Investors should beware long-term exposure to many of the largest blue chip stocks and consider paying more attention to unquoted firms in the energy and healthcare industries, according to Baillie Gifford’s James Anderson (pictured), manager of the Scottish Mortgage investment trust. 
It was announced last week that Anderson is seeking to increase the mandate of Scottish Mortgage to allow up to a quarter of the £3.4bn portfolio to be invested in unquoted smaller companies where he believes the big opportunities now exist.
Putting his money where his mouth is, Anderson has approximately £25m of shares in Scottish Mortgage and has managed the portfolio since April 2000.
Since he took over, the trust has gained 252.08 per cent, according to our data, vastly more than its sector average and benchmark. It is also top decile in the IT Global sector over three, five and 10 years.
Performance of trust, sector and index since April 2000
Source: FE Analytics
Some of Anderson’s early successes were in the more exotic oil majors such as Petrobras and Gazprom, having sold legacy positons in Shell and BP. However, more recently the big wins have been in the technology space such as Facebook, Alphabet (Google) and Tesla.
But he says due to tectonic shifts in technology and the nature of capital raising in earlier stage companies, huge swathes of ‘blue chip’ firms are at risk while those driving the change stand to gain.
“I challenge anybody to come up with a view as to why most of the big companies today are not much more risky in the sense of permanent loss of capital than the unquoted companies that we own, even accepting that plenty of them could fail. It is that potential destruction of the vast bulk of the quoted major British companies that worries me, rather than the volatility of disclosure surrounding unquoteds,” he said.
“One of the most recent terrifying hours of my life was spent with [Tesla's] Elon Musk. He says by 2030 the car industry will be an entirely, completely 100 per cent non-petrol and autonomous. He carried on to say by the time we get there it won’t matter what the price of oil is. It could be nothing and still running an electric vehicle will be better and cheaper than traditional combustion engines.”
“What does that take out? Obviously the car industry but also if we don't need it for transportation, what will the cost of oil be and also adding in what happens to solar, batteries and storage as well. How does BP and Shell exist in that background?”
Both oil majors are two of the largest firms listed in the FTSE 100 and are hugely popular with income investors. Some 35 of the 84 funds in the IA UK Equity Income sector hold BP while 48 hold Shell and many hold both, according to data from FE Analytics.
The companies have fallen significantly over the past two years largely because of the plunging price of oil that has been driven, in the opinion of most analysts, because of over-supply from Saudi Arabia.
The world’s largest producer of oil is concerned about maintaining its market share in the face of a supply increase from US shale firms.
Performance of shares and index over 2yrs
Source: FE Analytics
For many the idea of unlisted exposure is tempting but more fraught with risk due to the illiquid nature of this type of equity and its firms’ mostly short-lived existence. Anderson disagrees.
“I quarrel with the notion that this is risky. We think there is a terrible and dangerous confusion between risk and volatility in the financial markets. We think that most share prices and most companies that are un-volatile are most like most states and people who appear to be un-volatile and then will change dramatically,” he said.
“We do not think you can view volatility as a proxy for risk. What is risk? In fixed terms it is permanent loss of capital. We think these companies have much less potential for permanent capital loss.”
However, Anderson e does anticipates that of many of these businesses will underwhelm or even flop, overall.
“You expect most of them to fail. That is the mass of it,” he said. “What matters is whether within your crop of them you have the next Facebook or Alibaba. That is what alters it. You need one success on that scale. It is of the essence that most of them will go down, that is what is going to happen.”
The problem for investors, Anderson argues, is that it is difficult to gain access to such firms and capture their stellar private growth.
“But how do most ordinary savers get access to these sorts of companies? We are giving them an opportunity that they are not going to have elsewhere because they can’t be invested in these venture capital funds or hedge funds who get access to them,” he said.
“We think we are doing it at a really low cost and we think that is a good thing and therefore we want to be open about it.”
“We live in a world where we seem to regard it as 'investment' that people put money in government bonds, £6trn of which are yielding less than zero, another £20trn are yielding less than 1 per cent and think that is somehow going to translate into a healthy economy.”
Anderson was joined on Scottish Mortgage by Tom Slater in 2009, who is now co-manager. The two mangers use a largely thematic approach to their portfolio. The trust has seen more volatility than both the index and its peers over recent periods while the latter half of 2015 and the first four months of 2016 has been difficult time for the strategy.
The portfolio is down 7.48 per cent year to date, almost triple the fall of the index.
Performance of trust, sector and index in 2016
Source: FE Analytics
Scottish Mortgage has ongoing charges of 0.48 per cent, is 13 per cent geared and is currently on a premium of 1.3 per cent.
Daniel Lanyon was recently a guest of Baillie Gifford in Edinburgh.