The CIO View: Conversations with Saftar Sarwar. Episode 3: Tom Slater

Well, thank you for having me. It's great to be here. Yeah, as you said, I joined Baillie Gifford straight out of university. So in 2000, just past the peak of the dot-com bubble. And I've been there, what, 26 years just about ever since. Why did I get into investment? I don't know. I think it's probably a sufficiently obscure career that very few people grew up thinking, I want to become a fund manager. But I think, you know, coming from that computer science and maths background, there was a lot of people going into tech companies at that time. I was more interested in trying to work out why some succeeded and some failed, and that was the sort of analytical aspect of it that interested me. And then a friend of a friend had joined Baillie Gifford the year before. And I think back at that time, you know, there were graduate recruitment programs at a lot of the big investment management firms, but almost the first stage of the Baillie Gifford selection process was that you had to have heard of Baillie Gifford. It was a much, much smaller, much lower profile in that day, and it did not go out of its way to make itself high-profile. So I think you had to sort of have sniffed around the investment management industry and to sort of come across it. And then what attracted me to it was whereas a lot of firms would have these sort of elaborate selection days, you know, you've been dropped in a desert with your team of six and try and put the items in order, it was just much, much more sort of down to earth and personal. You know, CV, covering letter, come and talk about what you're doing, why you're interested, a genuine interest at a personal level that sort of drew me in. And then I started on our Asia-Pacific desk as it was then. As all of our trainees do, I rotated round some different teams into the UK equity desk. And then I joined the Scottish Mortgage team as the deputy manager in 2009 and then sort of been part of the management team for the past 17 years.

I think it's been a few things. When I would go back to maybe sort of 2008, 2009, and I went and did some extended trips to the west coast of the US. We had big investments in Amazon and Google around about that time, and we're trying to both get closer to that technology ecosystem, but also understand what was happening in the private sphere and some of the private companies that were coming through. And so I think those trips were pretty formative for me, just apart from anything else, just a completely different approach and attitude to risk and opportunity that exists on the west coast of America as compared to the UK. You know, met some brilliant business leaders, met some brilliant investors on the private side who had shepherded some of these companies through their formative years, and I think that shaped a lot of my thinking about where growth might come from over the next decade or two. I think then in parallel, I'd say spending time in China. We'd invested in the likes of Baidu, the search engine, the social media company, and I've been lucky enough to work with some great Chinese colleagues who were able to really help me see a side of China that it's often quite hard for a foreigner to do. And I think some of the numbers that, if you go back to that time, some of these numbers that were coming out of these companies just looked ridiculous. And actually understanding that these growth rates, the scale of what was happening was real. And I think was really helpful to me in, you know, evaluating later opportunities that came through. And go into that if you're interested, but so I think spending time in those two areas has been really important for me. You know, as you alluded to, some of the people, the partners at Baillie Gifford that I've worked with, I think, you know, we're one of the very few unlimited liability private partnerships left in the investment world globally. And one consequence of that is that partners tend to stay and work in the firm for long periods of time. You know, I've been there 26 years, but I'm not unusual in that respect. And, you know, obviously James was very influential, and we, you know, we worked together for a long period of time and crafted the investment philosophy of Scottish Mortgage as it exists today. But yeah, there have been others across all parts of the firm, and I think that partnership structure and that collaborating closely with senior investors is a really important part of the integrity of the investment process at the firm. There's a certain sense in which this is the best job in the world because you get to spend time with the people who are building the future of the economy, and because of our investment approach, which is to be very long-term in everything we do, to try and evaluate companies over decades, not quarters, try and get away from that game that most of the market is playing about guessing what the earnings will be in the next 12 weeks, that we've been able to build proper relationships with some of these leaders. And, you know, they're geniuses. I'm certainly not a genius, but, you know, whether it's Bezos or Musk or, you know, some of the private founders like Pony Ma, I think being able to just absorb some of that wisdom, some of that thinking and bring it back into your own investment process has been a really important source of alpha.

One thing I would observe is that if you have the type of time horizon that we have, what you see is a power law distribution of returns in stock markets. And what I mean by that is that a very small number of companies contribute an outsized proportion of returns. And so that frames the job for me as trying to identify companies that have the potential to be one of that small number of companies, you know, that have an opportunity that's big enough that they could be one of those outliers, and then to try and hold them for long enough. Now, for me, the way that that's manifested is being a growth investor. It's trying to identify the companies whose revenues, whose sales could be a lot bigger five or ten years from today, and where that opportunity isn't appreciated. That's of course not the only way to be long-term, but for me, as a way of taking advantage of that structure of stock markets that comes over the long term, it has been about thinking just how big a big company could become, how great a great business could become. You know, the archetypal example for us is Amazon, which we bought in 2004, still a big holding in the Scottish Mortgage portfolio today. At the time, you would have said that was an online bookseller. And obviously the opportunity has continued to expand and expand and expand. And where you can find a company that has that type of profile, I think that's where you can generate supernormal returns.

