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The transcript from this week’s, MiB: Tom Slater, Baillie Gifford, is below.

You can stream and download our full conversation, including the podcast extras on iTunes, Spotify, Stitcher, Google, Bloomberg, and Acast. All of our earlier podcasts on your favorite pod hosts can be found here.

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This is Masters in Business with Barry Ritholtz on Bloomberg Radio.

BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have an extra special guest. His name is Tom Slater, he’s the head of the U.S. equities team at U.K. firm Baillie Gifford headquartered in Edinburgh. The firm’s been around since 1908. They manage, pick a number, almost $300 billion in assets.

They’ve had explosive growth and they are not your typical growth manager. They run concentrated portfolios. He referred to one of the funds they run as growth at an unreasonable price. But it’s worked out really well, that fund is up 112 percent, almost 100 percent more than the S&P 500.

And really, this conversation is very much along the lines of what happens when you rethink the investment process over long, long periods of time and make well thought out intelligent adjustments to how you go about selecting companies, constructing portfolios, making cell decisions which Tom points out is where so many investors go awry.

Your downside in any one stock is limited, pretty much to 100 percent but your upside is far, far greater. And as he points out, four percent or so of the total U.S. equity stocks are what has driven all of the gains over the past century.

And so, it becomes very important not to sell a stock that has potential to keep growing. And if you look at their portfolio, grow substantially. They own things like Tesla and Netflix and Alphabet, etc. This was really a fascinating conversation.

If you are at all interested in growth investing, if you want to know why having a large active share and not being a closet indexer is important as an active manager, well this is going to be the interview for you. So, with no further ado, my conversation with Tom Slater of Baillie Gifford.

VOICEOVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.

RITHOLTZ: My special guest today is Tom Slater. He is the Head of the U.S. equities team for Baillie Gifford where he has been a partner since 2012. He runs the long-term global growth portfolios which are focused on growth companies that are both listed and private.

Tom Slater, welcome to Bloomberg.

TOM SLATER, HEAD, U.S. EQUITIES TEAM, BAILLIE GIFFORD: Hi, Barry. Thank you very much for having me.

RITHOLTZ: So, let’s start a little bit with your background. How did you find your way into the investment management business? I know you have an experience in computer science and mathematics.

SLATER: Yes. That was — that was my background. I studied maths and computer science at the university. So, I was thinking probably about — about doing something in academia. It was quite an interesting and exciting time. And in the computer science world, ’96 to 2000s when I was at — when I was at university.

So, I had a very good friend that I — that I studied math with and she went and worked in the City of London, doing our finals in university and she came back, Fran (ph) — so, Fran Anderson (ph), her name was. She came back and she said to me this is the direction we want to be looking at and that’s what — that was really the first time I encountered the world of investment management, probably the summer of 1999.

RITHOLTZ: Really. That was a heck of a time in terms of the end of that last big stock cycle. Was that your formative experience, the dotcom boom and bust?

SLATER: Yes, it — in lot of ways, it was. I started to working at Baillie Gifford in September of 2002, just after the peak of boom. And then for the — for the two years, so the first two years of my career, watch markets declined substantially.

I think there’s a slight danger in calling it informative and, of course, there had been a lot of speculative excess in that period. But some amazing things have come out of it as well subsequently.

We’ve had a lot of time for the work of Carlota Perez at Sussex University in this — in this regard and the link between financial mania and subsequent technological innovation.

RITHOLTZ: Quite interesting. So, let’s switch gears. You’re an active manager and you are both selecting stocks and determining how long to hold them and I want to ask you about a quote of yours that I read where you had written, quote, “the active management industry has done a poor job of making the case for its own existence.” Discuss that.

SLATER: I think it’s a really interesting area by the — the start of it was looking at this polarization between active management and passive management. And thinking through what is the — what are we really trying to say about — about the case here? And it struck me that both passive and active had become turns that it become quite corrupted.

So, in the case of the active management industry, you see so many funds that label themselves as active that charge fees for active management, but have huge overlap with the index or low active share as it is known.

And so, what those companies are really focused on is business risk and not producing an outcome that diverges too much from the market. Because, of course, diverging too much from the market is what leads you to your clients to fire you.

