Welcome to Marin Talks Money, the podcast in which people who know the markets explain the markets. I'm Marina Hyde. This week I'm speaking with Tom Slater, manager at the UK's largest investment company, Scottish Mortgage Investment Trust, something that I suspect an awful lot of you hold. If you do, you'll know that its long-term performance has been spectacular. If you invested in 2000, your money is up 10 times since then. The last five years have not been so great. 2022 and 2023 were not great years for the trust, but things are now picking up nicely again. Over the last year, you are up 17% and year to date 10%.
Tom's been involved with the trust for a decade now. He first joined Baillie Gifford in 2000 and he became a partner in 2012. So a little more insight in this conversation to how Tom is looking at investing at the moment and how the trust is faring. Tom, welcome to Marin Talks Money.
Thank you very much for having me.
Now listen, in the introduction, I've said a little bit about Scottish Mortgage, but I think it would be super handy, given it's such a well-known trust in the UK, but maybe not so much outside. Just give us a little rundown of how the trust works, what it's invested in, and what you do.
Sure. The trust is a portfolio of what we consider to be the most exciting growth companies in the world. And we spend our time looking for these opportunities. And where we find them, we try to be really patient long-term owners. We're not restricted by geography. We're not restricted by whether a company is public or private. Currently, we're about three-quarters public companies, a quarter private companies. But the defining characteristic is having a really long time horizon over which to assess these opportunities. And I guess the final point is, if you look at the portfolio, it has nothing really to do with Scotland or to do with mortgages. That is simply the inheritance of the name.
Yeah. And it's a name you're going to have long term, right? A lot of trusts with what you might consider to be old-fashioned names have begun to change them and shift around the place. But Scottish Mortgage is so well known as a brand that you can probably hang on to this name that doesn't in any way refer to the content of the portfolio. It's fine.
Well, I think the heritage is really, really important and the history. I do think it's sad when these trusts get incorporated into sort of bland corporate nomenclature.
Now, listen, one of the things I said in the introduction is that this trust has phenomenal long-term performance, but shorter term things have been a little ropey. So, if we go back to 2021, that was a phenomenal year. The trust was up, the share price was up nearly 100% or so. And then we went into 22 and 23, and 22 in particular was an all right year. 2023 was a horrible year, and since then things have improved, but not anywhere near back to the highs of those heady days of 2021. Just explain quickly for people who haven't been engaged with the trust what it is that happened during that period.
What happened, I think, as we went into the COVID period is that the world came to a lot of the companies that we owned. We owned Amazon, for example, and we all moved to starting shopping online. We owned many of the enterprise software companies that facilitated working from home. So we went through this period where the companies that we owned had this real boost to their businesses, and then as we exited the COVID period, I think habits reverted to normal a lot faster than we had anticipated, and so the tide went out for a lot of our companies, and that made things pretty difficult in the period you're describing.
I think if you wind the clock forward to today, what we've seen is these companies dealt with very rapidly rising interest rates and changing demand patterns, and the best among them really took those signals seriously and they thought pretty carefully about what they were going to do with their costs, with their headcount, and prioritized within their business the projects. You know, in an environment where capital had no cost, you do everything and you pursue growth. But as soon as the interest rates rose rapidly, they started to think much more carefully about prioritizing what they were doing. And so you've seen this recovery in profitability across the portfolio, companies moving from sort of break-even by choice to earning really pretty good margins today. And I think that's a real source of optimism as you look forward, that you have that degree of robustness and adaptability that's come from that challenging period in the aftermath of COVID.
And would you say that as a result of that challenging period that you've been through and your companies have been through, you have shifted anything in your investment process? I mean, looking back, for example, the investment process is very influenced by a piece of research that suggested that nearly all the returns in the stock market come from 4% of companies, right? I remember this fascinating bit of research that came out and Baillie Gifford really looked at very carefully and reacted to. But one of the things possibly about looking at the market like that and thinking, well, we must have those 4% of companies, was thinking we must have those 4% of companies at any price.
And so possibly going into 2020 and 2021, there was less of a focus on valuation inside your portfolio than there might have been. So I suppose the question is, since then, is there a different approach to the valuation of companies regardless of their amazingness?
I think the philosophy that you've mentioned is core to what we do. It is just a fact of life that if you extend the time frame through which you look at stock markets, you get a skewed distribution of returns. It's not the normal distribution that we're taught in our financial analyst training. It's that a small number of companies drive the returns. And so for us, it's how do you identify companies with that opportunity and how do you hold on to them for long enough that the return accrues for our shareholders. And in a way, it's that simple. But it also is really important that when you go through a period of tough performance, that it triggers some introspection, that you look at process and think about, well, what could I have done differently.
One of those process outcomes for me is thinking about resilience and robustness. So it's all very well to imagine where a company will be five or 10 years from today, but the conditions that it encounters along the way will be faced with today's business. So do you have the resilience and robustness to get through that in order to achieve that bigger picture? And that's why I started with this point that actually you've seen significant improvement in profitability in the companies we own. You know, that for me is really encouraging because it says you have the resilience and robustness to go after that bigger picture dream.
