When long-term investing pays

Through the patient provision of capital, we aim to support the people and companies that are building the future of our economy. So the absence of dramatic change in the portfolio over the past twelve months should come as little surprise. We still own 29 of our top 30 holdings from a year ago. We believe that having long-term, committed owners can increase the chance of success for companies. Moreover, long-term ownership is the key to capturing the value created by the small number of exceptional companies that drive long-term wealth creation. Our objective is to find such companies and own them long enough to earn that return.

Studying the output of our investment process (a portfolio with modest turnover and long holding-periods) risks confusing low turnover with no turnover. Amazon does not remain our largest holding because we are contented owners. It remains our largest holding because our constant search for the world’s most exciting and innovative Growth companies has not turned up another opportunity which we think offers greater risk-adjusted upside

This fierce competition for our capital goes part way to explaining the sale of Chinese internet search company, Baidu, once Scottish Mortgage’s largest holding. Baidu has struggled to use its enduring dominance in Search as a base to build new services for consumers. Failing to evolve means being left behind. China’s online companies have built the backbone of its consumer economy and their pace of development and innovation has been ferocious. Alibaba and Tencent have become dominant platforms through which much economic activity flows and recent events have further cemented their centrality. Whilst these companies started out in the retail and entertainment business, they now drive financial inclusion and provide access to credit. In a country where advanced software has been scarce, they are beginning to digitise and upgrade a huge swathe of China’s economy and public sector through the provision of systems and data on an unprecedented scale.

It is encouraging to see new innovative companies emerging from China’s internet ecosystem. Bytedance is a media company focused on short-form video. It was founded by several former Baidu engineers and may be the first Chinese media company to build a big presence internationally. Younger audiences have flocked to its social media platform, TikTok, which has transcended cultural and geographic boundaries. Bytedance’s core skill is in deploying artificial intelligence to predict the content that each member of its vast audience will be interested in. This skill-set should extend the opportunity well beyond current products. The addition of Bytedance to our portfolio has helped to ensure that we retain a significant exposure to Chinese companies despite the sale of Baidu. The creative ferment, intensive competition and relentless execution that exist in this vast market are a powerful combination for shaping great companies and it remains an important hunting ground for new ideas.

Chinese food delivery and local service company, Meituan, narrowly missed out on joining its geographic complement, Delivery Hero, in our top ten holdings. These businesses are driving change in the food industry and their focus on the fastest-moving countries has allowed them to achieve massive scale. Meituan delivers more than 20 million meals per day compared to a mere 500 thousand for US-based peer Grubhub (which we sold during the year). Scale is driving it forward towards profitability and dominance.

The current food industry paradigm of driving to a grocery store, pushing a shopping trolley around the aisles, queuing at a check-out, driving home, putting groceries into cupboards, retrieving them, preparing and cooking a meal then cleaning the dishes is inefficient. Amazon is attacking a number of the steps in the process as it broadens its online offerings and integrates the Whole Foods brand to provide click and collect and home delivery services. Competition in grocery is likely to be intense and capital-consumptive but that is exactly the type of environment Amazon thrives in. The scale of the opportunity is big enough to make a difference even to a company of Amazon’s size. Berlin-based HelloFresh’s subscription model of delivering locally-sourced, fresh ingredients for home-cooked recipes is seeing burgeoning demand across many markets including the US where, notably, it has outcompeted the domestic alternatives.

Bytedance’s innovation and audience creation have happened in a time of limited progress in the Western advertising industry from either a product or business model perspective. Facebook and Alphabet are smaller holdings than they once were. Whilst Alphabet continues to make good progress in Search, Facebook’s product focus has for some time been predominantly on firefighting. Thankfully we have been fortunate to benefit from the wisdom of others in navigating this evolving media landscape. We bought a holding in You & Mr Jones, an unlisted advertising agency founded by the eponymous former CEO of Havas, back in 2015. His underlying insight was that the corporate sector needed specialist help in harnessing the increasingly complex online and mobile advertising environment. That foresight has proved correct with big brands moving their business away from large agencies to You & Mr Jones. With consumer internet development muted, it has been left to Tesla to uphold the reputation of West Coast America for bringing disruptive innovation to the world. It has made remarkable progress.

The vision and ambition at Tesla have always been clear but at times the company has struggled with execution. That has changed. Steadily increasing and profitable production of the Model 3 sedan has been accompanied by the successful (and earlierthan-planned) production ramp of a new SUV, the Model Y. At the same time the company has completed a second production facility in Shanghai and launched a pickup truck which has already amassed hundreds of thousands of pre-orders. This progress has come amidst delays, cancellations and false starts in electric vehicle production for the established auto manufacturing industry. We wish we could find other big companies that were making such progress in the move to a sustainable energy economy.

We believe software is going to bring profound changes to the transport industry over the next decade. Tesla’s autonomous driving functionality continues to improve as it gathers data from the sensors attached to its large and growing fleet of customer vehicles. The traditional industry will be unable to compete with this technology and we expect it will increasingly turn to companies like our holding, Aurora, which is building a virtual driver for car manufacturers to integrate into their vehicles. If the task of producing autonomous terrestrial vehicles proves too complex then it may be left to companies like Joby Aero to bring the once fanciful idea of flying cars into reality.

Healthcare has dominated the headlines of recent months but at the corporate level there have been relatively few noteworthy developments. We are encouraged by the progress of companies working at the intersection of information technology and medicine such as Grail, Zipline and Tempus Labs. Thus far their growth rates reflect their software inheritance rather than the institutional inertia of their chosen market. However, it has been the companies deploying the tools of modern biology in an industrial setting that have been making the most progress. Ginkgo Bioworks is automating the jobs performed by human scientists in order to industrialise the development of new materials. It is harnessing the power of micro-organisms to produce products across industries as diverse as food ingredients, agriculture and speciality chemicals. Without the understandable safety constraints and (less understandable) bureaucratic challenges of working within a healthcare environment, the pace of improvement and related cost declines are remarkable.

Whilst the newspapers focus on the gloom associated with the impact of Covid-19 it is important not to lose sight of the fact that we live in a time of great progress. The opportunities for Growth investors are plentiful.