And so, I think when you hear this sort of how’s (ph) from the active management industry about losing assets to passive management, in some ways, the industry has been the architect of its own demise by providing sufficient value to savers and that leads to these sort of remarkable results from the likes of claimers and (inaudible) that show there being a correlation between active share and performance.

So, you have this remarkable idea that you don’t even need to know what bets your fund manager is taking simply that the fact they are taking bets is likely to lead to a better outcome and just because the aggregate statistics are dragged down by those who are actually offering a genuine active experience.

At the same time, though, the passive management industry I think has been guilty of coming up with so many indices against which to manage assets possibly that you can’t help but conclude that it is a little more than an asset gathering exercise. There are more indices than there are stocks to invest in which was — which was threshold was crossed two or three years ago.

And so, I think both sides of this argument had become quite polarized, they’d become, at times, quite disingenuous and that’s what’s taken Baillie Gifford toward this idea of categorizing ourselves as actual investors by which we mean that we aim to be long-term supportive engaged shareholders and companies which is — which has nothing to do with taking positions relative to an index.

RITHOLTZ: So, let’s talk about one of the funds you’re affiliated with, the U.S. equity growth funds. It’s up over 112 percent year to date. I have to assume that has a substantial active share given the S&P 500 is up only 15 percent year-to-date.

SLATER: Yes. We do not look at the index when we construct portfolios. I think indices are a good way to evaluate the performance of a fund manager so long as you do it over a timescale which is commensurate with the way that much the fund has managed.

But I — I think it’s an extremely dangerous way to start constructing a portfolio. So, our portfolios are constructed, simply of the stocks that we think are further most exciting possibilities, the greatest chance of being exceptional companies by which we mean addressing large opportunities, having some form of sustainable edge and something special about the culture and the way in which they go about the task.

So, I discourage people from looking at the one-year numbers because I think one-year numbers are filled with noise and naturally extending the timeframe, looking at three years, looking at five years — is much more likely to give investors evidence or otherwise of the scale of the manager.

RITHOLTZ: So, you use a benchmark that is the S&P 500 plus 1.5 percent. I have to ask where that benchmark came from? If you were British, I would accuse you of showing off.

SLATER: I think that is actually an alter factor of method regulation that we have to — have to declare our performance objective, not just the benchmark but a performance objective for the fund.

And I think the — if I shall link that to a characteristic of Baillie Gifford, we have an extremely strong compliance culture. If you could go back in time, after the and the raid on the pension fund, who is our pension fund given to manage was Baillie Gifford because the firm has a reputation of being white and white when it comes to all of these compliance and management traits.

And that’s — that’s really a function of the fact that the firm is an unlimited liability partnership which I think is a very rare structure these days if you look at the fund management industry. But the 40-yard partners who worked directly in the firm are personally liable for the firm’s liabilities.

And so, when it comes to things like method (ph) regulations, we tend to follow the absolute (ph) letter of the law and declare our performance relative to the one and a half percent above the benchmark. In part, say, a slightly more enthusiastic way than many of our peers might.

RITHOLTZ: Quite fascinating. So, Tom, let me ask you, how do you think about both assets under management and how quickly the firm is growing when you’re out looking at companies’ stocks to buy?

SLATER: Yes. So, really interesting question. The firm was actually founded in 1908. So, if you look at the full sweep of existence, the good hasn’t been that explosive. But certainly, our assets under management have grown reasonably sharply of late.

But if you actually look at the flows of our clients, there’s — there’s significant flows both in and out and the net of those turn to numbers is just about zero. So, the growth in assets has been much more to do with investment performance and alpha-generated for our clients that it has from an exercise around other asset gathering.

And the reason for those two-way flows is a mixture of both the — our core base of pension fund clients actually (ph) reducing their exposure to equities overtime. And then also clients rebalancing their portfolios.

But in terms of how I think about it, if you — if you asked me the question today what is Baillie Gifford’s assets under management, I — I wouldn’t be able to tell you the answer. It’s a statistic that at one stage and our life used to be available on our intranet, but we purposely removed it.

