the business.
The manager said: “We think it is quite possible that in years to come this will be a major source of new ideas for SAINTS and for Baillie Gifford more broadly and we are now trying to explore ways to tap into new ideas from the Chinese market.
“I don’t expect those to feature imminently but in 10 years’ time I would be staggered if we didn’t have a number of A-Share names within the portfolio.”
One other area of difference may occur in the trust’s non-equity portfolio. Like many investment trusts, SAINTS has structural gearing which it uses to boost the overall income offering.
“We have the ability to borrow long-term and we invest that in some income enhancing assets. Today those are a direct commercial property in the UK and a small bond portfolio,” Ross said.
This debt, taken out when interest rates were significantly higher, is coming to an end and will therefore need refinancing over the next five years.
“So, our costs of borrowing are going to drop a lot and the question is what else might we invest in in this income enhancing portfolio that we have on the side,” he said.
“There is no reason why it couldn’t be infrastructure [projects], logistics businesses, data centres or healthcare assets. We think there are many different types of income enhancing opportunity around the side that SAINTS should be able to find and invest in.”
Ross has co-managed the £594m Scottish American Investment Company alongside James Dow since July 2016. The pair had been deputy managers alongside lead manager Dominic Neary but took full charge when he left in August 2017.
Since taking over the portfolio, the investment trust, which has been the second-best performer in the seven-strong IT Global Equity Income sector over one, three, five and 10 years, has returned 8.7 per cent, as the below chart shows.
Performance of fund vs sector and benchmark under managers
Source: FE Analytics
This is more than double its sector peer’s 3.82 per cent but slightly behind the FTSE All World benchmark’s 10.75 per cent.
SAINTS’ shares are trading at a premium of 5 per cent to its net asset value (NAV). It is 15 per cent geared, has a yield of 3 per cent and ongoing charges of 0.8 per cent, according to data from the Association of Investment Companies (AIC).