The rules of Great Investing keep changing

Blain’s Morning Porridge 22nd June 2021:  The rules of Great Investing keep changing

“Watch not where the conjurer’s hat is, but where his hands are going.”

This morning: There are many very clever investment firms – Baillie Gifford takes a long view to recognise and consider the future and trends, while Bridgewater is taking a view on inflation and rates. But, what if the most important factor likely to drive long-term returns proves to be the destabilising consequences of the last 10-years of interest rate repression and the distortion of rules, regulations and fads? These could prove the “no-see-ems” that tumble markets!

I’ve got a slightly different Morning Porridge for you this morning. As I perused my digital copy of the Pink Un (The FT) this I was struck by its two leading stories… two successful investment firms, Baillie Gifford and Bridgewater each pushing their very different investment agendas. It struck me they may both be very successful, but equally both are products of this time and convention.

I reckon the real investment story of today remains the threats posed by ongoing distortion and how the consequences of distortion will continue to drive investment and corporate behaviours in surprising ways until they are addressed….

Part 1 – Why is Baillie Gifford so successful?

What makes a truly successful investor? Following trends or predicting them? Ticking the ESG tick boxes or arbitraging them? Making a million today on a smart opportunistic trade, or making tens of millions tomorrow by identifying how that trade presages the future? These are all question spurred this morning by the retirement of Baillie Gifford’s James Anderson.

If success is measured in FT column inches, then Bailie Gifford is the most successful firm in the UK this morning.

Baillie Gifford’s £18 bln Scottish Mortgage Investment Trust has made a 1500% return since 2000. It was an early post dot.com investor in names like Amazon, Facebook and most famously in Tesla – where it has recently reduced exposure. Now it’s looking for its next big theme, moving its focus into another challenging area – China.

Buried away at the foot of a FT puff-piece on Baillie Gifford is a critical comment from Anderson: “I don’t see political risk as an issue that’s unique to China. We have no direct evidence the West’s way of development is the only one, or the superior one. The political decline of America is so great and so enormous and so threatening. Am I sure that America will be a democracy in 10-years time? I’m not sure at all.”

He says it so much more eruditely that I ever could.. It’s a fear I share… But, I must admit I have an interest: I’m invested in BG’s China strategy fund. It’s not just because they are Scottish, but because success often breeds success…. Meanwhile, China investment is stuffed with moral dilemma – and that is highly challenging. I promise it will be the topic of many Porridges yet to come..

The FT has gone to town on the Bailie Gifford news – with no less than two stories on Anderson: “Tesla investor warns of ‘deep sickness” in UK Capital Markets, and the puff piece on the firms new management cadre, Bailie Gifford: Can a new generation keep riding the tech boom.

The key article is the first one – challenging the whole basis of the UK’s investment industry. A sign hung over the door: “Actual investors think in decades. Not Quarters.” BG made its name on big bets on fast-growing, distruptive companies – if that sounds familiar, remember BG has been going over a century, while ARK has 5 years behind it. Its time horizon is 5-10 years, rather than 2-3 minutes that seems common across London. They note the Bessembinder rule: 4% of stocks account for 99% of wealth creation over the long term.

Anderson’s gripes with the structure of the UK Investment Industry are themes I regularly hear from investors within the industry. They agree the bonus structure tends to favour short-term returns rather than long-term investing, that enhanced compliance and regulation holds back investment returns rather than encourages them and that ESG box-ticking increasingly dominates investment thinking – a topic I’ve covered many times in the Porridge. They also gripe fund management and clients are not aligned.

I’d be interested what readers think… Meanwhile… back on Planet Earth

Part 2 – Bridgewater sees subdued price pressures

Despite the Fed’s threat last week’s to raise interest rates sometime in next 1000 years, the US market has decided inflation is not a risk and staged a risk-on rally yesterday.

You must think me terribly uninformed, because this story is also in the FT (other financial periodicals are also available.)  Another investment firm I like is Bridgewater – which has come out in favour of a short-term moderate inflationary moment but that long-running deflationary forces will keep prices under control: Bridgewater’s Prince rejects return of 1970s “Great Inflation”.

The Bridgewater transitory inflation scenario is shared by over 70% of US fund managers – apparently. That sounds like a classic investment trap; remember Blain’s Market Mantra No 1 “The market has but one objective; to inflict the maximum amount of pain on the maximum number of participants.”

Interestingly, the Bridgewater team are looking for red flags that might suggest Inflation is becoming more sustained – like wage demands. I reckon they should look wider – the motivations driving speculation and corporate board behaviours.

Part 3 – the Distortion Threat

We live in a very different financial market. I am wondering if its just inflation/deflation we have to worry about.

Rules and regulations are a form of distortion we all accept as often burdensome, but necessary. When do good concepts become regulation? We are seeing that happen with ESG, where rules and taxonomies on sustainability, carbon neutrality, visible virtue signalling and diversity awareness seem to score much higher that the returns a fund can actually return to investors.  ESG is just one of many distortions.

Absurdly low interest rates are another. Essentially free money changes investment and corporate behaviours. When money is so cheap to borrow, and stocks rising, the returns from stock buybacks look far more attractive than building a new factory, with the added incentive of pushing up executive bonuses. As I’ve said many times – inflation is obvious and here – it’s in stock and bond prices. It’s in the value of vastly inflated corporate valuations – Tesla being, perhaps, the most absurd valuation of them all.

The cumulative effect of ongoing distortions caused by rates, rules and financial asset inflation are to rebalance, or unbalance, markets.

Sooner of later something will give.

Very few people really understand or have the imagination to understand how these financial distortions affect the whole raft of society via issues like wealth inequality – driving people to speculate money they don’t have to live the better lives they see on Instagram, or the breakdown in trust when paying the rent becomes optional because of lockdowns, or even as corporates scrabble for workers, they get away with treating them worse… It raises dissatisfaction, which is being fuelled by targeted social media and crafted fake-news being delivered to those most likely to believe it – hence the comment from James Anderson of BG on whether the US will remain a democracy.

I suspect distortion and social unrest will become a much bigger source of market destablisation than we currently perceive. Get ready for it…

Five Things To Read This Morning

FT – Investors should prepare for impact of green stress tests on banks

BBerg – Your Face is the Next Frontier in ESG Investing

BBerg – Brent Oil Edges Above $75 as Investors Assess Tightening Market

WSJ – What Investors Can Learn From The History of Inflation

WSJ – Long Dated Treasuries Win Favor on Receding Inflation Bets

Out of time and back to the day job

Bill Blain

Shard Capital