And on the reason we did so is that our objective is not to grow assets under management and of itself. What we believe is that if we do a good job from an investment standpoint for our clients, if we provide a really high level of service that the assets under management figure will take care of itself.

One of the directors of the investment trust that I manage, Scottish Mortgage Investment Trust, wrote a book called Obliquity and talking about how firms had the greatest success often did that because s they pursued a different goal around delivering an excellent product or service for their customers and the success followed from that. They didn’t target those financial objectives.

RITHOLTZ: Quite interesting. Well, let’s stick with the concept of both active share and active management. It’s been — the decade has really been defined as the rise of passive and indexing and when we see firms like Vanguard at 6 trillion or BlackRock at 8 trillion, they become the 800-pound gorillas.

What should investors know about active strategies? What types of strategies can work beyond simple passive indexing?

SLATER: Well, I think passive indexing can be a great product for — and safest. I think Vanguard does a fabulous job of producing a really great value for money product for savers and doing it with real integrity.

They also have a very significant active management business and it gained — they bring that high-quality attitude towards the way they approach the task. I think that in an era where there is so much change going on, where there are companies using new business models often underpinned by technology to bring transformational change in industries that have really historically seen very little progress.

It creates pockets of growth, creation of value that if you can pop in to as an active management can be hugely valuable to your underlying clients. Now, it’s — it’s important that you clarity around philosophy and process, what you’re actually trying to do, and it’s essentially important that your fees are reasonable and don’t detract from the underlying experience with the investor.

But I think, subject to those qualifications, active management has a huge amount to offer savers.

So, let’s talk a little bit about active management, this ear is known especially the past couple of years for the high valuations we’ve seen for multiple growth companies. How should investors think about valuations? The best stocks never look cheap, but names that have looked historically expensive have done exceedingly well this year.

SLATER: One of the ways we would characterize our approach investment would be the idea of growth at an unreasonable price. And what it mean when I say that is that we’re looking for companies that address really big opportunities and went where that opportunity is often dynamic, it’s often changing.

And you have a hypothesis about why this company might be the one to benefit from that change. But we don’t know. But if the opportunity is big enough, if they — if the edge of the company is great and if there’s something special about the way it goes about that task, then it can generate a huge amount of value.

So, if you look at a company like Alphabet or Amazon, these companies have been vastly underestimated for most of their life cycle. And I think was Michael Moritz at Sequoia who said, why do we persistently underestimate just how great a great company can be?

And so, we don’t really look at multiples of net in earnings or net in sales. We look at what might this company achieve and where could it be five years from now. And I think of it that time, you can think probabilistically. There isn’t an answer to that question.

But if you — if you can identify one of those small number of companies that are big winners in markets, then they can justify paying what may appear to be optically high/short-term multiples because some of the growth opportunities at a bond today are so open-ended and you see a lot of winner takes all or winner takes most economics.

RITHOLTZ: So, I’m looking at the Baillie Gifford U.S. equity growth funds. The top 10 holdings are fairly concentrated. It’s about 55 percent in the portfolio with a lot of names that I think a lot of people would recognize. Tesla, Amazon, Shopify, Wayfair, Netflix, Alphabet, MasterCard. I have to ask about Chegg and Trade Desk, two companies I am not all that familiar with.

SLATER: Yes. If you look at those two companies, Chegg is an education platform. I think there are — there are a lot of challenges faced by the education system. And what Chegg has done is through a direct-to-consumer model based around the questions and answers products.

It is helping students to get measurably better outcomes in their examinations. But around that and on top of that, they can build all sorts of products associated with student access. And in an environments where college education is so expensive and inflation is so high, actually providing a cost-effective solution that demonstrates value of money for students is something that I think has a huge potential runway.

If you — if you talked a little bit about this year and the unusual traits of this year, I think what this year had shone a spotlight on is that the challenges, the education sectors faced in embracing digital tools, digital methods of delivery. Infra (ph) management industry, here I am working from home, using a whole array of cloud-based services, it’s probably made me more productive, not less productive.

