Tom Slater interview: Scottish Mortgage’s lockdown winners and new trends

The joint manager of the Scottish Mortgage (LSE:SMT) talks to interactive investor’s head of markets Richard Hunter about the trust’s objectives, searching for the world’s great entrepreneurs, and innovative tech stocks.

Richard Hunter, head of markets, interactive investor:    

In this episode, I’m delighted to be joined by Tom Slater, joint manager of the Scottish Mortgage Investment Trust. Tom joined Baillie Gifford in 2000 and became a partner of the firm in 2012. After serving as Deputy Manager for five years, Tom was appointed joint manager of the Scottish Mortgage Investment Trust in 2015. During his time at Baillie Gifford he has also worked and developed Asia and UK equity teams. His investment interest is focused on high growth companies both in listed equity markets and as an investor in private companies. Tom graduated with a BSc in computer science with mathematics from the University of Edinburgh in 2000.  

Well, starting at the very beginning, could you talk us through the kind of style and objectives of the Scottish Mortgage Investment Trust?

Tom Slater, Joint manager of the Scottish Mortgage Investment Trust:

We are trying to achieve long-term capital appreciation for our shareholders. And the way we do that is to invest in what we believe to be the world’s outstanding growth companies, companies that we see as having very big opportunities that span decades and companies that have some particular edge in going after those opportunities. And where we find those companies, we aim to be very long term, very patient shareholders.

Richard: Seems to be a fair smattering just within your top 10 holdings of technology stocks? Is that a particular area of focus?

Tom: It is, in the sense that we invest in a lot of companies that are using the tools of modern technology to bring change into their areas of focus. But the interest isn’t the technology in and of itself. We aren’t interested in companies that make widgets. It’s more the new business models that technology can facilitate, and the addressable markets it opens up, you know? It seems to us the combination of progress of Moore’s law, advanced software, ubiquitous mobile communication, are tools that companies are able to utilise to grow their share or to grow dominance in industries that have previously not seen a great deal of change.

Richard:  And, of course, rightly or wrongly, the very mention of technology enablers or indeed technology, in itself, brings to mind the US. But, of course, you’ve got an equal interest in what’s happening in the light of China as well?

Tom:  Yes, absolutely. So, you know, some of the most important growth companies of the past decade have come out of the west coast of the US. The rise of the big online platforms has almost been the most important feature of the investment landscape over the past 10 years. And the only companies that have really rivalled what has come out of the west coast of the US have come from China. So, companies like Alibaba (NYSE:BABA), like Tencent (SEHK:700), you know, innovative companies in their own right that have been able to grow extremely strong positions, have world leading technology.

And what has been really interesting is that these big platform companies have achieved huge returns to scale. They’ve often grown faster, they’ve needed less capital as they’ve got larger, which has been a real challenge for everybody else in trying to compete with them. And the sad fact is that there haven’t really been any substantive competitors or peers emerging from the European economy.

Richard:  And presumably, the fact that it’s such a populous country, China, gives them an additional edge as well once successful?   

Tom: I think that home market advantage is one that’s becoming increasingly important, you know? As you say, it has been a really populous country, but there has not necessarily been the wealth in that populous to drive really large businesses. But as we’ve seen the growth of the consumer economy in China, the emergence of the middle class, the spending power that comes with that, the greatest sophistication and understanding of online tools. I think what you’re starting to see, real momentum from that domestic market. So, to take the example of food deliveries. We used to own GrubHub (NYSE:GRUB), the US food delivery business. They deliver about half a million meals a day. We do own Meituan Dianping (SEHK:3690), the Chinese local services business. They deliver 20 million meals per day. So, you know, for some of these emerging network businesses, the Chinese companies have had that home market advantage.

And, I think, there’s another advantage in there which is that the Chinese domestic market is ferociously competitive. So, Meituan hasn’t emerged as a dominant player in that market because, you know, it had a first mover advantage and got on with it. It has come because on an operational level it has moved faster and been more aggressive than 2,000 other local competitors to get dominance of that vast market.  

