Yes, things can go wrong – but what if they go right? With Tom Slater

With a self-confessed focus on “growth at an unreasonable price”, podcast guest Tom Slater’s investment style could hardly be further removed from our own – and yet there are some surprising levels of overlap



Nick Kirrage
Co-head Global Value Team
Vera German
Fund Manager, Equity Value

It is a scene played out in countless movies – two old adversaries eventually meet and one muses to the other: “We are not so different, you and I.” In the 2011 version of Tinker, Tailor, Soldier, Spy, George Smiley goes on to observe to his nemesis Karla: “We’ve both spent our lives looking for the weaknesses in one another’s systems. Don’t you think it’s time to recognise there is as little worth on your side as there is on mine?”

With all due respect to John Le Carré’s veteran spy-catcher, we had a less cynical mindset when we invited Tom Slater, co-manager of the Scottish Mortgage investment trust, onto The Value Perspective podcast. On the face of it, with a self-confessed focus on “transformational growth” and even “growth at an unreasonable price”, his investment style could hardly be further from our own – and yet, in places, “not so different” ...

For one thing, both investment processes aim to take advantage of human nature, human biases and, as we discuss in some detail in Why value works, the fact that human behaviour does not really change. Whereas value investors focus on how people tend to overreact to bad and good news and the opportunities that can result, Slater’s focus is more on people’s inability to grasp how different things can be to how they are now.

So why does Slater believe human beings are generally so poor at picturing outsized or different outcomes?

“The investment industry tends to polarise around these ideas of growth and value,” he begins. “I think the distinction can be shorthand for a lot of different things but, actually, it obscures the point that, as an investor, what you are really trying to find are underappreciated opportunities.

Tail of outliers

“As I think about this, a lot of my analysis actually goes back to looking at historical data. If you look at the past 30 years in US stockmarkets, for example, you see this fairly consistent rule over time that about 5% of the companies go up fivefold in any five-year period. The result also holds if you look at global stockmarkets and you end up with this pattern of distribution of returns and this tail of outlier businesses.”

Thus, rather than a starting point of identifying the central case for buying a business over the next five years, say, Slater focuses on, as he puts it: “What happens if things go right?” “That way of viewing the world is quite alien to many people in investment,” he adds. “And of course figuring out what might go wrong, what might trip you up and how you might lose money is human nature and it makes sense in all kinds of settings.

“To my mind, though, the stockmarket is not one of them because of this distribution – that you can make so much more money in a company, if you are right about it, than you will lose if you are wrong about it. And so, from a process perspective, we ask how might a company end up among that tail of outliers that can go up fivefold or more? And why do we think it is more likely to do so than a company picked at random?

“To go after these growth opportunities, then, you have to think probabilistically, you have to think about the upside and you have to be an optimist. And if you do, almost by definition, you will tend to sound naive. If you start talking about what might go right for a company, you will find plenty of people to tell you why that optimism is misplaced – that endless list of things that could go wrong in an investment.

Maximising chances

“If you are a buy-and-hold investor, though, it is the impact of that small number of outlier investments that really drives your investment return over very long periods of time. So, for me, the process is about how do you maximise the chances of finding companies with that potential? And how do you maximise the chances that you hang on to them for long enough that you actually earn that return for your clients?”

Investing for the longer term is another area of overlap between our respective investment styles – and we will return to that another time – but, for now, let’s stay with optimism. It is not, we concede, a quality everybody immediately associates with value investors and yet it is literally in our job description always to be looking at businesses that are blowing up and asking, could things be a bit better? Might we make money here?

It is fascinating to find Slater flipping a key investment question towards thinking about what happens if things go right rather than wrong. This is a distinctly contrarian approach, given the behavioural concept of ‘loss aversion’, which holds that human beings feel the pain of financial loss twice as keenly as they feel the enjoyment of any gain – as we have discussed in pieces, such as All-too-human instincts.

As a rule, the wider market’s natural optimism tends to fail when faced with value stocks but that is what allows value investors to buy them more cheaply than we otherwise would. And it is that ‘margin of safety’ – in effect, paying a price that should be cheap enough to allow for a range of unexpected adverse outcomes – that is the basis for our own, admittedly counterintuitive, brand of optimism, here on The Value Perspective.

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Nick Kirrage
Co-head Global Value Team
Vera German
Fund Manager, Equity Value


The Value Perspective
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