But if I look at my children and their educational experience at these stay-at-home orders have come through — it’s really shone a spotlight on how slow the education sector’s been to embrace some of these tools. Now, Chegg is a company that is run by, its founder, they have significant amount of equity tied up in of their wealth, tied up in the equity of the business. Its run with a very long-time horizon, exactly the type of characteristics that we’re looking for and — in a long-term growth businesses that we invest in.

I would say if you — when you talked — you talked a bit about some of those top holdings and if I was to pull out a difference, perhaps, in a way we approach the task, this is — versus some of our peers, it would be in the — in the longevity of the holdings.

So, Amazon, we bought in 2005. So, the holding period, thus far, has been 15 years. And Tesla, 2013, it’s been seven years. So, it’s the time horizon, not the recent growth that I think is the really important defining characteristic.

RITHOLTZ: Quite interesting.

VOICEOVER: Masters in Business is brought to you by T. Rowe Price, delivering a strategic investing approach with a long-term perspective to help advisers and their clients feel confident through a variety of market conditions. Since 1937, T. Rowe Price, invest with confidence .

RITHOLTZ: So, Tom let’s talk a little bit about passive. You’ve talked about why active doesn’t do such a good job of explaining their own existence, kind of left the field all alone to passive. But I want to come back to another statement you made, quote, “the average active manager will underperform the market.”

Unfortunately, this statement is mathematically inevitable. Isn’t that essentially the underlying argument in favor of passive?

SLATER: Yes. And I guess what — what I was getting at is if you say the market is made up of all active and passive approaches to investment, then after fees, you are — you’re guaranteed to see the approaches underperform whatever the benchmark is and since the fees of managements are higher, the fees on passive management, you’d expect that that in some, they want to, as a group, underperform on by a greater amount.

Because I think you have to come back to some of the challenges around what is active management and there are some rules of — and not even rules of some but there are some interesting academic results in this area.

One, we’ve touched on is that simply having a higher active share correlates positively with performance outcomes. But I think in the subsequent academic results have shown that time horizon is also important in this. And as you extend the time horizon, the academic evidences is also supportive of better outcomes for active management.

So, I don’t think the average is a matter of great deal, it’s much more about can you — can you find an investment manager with a philosophy and process that you believe in. Do they keep their fees to a minimum so that you, as an individual, have to — have the best chance of outperforming because the fees are the one part that we do have certainty about.

And then it’s — when you believe who have found a manager that meets those criteria, if level changes, then stick with them through inevitable performance cycles.

The oldest client I manage money for at Baillie Gifford is Scottish Mortgage Investment Trust. We’ve managed that fund for 112 years through the Great Depression and to World Wars.

And unfortunately, the performance numbers that come out of that are not GIPS compliant. But over that 112-year period, it is — has been a phenomenally attractive thing for investors to be invested in in an actively managed fund.

RITHOLTZ: Quite interesting. For Americans who may not be familiar with what the Scottish Mortgage Trust — Investment Trust is, can you explain a little bit exactly what that entity is?

SLATER: I can. Yes. It’s a close-ended investment vehicle listed on the London Stock Exchange. It’s capitalized at around $25 billion. It’s a member of the FTSE 100 Index. But it’s really a collective investment vehicle that was raised in originally in 1908 and the fund structures that invested in the time.

But it’s an incredibly flexible structure. It has an independent board of directors who are extremely valuable source of console and advice for us as the managers who do a great job of protecting the interests of the tens of thousands of independent shareholders in the trust.

And it’s a very flexible structure being — being closed ended in a permanent tool of capital, allowing us to invest in both public and private companies.

Really, on the basis of where we find the most exceptional opportunities without worrying about a company’s public or private status. And in an environment where many companies are able to grow very rapidly with very modest capital requirements often staying private for longer. It’s a structure that allows us to maybe maintain the opportunity set of investing in the world’s greatest growth companies.

RITHOLTZ: So, let’s stick with the idea of private. Generally speaking, were seeing companies staying private for longer as you mentioned. They’re not IPOing as often and there’s clearly no passive comparable sort of fund for pre-public companies. How different is making the stock selection decision about private companies compared to what we see for publicly-traded firms?