Richard:  And in terms – again, just looking down the list of your top 10 holdings, featuring very prominently there is Amazon (NASDAQ:AMZN). And given the success Amazon has had both in terms of its share price performance as well as its exponential growth, clearly you obviously remain fans of the longer-term story?

Tom:  Yes. I think Amazon still has a really big opportunity in front of it. Sure, it has been successful and in some categories, ecommerce has now achieved reasonable penetration. But there are some really big categories where they’re only just getting going. I think grocery is the one that stands out to me, you know? A market that runs to trillions of dollars. We’ve seen a reasonable penetration of online grocery here in the UK, actually, it is the most penetrated market globally. But for continental countries, we really haven’t seen anything like the type of penetration. And, moreover, I think the UK model of simply running vans from existing supermarkets is hardly revolutionary.  

But I think we’re seeing a stitching together of online with click and collect with physical stores, overlaid with data. And I think that’s going to drive a real change in the model of grocery. And that’s a market big enough to make a difference even to the likes of Amazon. And, at the same time, they’ve been able to use their technology skills to expand into adjacent areas. So, the provision of IT infrastructure to companies. I’ll give you an example.

I was out in Seattle just before lockdown hit, in the spring of this year. I went into the new Amazon Go supermarket format. They’d started in convenience stores with this technology, but they have now increased the scale up to the size of a local Tesco Local type small format supermarkets. But you go into this supermarket, you scan your device as you walk through the door, put it back in your pocket and then walk around and pick things up off the shelves and walk out. So, they’ve addressed some of the pain points that the supermarket experience has for people. And they’ve used data to basically create an experience which is much better.

But again, you go back to what drives this, the technology that powers it gets exponentially more powerful, the cost of that technology declines every year. So, we should expect this to get cheaper, faster, easier and move to larger format stores. So, you can see how that could be an opportunity big enough to make a difference even to a company of Amazon’s scale.

Richard: Understood. And in terms of looking at the number one holding, as well indeed as the number 10 holding, seems something of a past, present and future of the automotive industry, although I’m sure you hold them for different reasons. So, number one we’ve got Tesla (NASDAQ:TSLA), number 10 Ferrari (NYSE:RACE). Presumably you’ve got different reasons for holding those two stocks?

Tom:  Yes, absolutely. So, I think, for Tesla, there are some really big changes underway in transportation. Electrification is the first, autonomy, I think, is the second. And then, as a consequence of the first two, I think we start to see changes in the model of transport and the ownership of the transportation theme. This is a really big opportunity, 100 million passenger cars are sold each year, very, very small penetration of electric vehicles within that, but growing rapidly. And what we’ve seen over the past 18 months is that when you give consumers a product which is at the same upfront price point but has lower cost of ownership, better performance characteristics, there’s huge pent up demand for these products. 

And at the same time at Tesla, their operational execution has improved dramatically. And I think we can now have greater confidence that they will be the ones, one of the ones, to capitalise on this opportunity. At a time when the traditional auto industry seems to be seeing model launches delayed and/or cancelled and we’re really failing to grasp what’s happening. As you say, Ferrari is slightly at the other end of the spectrum and particularly in terms of volumes. This is a business which is effectively, in our eyes, the world’s most valuable luxury brand. The number of buyers are measured in thousands of very wealthy individuals.  And our contention is that the very sensible management of that brand, all the brand associations, can carry through from the internal combustion engine age into other forms of technology.

So, sure, you have to keep the audience that love the V12s and the V8s happy, but equally the Ferrari brand is synonymous with performance, that’s the importance of Formula One and using the latest technology to create a phenomenal experience. And really, you’re only talking about Ferrari recruiting thousands of new buyers, a small number of thousands, from amongst the emerging Asian middle class or Asian wealthy, I should say.  I don’t think the middle class will afford Ferraris. And there’s just a whole different set of demand drivers and demand dynamic for that business.

