Going against the crowd

Curiosity and patience are two aspects of what we believe constitutes our competitive advantage. But to be curious, and to be patient, we need another ingredient. We need to be brave.

I’m not talking about the type of bravery shown by medical workers in a pandemic or soldiers under fire. The type of bravery I’m referring to is that which enables us to be different from the crowd.

 

We can’t be different in every aspect, so we need to be intentional in how and why we choose to be different. To help us think about this, we can use two competing theories of crowds: The Wisdom of Crowds and the Madness of Crowds.

 

The Wisdom of Crowds suggests that the average guess of the crowd is not only better than any given individual, but almost entirely accurate. The aggregate estimates of a crowd will be made up of some element of truth, and some element of error. In the case of wise crowds, the error is randomly distributed. This means the error, high and low, cancels itself out, leaving an average guess that seems very close to the truth.

 

It is often treated as magic and underpins much of the Efficient Market Hypothesis, but why, if it is true, do crowds sometimes behave in strange ways?

 

The basic hypothesis of the Madness of Crowds is that even though an individual might behave rationally, the aggregation of these behaviours leads to a crowd that seems to behave irrationally. The leap from a wise crowd to a mad crowd happens when the error is no longer random, but systemic in a particular direction. We start to see crowds behaving irrationally, not because any given individual is inherently wrong, but because the aggregation of the crowd’s biases overwhelms the truth.

Going against the crowd is inherently uncomfortable and requires courage. What enables us to be brave is the structure and culture of Baillie Gifford.

This is what we see happening in financial markets every day. Recognising and exploiting the systematic errors of financial markets is core to our competitive advantage as investors at Baillie Gifford.

 

Where others look at share price targets and near-term earnings forecasts, our investment research focuses on the long-term qualitative evolution of a company and only then do we translate this into financial characteristics. Broadening this out, we have also sought to challenge the way financial markets are divided between public and private companies.

 

In 2012 we started investing in private companies. The received wisdom then was that a hard line existed between private and public companies that could not be crossed by investment mandates.

 

We challenged this idea, arguing that it made no sense to use the arbitrary IPO line as a way of dividing up financial markets. Furthermore, we sought to bring longer-term vehicles and lower fee structures to create better alignment between companies, investors, and asset owners, all of which cut across market norms.

 

Going against the crowd is inherently uncomfortable and requires courage. What enables us to be brave is the structure and culture of Baillie Gifford. We are a partnership which means we are not beholden to outside shareholders, making it possible to run the business for the long term. We don’t have to second guess what an external shareholder might want, which means that once the partnership is committed to something, it can be executed with conviction.

 

The key cultural aspect of Baillie Gifford that helps us be brave is an institutional acceptance, even embracement, of uncertainty. Sometimes doing things differently from the crowd works, and sometimes it doesn’t. There would be no quicker way of creating a conformist culture than insisting on certainty before any action was taken. Acceptance of uncertainty informs the creation of new strategies within Baillie Gifford, but also individual stock selection within portfolios.

 

Being brave is a rare quality. Although the concept is simple, embodying it within the broad culture of finance is hard. Why, if it is such a rare quality might Baillie Gifford be able to live up to it? Well, it’s not because we are virtuous or clever. If we can be brave and if we can use this characteristic to do a better job for our clients, it’s because the structure and culture of Baillie Gifford enables these qualities to become not virtues, but habits that persist over the long term.

Peter Singlehurst

Investment manager

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