SLATER: We have to be clear about what we’re trying to do here. We’re investing in growth companies and companies that were beyond venture capitalists, we’re not going in and funding two people in a garage. We’re — but we are investing in companies that have chosen to stay private, possibly because into today’s world where your addressable market is 3 billion people globally that have a small firm, where you can address that market without investing so much in significant capital, you would pay five percent of revenue to Amazon Web Services, pay 30 percent to up app store.

And then suddenly, you that 3 billion people is an addressable audience. Another result with very modest capitals and investors, you can see that the most successful companies really grow to phenomenal size very rapidly.

And so, our observation was the — these are companies in another era that we may well have been investing in, anyway, because they would have come to public markets at a much earlier stage.

So, I think in terms of the decisions by investment, there’s very little difference. There are some technical differences there are in the legal negotiations around the type of shares. But I think that’s sort of slightly tangential to the to the core task of picking the — picking the investments.

I think the other thing to comment on is the cost of which this can be done. The ongoing charges of Scottish Mortgage Investment Trust is around 36 basis points, so just over a third of one percent. And I think, for our shareholders to get access to some of the world’s most promising private companies within that type of cost structure is game changing.

RITHOLTZ: Quite fascinating. So, the equity markets in the U.S. have been dominated by the FANG stocks or the FAANMG stocks if we throw in Microsoft, Facebook, Apple, Alphabet, Amazon, Netflix, Google. I guess we could add even another A if we change Google to Alphabet.

These are the companies dominating today but they weren’t the dominant companies 20 years ago. Are these going to be the dominant companies 20 years from now?

SLATER: Well, I think the first thing that we ought to be careful of is how we talk about these companies. I try to ban the use of term FANG internally. And the reason is that it creates this idea of equivalence, that this is — these group — this is a group of companies driven by the same growth drivers, but also affected by the same risk factors.

If you go back 15 years, we were all talking about the BRICs, I think an acronym coined by Jim O’Neill. But it was an emerging markets, Brazil, Russia, India, China. Now, if you — if you actually look at what’s happened since that BRIC acronym was coined, China has created an economy, a new economy two times the size of the other three combined.

So, they were really never that alike as economies in the first place. And so, we try to think about these companies separately from one another. Amazon remains one of our largest holdings. And I think there, we see a runway to a much bigger business as you — as you look at some of the different components there from the general merchandise business to its movement to grocery and in the retail space to its moving to new geographies such as India.

But also, it’s in — this sort of intangible quality of being able to move into areas that they are somewhat adjacent to where they are, but where it’s very hard for people to imagine their progressive. So, I strongly believe Amazon Web Services is just about the most important business that exists in the world today.

Now, Wall Street is very good at valuing today’s products, today’s market. It’s very bad at anticipating or valuing imagination and ambition. And that has been such an important driver of value growth at Amazon.

So, I think these companies, over the past decades, when everybody’s been searching for who is the next Alphabet, who is the next Facebook, who is the next Amazon? What we’ve seen is actually those companies have reinvented themselves, they’ve got stronger, they’ve got bigger, that they sucked in economic activity from across the Internet and also from the real economy.

I think it’s a much more nuanced question for some of these companies that you — when you start out trillion dollars of capitalization. So, what excites me is that you see some of the technologies that have driven this transformation in retails, these transformation in media over the past 20 years, being applied to areas which have just didn’t seem nothing alike that pace of change and I think that creates a whole new raft of opportunities in areas from insurance to real estate to automotive industry.

And I think sort of one of the things that’s so exciting for a growth investor at the current time is just how we’re seeing the broadening of the impact of Moore’s Law, of the ubiquitous mobile communications of advanced software across huge sways of the economy.

RITHOLTZ: So, let’s stick with the concept of AWS and some of their competitors. Obviously, Microsoft is a key competitor. A recent IPO, Snowflake, is a company that went public and they seem to be in a similar space and they quickly scaled up to like $100 billion market cap.

How do you look at moats that these various companies create? Is Amazon now just a behemoth that can never be taken down or will anyone ever managed to penetrate the moats that they’ve built?

SLATER: I mean, I think ever is a long time. But some of the thigns we do know about — about Amazon Web Services business is, firstly, that the addressable opportunity is very, very large. You trillion dollar plus market for IT infrastructure.

