Following a recent period of unprecedentedly good performance, many Baillie Gifford growth funds are now underperforming worse than at any point in their history. If this market rollercoaster tells us anything, it’s that for growth investors, patience and imagination matter more than ever. Here’s a case for why.
There’s been plenty for investors to worry about lately, during an era of conflict. Trade tensions between the US and China, including the weaponisation of the semi-conductor trade, was followed by a planet-wide fight against the unseen quasi-life form Coronavirus, and more recently were the awful images of tanks rolling across a European border, a sight that ought to have been confined to history.
Not only has the world experienced serious humanitarian issues lately, but restrictions on supply chains have been caused by some of these challenges and have contributed to rising prices, which in turn has reintroduced an idea to global markets that many younger investors won’t have experienced before, interest rate rises.
This gloomy backdrop has led many to seek more immediate certainty from their assets. Time horizons have come in drastically and shorter horizon stocks have been favoured over longer horizon growth companies, the type that need time to earn their potentially larger cash flows. Not to mention that their forecasted cash flows must travel backwards through time by way of the market’s imagination to become today’s share price, labouring through things like costly inflation and interest rate expectations on the way.
This process, known to practitioners simply as ‘discounting’, is particularly laborious for growth stocks when the market is more nervous about the future. It’s why traditional business models in areas such as energy, commodities and banks have done so well lately. Their cash flows are already mature and much more dependable in the near-term.
The flip side is that portfolios of growth companies have had a tougher time. After all, growth requires patient investment now to realise greater profits later, not what the current market mood prefers.
However, the above immediate challenges belie three important facts. First, the market’s prevailing anti-growth sentiment can indiscriminately overlook a company’s financial quality, strength of management, and competitive advantages. Second, notwithstanding the current discount that the stock market is giving to future growth, the market is highly unlikely to discount actual profit growth when it accrues over time. In other words, businesses that grow their profits will be worth more as a result. Third, is that certain mature business models currently favoured by the market remain highly disruptable.
We further believe that the whole vast stock market consists mostly of companies that will be disrupted over time. This sort of ‘creative destruction', as Schumpeter called it, is part of the natural order of things. It's as old as industry itself. Otherwise, 19th-century industrial titans like the American Fur Company would dominate the index today, with beaver pelts, instead of becoming obsolete 150 years ago.
