27 Jun 2011
Person To Person
Monks Investment Trust - Talking Strategy
Gerard Smith talks to Heather Farmbrough about
his strategy to find big winners.
All the best ideas tend to be simple. Not surprisingly then, Gerald Smith, who has been the manager of The Monks Investment Trust PLC since 2006, argues that outperformance is often down to a small number of stocks that do very well. These can outweigh mistakes, bad performers and those that do nothing much.
Finding them is another matter. As Gerald, Baillie Gifford’s Chief Investment Officer says, “If you could easily identify the companies which will produce the higher returns, you could make fantastic amounts of money and retire in a remarkably short period of time. But it’s difficult, and I think one of the reasons is that we are always dealing with incomplete information. The stocks that tend to do very well tend to be those where there probably wasn’t enough information apparent at the outset to indicate whether they would be big winners or not, and where there were a wide range of possible outcomes.”
His strategy is to try to buy a wide range of stocks that could potentially be big winners. That means the portfolio tends to be slightly less concentrated than some of the other global Baillie Gifford trusts like Scottish Mortgage Investment Trust PLC or Edinburgh Worldwide Investment Trust plc. The investments Monks makes are also usually medium sized companies by market capitalisation, partly because larger, more established ones do not tend to generate such exciting growth and partly because the availability of information has improved.
A further difference is that Monks has historically had a more ‘top-down’ approach to stock selection than some of Baillie Gifford’s other global trusts. Previously, specialist geographic teams were mainly responsible for selecting individual stocks, but Gerald now does this, relying on the ideas of his immediate colleagues in the Global Opportunities team as well as his 80 or so other investment colleagues at Baillie Gifford. Gerald has extended the ‘top down’ approach by looking regularly at different investment scenarios and their possible consequences. When he does this he considers the composition of the portfolio and the different concentrations contained within it.
I am initially surprised when Gerald explains that he also makes decisions on the assumption that he could well prove wrong. This might sound alarming, but his philosophy is based on years of analysis, particularly from looking at the Emerging Market team which he formerly led. He says “We found that even though we actually outperformed, the majority of the decisions we made were wrong but the ones we got right, we got very right and achieved very big returns. It was about having the courage to take enough of a risk with the initial investment to actually get the holding into the portfolio in the first place, and not about waiting for safe consensus buys. I think the flipside is you have to be quite ruthless and weed out the ones that are not working and just say, ‘Right, goodbye.’”
Although he has a love of riding and classic cars, especially Aston Martins, Gerald, a philosophy graduate from Oxford and St Andrews, has always struck me as quite a cautious person. “Is that fair?” I ask him. “I think so,” he replies thoughtfully, “but I’m also quite happy to take quite large risks at the individual stock level - as long as I don’t think there is a possibility that it might completely undermine the portfolio.”
This is borne out by some fairly bold strategic decisions such as eliminating gearing and repaying some borrowings in 2007, and protecting the portfolio against possible falls in markets with some defensive purchases recently. Today he is more positive about equities being the place to be in relative terms. Gearing is around 110 per cent of shareholders’ funds. Nevertheless, he is concerned about the likelihood of higher inflation and current high levels of speculative investment. “I think we’re at quite a late stage of a liquidity-driven rally” he says. “I worry that I sometimes feel a bit like Chuck Prince (former Citigroup chief executive) when he said ‘As long as the music is playing, you’ve got to get up and dance.’ This is one reason gearing is currently constrained.”
Meanwhile, Gerald continues to look for those few special stocks. Even with a trust as large as Monks, he can only afford to buy a relatively small number to have a shot at the big winners. However, as he says, “If you have 100 stocks in the portfolio and you put them all in at 1 per cent of the portfolio, over time and with luck, a small number will go up 10-fold, and a small number of them will go to zero, and the rest will be somewhere in between. Performance will be driven by the small number that goes up 10-fold. One big winner could actually offset a series of stocks that go to zero. I think we’re playing a favourable game in the sense that the more times we roll the dice, the more likely we are to come out as a winner.”
The logic seems hard to dispute.
The Monks Investment Trust PLC
• Aim - To achieve long-term capital growth principally from an internationally diversified equity portfolio
• AIC sector - Global Growth
• Launch date - 1 January 1929
• Net assets - £1,054.05m
• 33.8% return over 5 years vs 30.3% FTSE World
Source: Morningstar, share price mid-mid, total return.
Past performance is not a guide to future performance.
All data is as at 31 March unless otherwise stated.
This interview took place in April 2011.
Please remember that the value of a stock market investment and any income from it can fall as well as rise and investors may not get back the amount invested. Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates.
Author: Heather Farmbrough
Heather worked in the city as a stockbroker and fund manager before joining the Financial Times where she was Junior Markets and Smaller Companies correspondant. She has contributed to publications including Weekend FT, Management Today and broadcast on Radio 4.