We know it has a very strong first-move advantage that it’s got to a scale long before others. If you listen to Jeff Bezos, the Amazon CEO talk, he would day he was amazed at the — at the head start he was able to get in this business.

RITHOLTZ: Right.

SLATER: I think — I think few people appreciated just how fantastic the economics of it could be. And I think scale is a self-reinforcing advantage here that it allows you to invest in infrastructure and beta service on the bigger datasets, I mean, better machine learning which means better outcomes for companies which means you attract more companies.

So, I think it is — an infrastructure is in a very powerful position. I think Microsoft has been very well using its distribution into the enterprise space to really get itself back into the game. And I think, it remains to be — to be seen how Google’s offering under the leadership of Thomas Kurian competes from here because it’s obviously a company with phenomenal technological prowess.

But this shift in enterprise from on-premise to the cloud is one which I think phased out over the 10 or 20 years. And is of enormously large size. So, I think the capitalizations that you mentioned, sort of a touch (ph) of things such as snowflake reflect the fact that investors are starting to incorporate just the longevity of the shift into their thinking.

RITHOLTZ: So, we’re talking about some pretty gigantic industries and companies but when we think about growth going forward, all these companies today, they didn’t — many of them, anyway, didn’t really exist 5, 10, 15, 20 years ago. So, that leads me to the question, where are the big opportunities out there that aren’t already dominated by these behemoth firms?

SLATER: Yes. I think one of the interesting dynamics that were seeing in the market today is around the companies that are providing scale as a service. And what I mean by that is that the biggest online players have — had phenomenal resources at their disposal which has been very hard to compete with.

But if you look at something like a Shopify, what that company has created is a platform for merchants to compete on a more equal footing with the likes of Amazon and Wal-Mart, by providing them with the tools to create their online store, the same sort of browsing experience for their customers, the access to a payments gateway, increasingly access to two days’ fulfillment.

And so, they’ve created that scale themselves. And then, as they’ve got — as they’ve attracted more and more merchants, they can then negotiate better and better terms with their suppliers and pass us on to the smaller merchants. So, they’re really scale to those underlying customers.

Now, Shopify is doing that in the retail area. But if you take good company like Strip in payments, that navigating the payments infrastructure is a phenomenally challenging things, right, because it’s different regulations, there’s different banks in every geography that you go to different business practices. Almost impossible for small businesses to incorporate payments on a global scale and to what they’re doing.

But what Stripe has done is navigate that incredibly complex world and then make it extremely simple for individual companies to then incorporate that capability into their — into their website.

And I could go on with this. Companies like Twilio doing exactly the same thing in communications and providing a gateway into this incredibly complex communication networks.

So, I think this one really interesting angle is around those — the set of companies selling — selling scale as a service into smaller merchants. I think the other angle I would go at it from would be about those companies that harness this new worked that we live in, this technology-led world to use new business models in established industries.

So, insurance is an interesting one. We invest in Lemonade, that IPOed recently. I think what they’ve done in creating a completely digital experience today for their customers in terms of accessing their insurance products, in terms of making claims, just is really challenging for business models that are based on mainframe computing and expensive — extensive distribution.

But I could go on. Redfin in real estate is another example of that. If you can create — if you can pop into a direct relationship with the consumers through your website, if you have an agent — directly employed agent force but give them all their digital tools to make them more effective in their jobs, then I think that gives you big competitive advantage over traditional incumbent.

RITHOLTZ: Quite interesting. So, I have to ask about the impact of the COVID-19 pandemic. How has that affected your thought process about the companies you want to have in your portfolio, how much of what you own has really been in the right space to deal with a work-from-home, shelter-in-place pandemic, and what happens to those companies sometime next year once we see widespread distribution of the various vaccines that have been developed?

SLATER: Yes. This is a really interesting area and I think, for sure, a lot of the companies that we owe and have been beneficiaries of the circumstances we find ourselves in, we own Zoom, the video communications platform which we bought in early 2019.