And then on the point about valuation, valuation has always been a part of our process and a really important part of our process. But what we don't do is look at short-term price-earnings ratios and say, well, this stock is valued at 20 times its earnings, therefore it's cheap or it's expensive. We think there's very little information in that. So the time frame that we think about valuation is how do we make our required level of return over the next five years, and at any given point there's a high degree of uncertainty in that. So if you take that back to what was happening in 21 and 22, with the benefit of hindsight, yes, a number of companies had got ahead of themselves.
But you also have to remember that valuation is always a relative game. And so with interest rates at zero, with growth rates that were being delivered by some of these companies, revenue growing 50 or 60%, then actually the relative valuation didn't look particularly challenging. And with the benefit of hindsight, the sensible thing to do would have been to have gone into a lot more boring types of stocks, which themselves look pretty expensive relative to their history. But that for us doesn't fit the philosophy of what we're trying to do. It would not have been consistent with the very clear objectives that we set out for shareholders. So, you know, yes, it was a mistake, but I think staying true to the philosophy is really important, and deviating from that would have been a bigger mistake.
Yeah. Well, you could also say that it's a little early to say whether it was a mistake or not.
The benefits have been long-term. Exactly. And I suppose the other question to ask really is that we know your answer to this, but a lot of people would say that if it is true that 4% of the companies drive the majority of returns, which of course it is because you've done very long-term research into this, then the answer is not necessarily to hold a trust or put your faith in a manager who believes they can find that 4%, but simply to hold an ETF that covers the whole market. So you definitely get them. So you have to have a lot of faith in a manager to believe that they're the ones who can find the 4%. So I think what we should do now is move on to talking about how you find those companies. How do you look at the market and say this is the one that will survive? I mean, even in something like AI, which is obviously going to be a phenomenally transformative thing, already is transformative for the economy and for everyone's lives, there are a lot of companies doing this. How do you look at a company and say this is the one that will be in that 4% that will almost definitely drive the returns that we've promised our investors?
I suppose the first thing is that I agree with your premise there. I think either you just own the whole market, and that's a pretty sensible thing for people to do, especially if you can do it at a very low cost, you will capture those companies. But you do have to accept the price of doing that is that you will be diluted by the other 96% of companies that don't matter.
So, in a way, you should do one or the other. You shouldn't mess around in the middle. You should either have someone who has the whole market or have someone who's making a genuine effort to have that 4%.
In my view, you should do both. I think it's a perfectly sensible thing to have that broad exposure at very low cost, and then I think depending on your risk appetite, we are a volatile portfolio. We embrace that volatility in the pursuit of long-term growth, but that's not for everybody. But we do think for those that want to go after that higher level of capital appreciation, that there's a role for both concentrated active management and index exposure. But key in this is keeping costs to a minimum. You know, if you're going to pay for active management, then pay as little as you can and get a genuinely active portfolio for your money.
Yeah. Okay. So, how... how... first of all, it's go back to what is the scale of the opportunity and is it growing or shrinking, and what is the likelihood of capitalizing on that opportunity and is that increasing or falling?
I think those are the two starting points for process. There are lots of great businesses out there, strong franchises, great competitive positions, but can you really say there is the opportunity for this business to be many times its size in the future? And so for us, that's a question that narrows down the universe pretty quickly. And then, is that opportunity growing or shrinking? So if you take Amazon, which is one of our most successful investments of the past 25 years, I think we bought it in 2004, 2005, so that's 20 years, not 25. But if you look at that business and through our ownership, what we were continually able to say is that the opportunity was increasing in size. It started as a bookseller. It went into e-books. It went into media more broadly. It went into general merchandise. It went into selling computing infrastructure. Every time we revisited the case, you could say, I think this opportunity is big and it's getting larger.
And then as you went through time, you could also see that its competitive position was getting stronger. We talked about its competition relative to Barnes & Noble and other physical book retailers. We talked about its competitive position relative to eBay in online commerce. But over the years, it just became clearer and clearer that this was a business which had a higher and higher likelihood of capitalizing on an opportunity that was growing. And so when you're looking at opportunities today, some of the companies we've bought in the past year would be Nubank and Revolute, two digital online banking businesses. Nubank focused on Latin America, Revolut more focused on Europe. And it seems to us that for the next billion consumers who are going to have a bank account, they're going to come through one of these digital platforms, not one of the traditional banks.
They have a huge advantage over traditional banks in terms of their cost structure, not having branches and all that goes with that, and their digital tools have huge reach. So they can get better faster than those that are limited to a single market and a smaller number of customers. So that's an opportunity that's big. It's an opportunity that's growing, and the longer time goes on and you don't see any competitive response from those traditional regional branch-based banks, the more likely it is we think those companies will capitalize on that opportunity.