Well, I think the starting point has to be that you're really clear with people about how you're going about this task. You know, there are plenty of black box approaches to investment out there, but what's really important to us is being as open as we can be about what our process is, you know, how we go about the task and what the trade-offs are from that. So, you know, we're trying to, for our shareholders, we're trying to deliver long-run capital appreciation by investing in high-growth companies. But one of the consequences of that is volatility, you know, and so if seeing volatility in the stock price is something that you find difficult, then Scottish Mortgage isn't for you. And I think just being upfront with people about that and saying, look, these are the type of companies we own. We want to give you as much transparency about the types of things that we own. We want to give you an understanding of why we own them, and then you can decide for yourself. Do you like these type of companies? Do you agree with this approach? And can you cope with the volatility? So you're absolutely right in the observation that we do deliver a volatile ride for our shareholders, and we don't try to manage that volatility. Now, one of the reasons for that is that if you look at the big winners in the portfolio over the past 20 years, and this applies more broadly across the market as well, that all of those big winners, without exception, have had a period where they've been really out of favor, and you've seen big falls in the stock price. And a really important part of delivering the subsequent return has been able to endure those periods. Now, some people might be really smart and able to sell before you have these drawdowns and buy back at the bottom, but that requires you to make two really good decisions. And our approach is slightly different, which is that if we see no change in the reasons that we own a company, we just endure owning through those more difficult periods because, you know, we think that the eventual returns will more than offset those, you know, those more difficult periods. A great example would be Nvidia, you know, by far the world's largest company today. Now, we've owned it since 2016, but in 2022 it fell more than 70%. Now, if you couldn't live with that volatility and you sold the shares, then you would have missed out on making many, many times your money since 2022. That return was only available to the long-term investor who could live through that drawdown.

Well, I think it's being really clear about why you own a stock. And so you're evaluating the news flow and the reasons it's going down in the context, does this change why I own this company? I think there's a helpful point from the process. You know, the reason I go back to being really clear with people is, you know, if you go back to 2022, which was a really difficult period for us, we didn't have a lot of people, you know, shareholders banging down the door saying, "This isn't what I signed up for. You know, what are you doing?" It was, "Well, we understand that growth is out of favor. We understand that you guys are more growthy than most and that, you know, that you've been upfront." So I wasn't coming under pressure from shareholders as we went through that more difficult period. And I think that's really important. And, you know, to be clear, I have a very significant part of my personal wealth tied up in the share. So I'm going through that difficult period too. But I think it's just back to this belief that, you know, it is inevitable that you will go through those periods if you want to make that long-term capital appreciation. It's not an unfortunate incident. It's an intrinsic feature of long-run growth investing. And that's why a lot of people say they're long-term, but when you actually look at the numbers, they're not long-term, because it's a pretty difficult thing to do.

Yeah, well, I think it's been a very, very difficult environment for active managers. Maybe just double check these numbers, but in roughly, if you take the Russell 1000 Growth Index, the biggest index of growth companies in the US, it's done about 18% per annum for a decade. You know, it's delivered a phenomenal return and it's been very difficult for active managers to keep up with that because at the same time as it's done that, it's become more and more concentrated in a small number of companies. You know, it's not a diversified measure of the market anymore. It's a concentrated bet on a small number of companies. And actually to meet the diversification requirements, you can't even own the index. So that's been a very difficult environment. And at the same time, you've seen the market become much, much more volatile. I met the CEO of NASDAQ fairly recently and I asked her about this and she agreed. It's just some combination of the growth of passive investing, the much higher levels of participation from retail in stock markets, highly leveraged hedge funds trading, that you get much sharper stock price reactions and therefore being an active manager can feel more risky. There's a lot more threat to your business if you're delivering an outcome which is very different from the index. So I think it's completely understandable the pressures that come from that. Now I would observe, if you go back to 2003, 2004, you know, we'd gone through the dot-com bust and you had active managers going to their clients and saying, look, I've outperformed the index. I've only lost half of your money. And clients are saying, well, I don't want this. You know, I want my active managers to give me a completely different exposure to the index. And I see this today as the absolute reverse of that. And, you know, I think over time these things change and even themselves out. You know, it is a response to a specific market environment that we're in. So, you know, I don't think it's easy at all. For us, it's about sticking to our guns that we think what we have an edge in is taking a long-term view. You know, there are lots of people trying to predict the short run and we don't have any edge in that. You know, Buffett talks about the idea of a circle of competence. You know, I think it's really important as an investor to think about what it is that you do that's different from others because you're not going to get a different outcome if you don't do something different. And for us, it's being resolutely long-term in the face of all of these pressures.

