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We Are Resolute

James Anderson - September 2017

We’re optimistic. We’ll return to this soon. But we’re also resolute. This may be even more important. That’s because it may be even more unusual. If fund managers find it professionally hard to be optimists, they find it harder still to show resolve. It’s not the way the financial services industry works. Instead it encourages participants to be endlessly restive. 

This is not unnatural. Activity pays. It pays for brokers, it pays for investment banks, and it pays for consultants. Fund management is the modern equivalent of an isolated citadel being attacked by a furious fusillade of weapons. Instead of canon and burning oil we have corporate earnings canisters fired at us, macroeconomic data lobbed over our defences, politics used to terrify us (if central banks have not already made us cower). If the scary news-flow shows dangerous indications of flagging, brokers are always there generously to provide recommendations for changes. By far the easiest response is to surrender. Brokers will then be very nice to you and the media will be delighted to convey your hasty outbursts of activity to an admiring readership. You will join the club of never being wrong for long. You may even be right for long enough to be rewarded with a large bonus for your performance over the last 52 weeks because that surely couldn’t be random chance could it?

Fund management is the modern equivalent of an isolated citadel being attacked by a furious fusillade of weapons. Instead of canon and burning oil we have corporate earnings canisters fired at us, macroeconomic data lobbed over our defences, politics used to terrify us (if central banks have not already made us cower).

But this isn’t at all helpful for clients. It isn’t at all helpful for fund managers trying to invest well. But then even the term ‘investor’ has been terribly debased. It should usually and usefully be replaced by ‘traders and speculators.’ Investors are interested in the ultimate value of an asset as eventually revealed by its free cash-flow. Traders and speculators are concerned by whether its price is going up or down in the next few hours. That’s very different. Sadly our media cannot be bothered with the distinction. Even more sadly the supposedly authoritative ‘Financial Times’ is bottom quartile in this regard. Pick up any edition at random and take a look at the confusion. I picked up today’s. On the page entitled ‘Markets and Investing’ it assures me that the dollar was bouncing back ‘as investors shrug off geopolitical tensions’, that ‘investors anticipated that tropical storm Harvey would generate demand’ for equipment rentals and - confusingly - ‘that investors have speculated’ that Kraft Heinz would buy Mondelez. Meanwhile Jameel Ahmad of FXTM told the FT that "‘Sell volatility, buy the dip’ has been the investor mindset." I could go on but this is exhausting and I apparently need to hurry off to take a position on each of these issues and then trade on them all to be a real investor. No wonder investing is so hard and we’re so well-paid.

The reality of stock market investing is that outstanding returns are reliant on the ownership of a remarkably small number of stocks over very long periods. We’ll frequently return to this theme.

But that’s what is so perturbing about finance. There’s no evidence that acting in this frenetic manner has any social utility. There’s no evidence that it is productive of impressive returns to clients. Instead all the evidence suggests that the great investors are dull, patient and resolute. They accept that it’s just not possible to predict all those events and moods that the Financial Times sees as essential to investing. Resolve isn’t just needed to block out noise it’s that even in the greatest of investments and companies there will be repeated and tiring periods of stress, difficulty, disappointment and deferred profits. Jeff Bezos was once said to be close to stepping down at Amazon. Wall St and the Square Mile will do their considerable best to convince you that these inevitable ascents of modest hills present Himalayan challenges and that you would be far better selling now because quarterly earnings have ‘missed’ by a cent or a penny ( it never seems even to occur to them that it could be their estimates that have missed earnings). But even this doesn’t do full justice to the need for resolve. The reality of stock market investing is that outstanding returns are reliant on the ownership of a remarkably small number of stocks over very long periods. We’ll frequently return to this theme. For now I’ll simply repeat the ever wonderful 93 year old Charlie Munger ‘The first rule of compounding: Never interrupt it unnecessarily’. That takes resolve.

The temptation to give into sentiment is even stronger at moments of market panic than it is in owning individual stocks. Scottish Mortgage suffered heavy falls in 2008. One broker still regards it as essential to warn all and sundry of this sinful period in all his reports. Yet there’s nothing that I’m prouder of in my career. Enduring those months was absolutely central to our subsequent performance. As Seth Klarman says the first question he’d ask any fund manager on a selection panel would be: did you hold your course in 2008-9? I’m proud that we did, that we bought Apple on what turned out to be 3x prospective earnings, that we didn’t sell Amazon at $40 back in that dark autumn. That took resolve.

The views expressed in this article are those of the author. Its express purpose is to highlight areas of intellectual thought and debate which inform the investment philosophy that underpins Scottish Mortgage, in the hope that they may be of wider interest. The author(s) therefore make(s) no suggestion that this article constitutes independent investment research and it is not subject to the protections afforded to such.

Further, it is not intended to be considered as advice or a recommendation to buy, sell or hold any particular investment. Those considering investing in any of the areas highlighted in the article should undertake their own research, seek advice if unsure, and be aware that the value of any investment and any related income, can fall as well as rise, meaning that investors may not get back the amount invested. For those looking for information on Scottish Mortgage specifically, please visit www.scottishmortgageit.com