But if you stick with that one for a moment to maybe explore some of the issues, the insight that we had when we participated in the IPO of Zoom was that video communications in the enterprise was massively underpenetrated. If we having this conversation a couple of years ago via videoconference, by what I think we would’ve done is that your IT team and my IT team would’ve arranged a meeting. They’d have gone into a room that sits somewhere in our offices but’s only used for videoconferencing and spent about half an hour trying to set up the call and then being on hand when we actually try to do it in person the next day.

But — so the constraints on much broader use of videoconferencing was that it was a dreadful product. And as you created a much more engaging user experience, as you made it possible for people to just do videoconferencing, that you would see an explosion in the scale of the market, and also a viable selling dynamics that if I phoned you via Zoom and you had a good experience, you’d say what’s this product? I’m going to use it.

And I think that was — that dynamic was unfolding through to 2019 but in — with the impact to virus, usage has exploded. And I think now, you talk about maybe 300 million users of this service. I think the last number I saw was that they had 11 million paying customers.

So, what happens going forward? Well, if the vaccines are as effective as we hope, then I think we will all be having a lot more in-person meetings because everybody is fed up of being cooped up at home. They want to get out.

So, the unprecedented level of demand that we have today, of course, declines. But then the question is, everybody knows what Zoom is and I’m not talking about people in the IT departments in big enterprises, it’s become of a million of salespeople and marketing people and people in education understand this product now.

And so, of the billion knowledge workers that are on the planet, how much of that is addressable for this company and starts with 11 million licenses. And I think those are the really challenging questions. It’s not we’ll demand the client. Of course, it will decline as we come out of lockdown.

And I think if you — you’ve expanded that more broadly, one of the frameworks that I’ve I found really helpful and it’s worked on with — by one of my colleagues, Dave Bujnowski, he’s a fascinating analyst. But it’s drawing on an idea of accumulated that accidents.

So, this idea that what were the structures that were the norm before COVID hit. But when the sort of local maxima (ph) or the perfect way that something should be done, but instead just the product of accumulated accidents overtime.

Because I think those are thing things that are — we’re unlikely to go back as COVID starts to unwind. And let me talk about it as an example. In advertising, a great deal of television advertising is sold a the upfronts in New York each (spring).

And it’s where big advertisers will go and bet on the content slate of the broadcasters and spend significant chunks of their marketing budget for the year.

Now, in a world where we have connected television a huge amount of data about the audience that content has been broadcasted, particularly through connected television, platform site, Roku, does a ceremony like that persist or do — they’re much more effective data-driven advertising products of the — of the digital age, now start to make significant inroads into that market?

And so, I think it’s — that’s a really helpful framework to us in trying to think about what the — what the post-COVID world looks like.

RITHOLTZ: So, let’s stick with that theme of data analytics and how much more information both clients and investors get. We mentioned earlier, you graduated from Annenberg with a degree in Computer Science with Mathematics. How much quant do you use in your investing process, or as differently, how important are all the metrics that are available today to be crunched versus 20 years ago to your process?

SLATER: I’ll answer that in two ways if I may. I think the first is that our process is very qualitative. What we’re trying to think about are what are the drivers? Where the revenues of this company be 5 or 10 years from now? What are the competitive advantages which is really getting into questions about — about profitability and margins?

But what is the corporate culture? What is it about make — that makes this business special? Why can’t somebody else do it?

And we think if we can answer some of these more causative questions, I think it gets you — it gets you to broadly correct answers. The left of the decimal point, if you will. And I see much more value in not for us than this — what we see in markets which is this is constant attempt to predict where the company will end this quarter or next quarter more accurately than everybody else.

Which is, again, we think, firstly, that we have no advantage in and it’s so important for an investor to be able to articulate what they think their own advantage is, we spent so much time asking of companies but so little time asking it of our selves. But we have no advantage in that more precise estimation of short-term earnings than anybody else.

But we do have being in Edinburgh, having a bit of distance and perspective on what’s happening in financial markets is maybe that ability to be patient in the — in this most impatient of industries. We think that’s more likely to add value for our clients over time.

Another take on it would be that if I — observing what’s been happening in our companies over — over the past five years, maybe a little longer, is just seeing the impact of machine learning and artificial intelligence and what these technologies are capable of. And its ability to ingest huge amounts all quantitative data and spot patterns in a way that a human just isn’t capable of.

