Baillie Gifford: Disruption does not happen in a straight line

A quote from the world's greatest value manager may also hold some important truths for a growth manager, says Claire Shaw, an investment specialist on Scottish Mortgage. In a difficult year for Scottish Mortgage shareholders, where the market noise has been deafening and the short-term outlook remains unclear, the managers recognise it is vital to focus on their circle of competence.

The Scottish Mortgage team recognise that only a small number of companies matter. Over the last 20 years, the trust has owned 749 companies. Of those, 398 have made a positive contribution, while 282 have destroyed value. Overall, over 90% didn't make a material difference to returns, with 69 companies - just 9% of the total - driving all excess returns. Only 14 companies accounted for half of wealth creation in the trust. This is a pattern that repeats across the world.

As such, it makes sense to focus on identifying those companies. These are robust companies with visionary leadership that can scale. While the prevailing narrative among investors is to reduce volatility and minimising downside, the gold needles that can be found the market haystack will more than compensate for losses elsewhere. Equity investing should be about finding the few exceptional companies.

These exceptional companies will often come with significant volatility. Inevitably, disruption does not happen in a straight line. Tesla, for example, has had ten drawdowns over 10%, but the trust has made over 40x its initial investment. Amazon has had eight drawdowns over 10%, but delivered 11x its initial investment. It can take years for the characteristics of exceptional growth companies to be reflected in their share prices price.

Great companies will be reinterpreting the industries in which they operate. As such, having imagination is just as important as understanding a discounted cash flow model. On Scottish Mortgages, the managers are striving to re-imagine the future of transport, finance, healthcare, food or energy.

It is equally important to accept the limitations of a circle of competence. The market is trying to process a lot today, from geopolitics to inflation, interest rates to supply chain disruption. Market time horizons have shrunk. The managers of Scottish Mortgage retain humility about their ability to predict these near-term events. They have little visibility about inflation, for example, or gross domestic product. Its aim is to own the world's most exceptional growth companies - their outlook has very little to do with interest rate cycles.

There are likely to be three main drivers that dominate the portfolio over the next decade: the energy transition, the intersection of healthcare technology, and the digitalisation of the economy. The world is moving inexorably away from a world of carbon-based energy transformation, healthcare is becoming more personalised, driven by genomics, while the digital transformation is broadening into food and finance and enterprise.

These structural shifts will continue whatever the market environment. On Scottish Mortgage, the managers remain open to change and the possibilities it presents.