Richard: Say from a wider perspective, you’ve got somewhere around 18% of your total assets in unlisted companies which obviously for different reasons has rung a couple of alarm bells over the last couple of years. How do you navigate that particular part of the market with having a fair chunk of your assets in those unlisted companies?

Tom:  The reason we got into investing in private companies was that we saw companies were able to use the tools of modern technology to grow their business with far less capital than has been the case historically. And as they haven’t needed capital, they haven’t had financial investors controlling their boardrooms and there hasn’t been the same pressure to move to the public markets. And so, if we wanted to invest in the most attractive growth companies in the world, we had to have the flexibility to invest in both public and private companies. But that’s not to say that we’ve taken to investing in small companies, you know? If you look at our largest unlisted holding in Ant Financial, if that company were listed in the UK, it would be the biggest listed company in the UK.

So, this is not venture capital funding. This is simply saying that these businesses in any other era would be large listed companies. And so, there are some technical or operational issues that one needs to work through, you know? Making sure you have current valuations for these assets included in your asset value. There’s greater legal due diligence before you make these investments. But really that’s admin. And the most important thing for us is, can we invest in the most attractive long-term growth companies, you know? Our average holding period is close to 10 years anyway in listed markets. So, it doesn’t really matter if we could trade every day or not.

But what really matters is, can you find the world’s great entrepreneurs, can you access the best opportunities? And we believe that in the long run that’s the most profitable approach for our shareholders.

Richard:  It will obviously be rather less of a concern for you, but as a matter of interest, how has the Trust been holding up over the last few months of madness that we’ve had since February, March time?

Tom:  Yes. As you say, our focus is resolutely on the long run. And, you know, we think the outcomes over shorter periods can be little more than chance. But what has been quite unusual about this crisis is that you haven’t seen a change in the leadership of the market. So, the companies that have been driving change in the economy, that have been providing modern technology tools for communication, for socialising, for work, have been the big beneficiaries of the behaviour changes that we’ve seen, you know? We’re having this call today on Zoom that their business has been massively accelerated by what has happened.  And, yes, that was a position that we took in the Trust when it listed on the stock market just over a year ago.

Now, it doesn’t mean that this level of demand will be sustained. I do hope we will all be back out in the real world very shortly. But I do think people will question exactly when do I want to use these tools and when is a face to face meeting and the associated travel, time, carbon footprint required? To answer the question directly, the Trust’s asset value has remained very robust through this period. The question here is, as we move through this period, what behaviour changes stick? To what extent have we brought in new cohorts of users that will underpin growth for the next decade? That’s what happened to Amazon in the 2008-2009 financial crisis, you know?

You’ve seen lots of people experiment with services that they hadn’t used before. You’ve seen lots of people use them for different use cases. I’ve bought my books off Amazon, now I’ll try and buy my weekly grocery shop. So, how much of that sticks and how much of it leads to sustained behaviour change is the big questions that will be answered over the next five years.

Richard: I notice also very much along those lines, obviously another beneficiary of the global lockdown has been the likes of Netflix, and that’s one of your top holdings as well.  Was that one that was already one of your top holdings, prior to the lockdown?

Tom:  Yes, it was. So, at our year end which was at the end of the March, we still own 29 of our top 30 holdings from a year previously, just illustrating the fact that we don’t tend to turn the portfolio over very often. And our longer standing holdings we’ve owned for more than a decade. So, there is very rarely big or revolutionary change in the portfolio. So, yes, Netflix (NASDAQ:NFLX) has been there for a while. And, you know, the argument here is that this is the first company to build a global distribution footprint in media. And, you know, my 20 years as an investor, I’ve sat through countless debates about whether distribution or content was more important.  But we’ve never had a company with this kind of distribution scale before.

And then they’ve used that position to invest more and more in producing their own content and exclusive content. And I think that has given them firepower that their spending is more than twice what the next biggest content producer makes today but they’ve got vast scale now in this. And, I think, there is just the possibility this becomes a really, really big global distribution business and running into hundreds of millions of users. And, I think, if we get to that point, the profitability will be unlike anything we’ve seen before in the media.

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