Okay. So when we look at themes, a lot of what you invest in is obviously tech. So it's around the AI revolution, it's around digitalization. Where are the most interesting parts inside the tech revolution, which seems to be moving faster, I think, than even you might have thought a few years ago?
The way that I look at this is that tech is not really a very helpful label. You know, we could talk about the companies that are using electricity or the companies that use telecoms. The fact that they are using technology is neither a helpful way of categorizing them or really understanding their advantages. The way we prefer to think about it is, you know, if you stick with the example of Amazon, it's part analyzing the retail business and it's part analyzing the infrastructure business. If you look at Meta, the owners of Facebook and Instagram, it's more about media and share of attention than anything else. It's about selling advertisements.
But I think, you know, where tech becomes really relevant is in the leadership of these businesses and the understanding of how technology is driving change in their industries. Take your example of AI. If you think about how a typical enterprise encounters AI and thinks about deploying it, senior management will say, right, there's something to this whole AI thing. Let's find somebody from the IT department who knows about it. And then, you know, if they get increasing conviction, they maybe bring in a consultant to tell them about AI. Then perhaps you do an experiment. Let's find some little bit of our business where we can develop some of these tools and let's see what happens. And, you know, maybe we can take some people out of the customer service department because we can use some of these tools to deploy AI. And that whole process, that feedback loop, just takes a long time.
Now you compare that to, let's stick with Meta and Mark Zuckerberg, somebody who has a real deep understanding of this technology. You can see immediately where it has application in the business. You know, how do we gain competitive advantage from deploying these tools? How do we drive revenue in the business from deploying these tools? And then you can see all these projects that are springing up, the way that they're transforming what they're doing. So if you look at time spent on Facebook, for example, which is a pretty mature platform at this point, it was up about 8% last year, and that's because they were using AI tools to surface content that their users loved and were engaged with. And so you can see the immediate impact in the business.
Shopify would be another great example. That's a business that creates tools for retailers to operate their business. So whether that's having their own website, you know, selling through platforms like Meta's platforms, Instagram, etc., helping their physical stores, doing point of sale. But what you have is a technical leader who immediately understands how AI can make the business better and deploys the technology to increase the relative advantage that they have to other players in that industry. So go back to the philosophy, it increases the size of the opportunity because you can do more with this technology, and it increases the likelihood of success because you deploy it faster than your competitors. And so when we're looking at technology, we don't get excited about, you know, this is a great widget or this is a great tech. It's more these are great businesses and they can deploy this to improve their relative position. That's what gets us really excited.
Okay. Interesting. And one of the things that you've written about and talked about before is how if we want this generative AI to be truly transformational, which we do, we want it to drive or expecting it to drive a productivity revolution across the world finally. Thank goodness we've been waiting a long time for that productivity revolution, haven't we? If that's to happen, it's got to be ubiquitous. So everyone has to have chips. So you can't have these very expensive chips. It's not going to continue that the producers have these very, very high margins. And one of your most successful positions over recent years has been Nvidia, of course, but that's going to suffer as a consequence of the commoditization of the products, right?
Well, Nvidia is absolutely at the heart of this AI revolution that we are seeing and we're going to see. But I do think that we have to bring down the cost of these systems massively. If you look at the deployment of technology in previous waves, whether that was the mainframe computer, the personal computer, mobile devices, online, the cloud, all of them brought prices down, and that was a really important component of the spread of the technology. Now that has been happening in AI. If you look at the cost of processing tokens in these models, it's coming down very rapidly. But there is this real constraint, this bottleneck, in that we just don't have enough compute, and that's led to very high chip prices. You can see it in Nvidia's margins because they have been almost a monopoly provider of the silicon that's needed for this.
And for me, I think if we're really going to see this technology reach its true potential, you are going to see more than one provider of the silicon to do it. As you move from the training phase for these systems to the deployment phase, so you're running inference, you're actually using the technology, it's not clear that Nvidia's edge is as strong in that inference market as it has been in the training market. So it's back to how much exposure do you want to have? And the decision we took last year is that we would reduce our direct exposure to Nvidia. We bought and then grew a new holding in TSMC, which is the biggest manufacturer of these chips and is a bit more agnostic to who has designed them. But we're also putting money into companies like Meta. So we don't want to reduce our overall exposure to this area, which is, you know, it's going to define the next 20 years of investing. But it's, you know, we don't think it's going to be as concentrated in Nvidia as it has been over the past two or three years.
Yeah, I mean, the other big bottleneck in the AI story is the energy part of it, right? So we're going to have all these huge data centers, and this is incredibly energy hungry. I'm sure it'll become less energy hungry over the years, but nonetheless, we do have this constraint on it at the moment. Do you have a look at investing in the energy sector? And we talked on a podcast a few weeks ago about how extraordinary it is that people will pay to the moon and back for a company that is connected to AI, but absolutely nothing for the mining companies that produce the materials without which none of these things can exist.