I think that investing passively is a very reasonable and sensible thing to do, and one of the principal reasons for that is it's such a low-cost way to invest your money. I think if you're going to invest in an active strategy, you want to keep your costs to a minimum as a starting point because that bit is inevitable. You'll pay the costs regardless. And then you want to get a genuinely different exposure to the index for your money. Now for us, and how you come to that genuinely different exposure, you know, there are lots of ways to do that, and it comes back to this, well, what do you think your edge is, and what can you do differently that's hard for other people to do? For us, it's back to time horizon, that we think we can be really patient in an industry which is ever more impatient. And then it's, as you say, if you really believe that stock markets are driven by a small number of big winners, you need a process that's oriented about finding those. It's not about covering every stock and every earnings announcement, but your process has to be oriented about uncovering those companies that have that opportunity to become much, much larger than they are today. That's difficult enough in itself, but the second one is you've got to hold on to them for long enough that that share price return accrues in your portfolio. And that's partly what we talked about before about not getting scared out of these long-run winners, you know, at low points in their share prices. But it's also not thinking that just because a stock has become a larger part of the portfolio, it has in some sense become more risky. So I think about it as scale of the opportunity and likelihood of capitalizing. And so if I own a stock and it's doubled, well, I ask the question, well, has its opportunity doubled or has the likelihood of it capitalizing on that opportunity doubled? And if that's the case, then I can remain a comfortable owner of that business even though it's larger. And a great example of that in the portfolio today that you mentioned earlier is SpaceX. You know, we bought that back in 2018. And, you know, as I looked at that business, it felt like they had a number of opportunities that can make it a lot, lot bigger than it was then. You know, that was partly in launch, but then it's partly, you know, if you can get launch working, you know, what opportunities that create. You know, we've seen that in Starlink, the satellite broadband business, but, you know, there were other opportunities. You know, could you have manufacturing in space? Could you have space tourism? These were questions that were asking back in 2018, but it seemed to us that we could confidently answer the question, could this, are there big enough opportunities for this company to be a real winner? And then we looked at the structure of the market, and, you know, there were relatively few commercial launch companies at that time. So we thought, well, you know, it looks like the market structure could allow them to be a winner. And so how have we managed to hold on to it and to the point where it's become a very big part of the portfolio at the time of the IPO? It's because that opportunity has just kept getting bigger and bigger. And we've seen satellite internet grow and become something really serious. And, you know, we can talk about the future and whether you can have data centers in space and so forth. And at the same time, the likelihood of them capitalizing kept going up and up because they were executing. They were launching the rockets, learning, bringing those rockets back, getting the data, increasing the safety record, and nobody else in the commercial sphere was actually getting their rockets into space. So the opportunity was getting bigger and the likelihood of capitalizing was getting bigger, and that's what allowed us to run that position to the point where it created billions and billions of dollars of value.

Well, I mean, partly the, you know, the issue was it was a private company back then, and private companies, and having a mix of public and private companies is not something that a lot of people have the skill sets to do. You know, the world tends to be divided into investors who are specialists in public companies and investors who are specialists in private companies. And I, you know, what we've done with Scottish Mortgage is try to bring that together and say we just want the best growth companies. Let us worry about whether they're private or public and the technicalities of implementing that, but first and foremost, let's just find the best companies. And then I think the second part of it was, you know, we'd been, we invested in Tesla back in 2013. And so we knew Elon, we knew his approach to managing companies, and more importantly, private companies get to choose their own investors, which is very different from investing in the public markets. And so, you know, I think the way that you invest and your reputation becomes so much more important. And, you know, we were able to go to him and say, we'd like the opportunity to invest in SpaceX at a point where he can say, well, you know, I can see that this investment team have held my shares for five years, you know, they're not speculators, they're serious investors, and they try to engage on the fundamental issues, and therefore, yeah, I'm prepared to give them the opportunity to buy some SpaceX stock. And, you know, for others, that wasn't necessarily an opportunity that was there. So, you know, there were some serious, you know, we had some proper debates internally about, you know, first of all, how big is the opportunity? How capital intensive will it be? You know, how much competition? It wasn't obvious, but the guiding light was back to, well, if we're right, is the opportunity big enough to make a lot of money? And that was the piece that we had.

So we're about 20% in SpaceX, and that is an unusually large position for us. You know, I do...

I think, as somebody evaluating Scottish Mortgage as a prospective investment, they have to be mindful of that at the moment. It, you know, I think it almost requires a view on SpaceX as well as the rest of the portfolio. We have to make the investment decision based on what's in front of us. You know, what is the valuation? What are the other opportunity sets? But the expectation over time is that we wouldn't have this degree of concentration in a single stock. It's arisen because the value of the company has grown so much as a private company, and then it listed on the stock market earlier this year. And if you're an existing investor in the company when it's private, you aren't then typically allowed to go out to sell your shares. You have what you mentioned, you have a lockup. So it determines, you know, the time scale, and basically what it means is that over the six months from the time of listing, we'll have opportunities to sell down our holding, and we'll, you know, we will over time make those decisions based on the opportunity set. But investors should expect over time that that degree of concentration in a single stock will come back down to, you know, within the historic ranges.