Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Helen Xiong, Manager of the Baillie Gifford American Fund.
Hello, Helen.
Helen Xiong: Hi, Emma.
Wall: So, with America, with the U.S., the question on everybody's lips is, how long can this rally continue. We hit yet another all-time high on Friday for the S&P 500. Is there much further to go?
Xiong: I think that's a question that a lot of people are asking at the moment. And I think that if you look at the world in the past, it made sense to break down the market by geography. So, you compare the U.S. market compared to the British market, for example, and you say, U.S. looks expensive, at least on traditional measures such as P/E.
But I think that technological change is increasingly breaking down those barriers. And that the main winners of the technological change, companies such as Amazon, Facebook, Google or a Netflix, are companies that – they are not U.S. companies, they are global companies.
I think, whereas in the past, you could say, BP is a British version of Exxon or a Tesco is a British version of Wal-Mart. These companies are companies where there isn't a British competitor. So, these companies are truly global. And I think one of the greatest risks for investors right now is not whether they own too much or too little of the U.S. market, but whether they own enough of these companies.
Wall: So, then you think it's about stocks and their valuations rather than about the market as a whole, because some of the drivers of this market have arguably been political, which is a very U.S.-centric issue. You're saying, forget about the U.S., forget about the politics, forget about the macro and focus on these individual stocks?
Xiong: Absolutely. So, we are long-term investors. And I think a very good piece of research that was published earlier this year looked at long-term equity returns over the past 90 years from 1926 to 2015 and one of the big findings of the research is that over the past 90 years – well, firstly, that equity markets outperformed all other asset classes to the tune of $32 trillion, I think, it was, but also that the nature of where equity returns come from. So, it looked at all the U.S. stocks that were listed on the market, 26,000 stocks, and of that the $32 trillion value being created. Do you care to guess what percentage of stocks actually mattered for the value creation?
Wall: 20%?
Xiong: The answer is 4%.
Wall: Wow.
Xiong: So, 25,000 of those 26,000 stocks did not matter for long-term equity returns. And that suggests sort of two things to me. The first is that the Efficient Market Hypothesis or the Capital Asset Pricing Model is complete nonsense. It's not about a risk premium to the average stocks, because most stocks do not matter for long-term equity returns.
And the second is idea of asymmetry, the idea that there's only a few stocks that really matter for long-term equity returns. So, 86 stocks contributed half of that $32 trillion in value creation. So, it's not about how often you are right, but how much money you make when you are.
Wall: I suppose that then very neatly makes the argument for active fund management. Because if all of those thousands and thousands of stocks which meant nothing were not included in a fund portfolio and you just included the ones that did deliver, then you are laughing, aren't you?
Xiong: Absolutely. So, the Baillie Gifford American Fund, for example, we are active. We don't own the American market. We only own 40 stocks and our active share is well over 90%. We believe in asymmetry and we try to exploit that. So, our investment philosophy and process is designed to identify the companies that really make a difference to long-term equity returns and we do so by thinking about the culture of the companies.
We think culture is something that is systematically underappreciated by the market, but it's so intangible and is not something that you can model or put on the spreadsheet, and we do it by thinking about the valuation but in the context of upside. How much money can we make if this goes really well? And we are not looking for something that can double. But we are really looking for something that makes 10 times or 50 times or 100 times over the long term. And finally, we are long-term. So, where we can identify these companies we'd like to own them for as long as our views remain differentiated.
Wall: Helen, thank you very much.
Xiong: Thank you very much.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
