24 Nov 2009 | Business

James Anderson on Global Investment 

Baillie Gifford's Chief Investment Officer, James Anderson, talks to Heather Farmbrough about the pros and cons of global investment.

Share prices have climbed back up again. Can you say we
are back on track?

In one way, we're much, much further forward and in another we are in serious retreat. The last year has surely confirmed that economic leadership in the world has shifted away from the so-called developed world to China and countries we have labelled as 'emerging' markets, however inappropriate a description that is becoming. These markets, from Brazil to Poland and Turkey, have had the hardest road-test imaginable and come out with flying colours. This is important because, in almost every other crisis over the past 100 years, emerging markets have proved extremely vulnerable.
 

I accept that so-called 'emerging' markets have tended
to cope better than more developed ones, so following
through the logic of what you are saying, why don't you
have more investments in them than elsewhere?

We have been considering whether we should invest more in these markets. Over the last 12 to 18 months there's been a real wave of corporate excitement, creating growth opportunities for a number of companies with strong market leadership and intellectual property. These range from Baidu.com, the Chinese search engine, and Tencent Holdings, China's largest Internet services portal. I don't believe, though, that you, any more than the readers, would expect me to say that these represent the only opportunities we have identified. There are always going to be interesting individual companies. Now that it's not so easy to raise capital, competitive advantage actually counts for a bit more. Many Western technology companies have demonstrated the power of their business models over the last 12 months; nobody could say Apple or Amazon wasn't in a stronger position than it was this time 12 months ago, relatively. So while we are looking at investing more in emerging markets, we're not looking at emerging markets solely.
 

You said earlier that in some ways we had gone back. How?

I had hoped that there would be many more opportunities in Western financial stocks. I am concerned that there seems to be no evidence of an effort to understand what went wrong with the financial system, nor to reform, or to address the absurd remuneration structures.
 

What would you do?

There are numerous things to consider, but the biggest danger is from the extent of the investment banks' unknowable risks. The Royal Bank of Scotland's balance sheet was almost twice the size of the British GDP. It needs to be clear that there will be no state guarantee in the future for banks involved in those areas. It worries me that they've got away with it this time. I think various instruments they use need to be taken away.
 

Such as?

Credit derivative swaps (CDSs) - which are privately traded instruments - are the most obvious. Probably the most damaging, and one of the most difficult to get right, is that the reward structures to financial companies or for the pharmaceutical industry, for instance, from political lobbying are so much greater than the rewards available for good governance. I see no evidence in Britain that reform is taking place - maybe more in America.
 

You mean that our economic, financial and political systems
are so closely interrelated?

Absolutely. That is what has got to change.
 

How do you deconstruct the links?

think the first question to ask is: what is the point of the financial services industry? It is to manage the savings of individuals, society collectively, in a sensible manner to give the highest possible reward to savers. It is not to generate the highest possible income for people working in the industry. I think the fees paid to US mutual funds for the last year reported came to $100bn - that's just straightforward US mutual funds, not even hedge funds. This income is detracted directly from the returns available to shareholders. I don't see why this is necessary - and yes, in Scottish Mortgage we do keep a close eye on what fees we charge and try to ensure they are comparatively low for the industry.
 

What are the risks you see ahead - financial risk, presumably?

Much of it is financial risk. One of the tragedies is that we've used up much of the available stimulus, or available reserves of our societies, in trying to rebuild the financial system. Yet we are approaching the point where the demographics are becoming challenging and our economy, society and savings system will be in trouble. Even in such an equable, peaceful society as Japan, this has been very difficult. Barack Obama says the greatest risk facing the US is the complete and almost inevitable bankruptcy of the health care system. All the money that could have been spent on trying to solve the health care problem in the next five to 10 years has been thrown away.
 

Is the situation in the UK just as bad as it is in the US, or worse?

In some ways it is worse, because of little evidence of attempts to reform and because America will probably continue to produce great companies that will create income and employment. I don't see much of that in Britain. In some ways it's less bad, because some of the absurdities and excesses in financial services or industries such as health care are not as great as in America.
 

When do you think that the stimulus programmes under
way in the States will stop and what will the legacy be?

There is every chance that the stimulus is only really beginning to kick in now, and it may stimulate the economy at precisely the point when it is past its worst. In one way, that makes me confident about the economy over the next 12 months. But in another, it worries me because there may be some disturbing market reactions. If America grows at the historic rates that it tends to, coming out of recession, say 5 per cent per annum early next year, will investors say, "America is back, it's all fine; why bother with emerging markets?" At the same time, they are also likely to worry about inflation and interest rates going up. Obama and his economic advisors are indicating that the only way to cope with their challenges - or the risks, as you put it - over the coming decades is to make the economy boom. But if they put too much petrol on the bonfire, there will be inflation and a loss of confidence in the US dollar.
 

And how will this affect the UK?

If Britain is bailed out because America really pulls off a boom, and we can quietly do some restructuring and repay some debt, we may escape the worst of it. But it will be because we've been lucky, not because we've done anything to deserve it.
 

As a fund manager, you could be perceived as being
part of the reward structure you've mentioned. What
would you say to shareholders?

I'd have a series of responses. I think one has to distinguish between what I see on the one hand as a temporary, ridiculous element of volatility in the markets, but which is nevertheless offering an opportunity for investors, and on the other a long run situation where I've lost capital permanently. I have always tried to be honest with shareholders: my job is to create savings or returns for them ahead of the indices over long periods of time. One of the many things I admire about the US investment company Vanguard is that their information always says clearly at the start who should not own these shares. People should not own Scottish Mortgage if they will be upset if they lose money or diverge from the performance of the index over a short period of time.

Heather Farmbrough is a financial writer and editor of Trust.

Investment markets, including currency exchange rates, can go down as well as up and market conditions can change rapidly.

The views that are expressed in this article should not be taken as fact and no reliance should be placed upon these when making investment decisions. They should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

This article contains information and opinion on investments that does not constitute independent investment research and is, therefore, not subject to the protections afforded to independent research.