And so, we’ve been having an experiment within that effort (ph) looking at could we apply this same technology to recreate the human investors that we have. And so our systematic investment strategy which we started incubating in the past couple of months were — after three years of investment in the team and the knowledge and algorithms is our own experiments trying to disrupt ourselves in going about the task of investment.

RITHOLTZ: Quite interesting.

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RITHOLTZ: I have to ask you a question about — a little bit about some of your background relative to being a U.S. and a global investor. You worked on the developed Asia team at Baillie Gifford and you also worked on the U.K. equity teams. What was the take away from that experience when you’re either looking at U.S. investing or global investing and how different is investing in those areas versus, let’s say, the U.S.?

SLATER: Well, I think, for most of my career, the emergence of China as a global economic superpower has been an absolutely central phenomenon in the world of investing. And not only its economic rise, but the emergence of companies on the East Coast of China with a innovative capacity and entrepreneurship to match some of those that you have on the West Coast of the U.S.

And so, I suppose the, well, one of the things I take away from my experiences is just an appreciation of that phenomenon. Helped by some of my Chinese colleagues, helped by the fact that we’ve now opened an investment office in Shanghai where neo f my partners has moved out from Edinburgh, some of my Chinese colleagues have moved back to China as part of that effort. And a really important part of understanding what’s going on in the world is understanding some of those developments.

I think in looking at the U.S. with an international perspective, can yield insights that are just aren’t looking for? So, I link it to Netflix and because I think this — there’s a few points in that that are really relevant to our process. What we’re trying to do is look for big winners.

On the sort of time horizon that we have, so 10 years, you see this hollow distribution in stock market returns. You see a very small number of big winners.

And so, what we’re trying to do is identify companies with that sort of potential and then where we find them aim to be very patient in long-term owners, accepting that at times we live very out-of-favor with the market. And one consequence of that approach is that actually, the biggest mistakes that you make are not stocks that you own which go down — which are inevitable. I make lots of mistakes.

But it’s the ones that you look at, doing assets on and you don’t buy that then turn out to be big winners. And I put Netflix into that category for us. We were looking at it back in, I think it was 2012, around by the time they split, they been on to the plan to split the streaming and that DVD business.

And with which — which was taken very badly by both their customers and the stock markets. And we didn’t take the plunge and buy the stock at that point which is — which I feel as one of my biggest mistakes over the past 10 years.

But then, so looking at the stock, maybe three years later, and it was up a lot at that point. And of course, it’s very difficult to buy a stock that’s gone up severalfold since you’d last looked at it.

And but I — but what stand out for me and what are the loudest to make that purchase despite the stock price having increased was looking at the progress of the international business, the U.S. investor base in Netflix at the time was almost singularly-focused on the U.S. subscriber additions in any single quarter.

RITHOLTZ: Right.

SLATER: And because the international business wasn’t making much money at that time. And I think our insight was that it did seem for a long time that Netflix wouldn’t get away with what it had managed to achieve in the U.S. in other markets because the incumbents would see what had happened and they wouldn’t let it happen. And our insight was that this — they’ve managed to turn all these markets in one sweep and that the traction that they were getting would ultimately lead to an extremely profitable business.

And so, it was that ex-U.S. piece, when everybody else was focused on the U.S. subscriber base, that I think was our insight at that point.

RITHOLTZ: So, let me raise an interesting question about this. You mentioned a number of different companies, a number of different stocks, how did they fit into managing a portfolio? It’s obviously the analysis of a single stock or any stock is certainly very different than constructing a portfolio? How do you think about weight, portfolio weights, how do you think about different positions you run a fairly concentrated portfolio, so there aren’t a whole lot of openings for any one given company?

SLATER: Yes. So, the way that I think about this is it comes back to this asymmetry of returns or the concentration of returns in a small number of companies. So, I was doing some work on this back in 2012-2013 and the starting point for me was actually trying to think about outcomes for individual companies, and how — I was looking at Amazon and said it had a 100 percent upside and somebody else is looking at Alphabet and said it had 200 percent upside, how could we think about those different outcomes and how would you attach (inaudible)?

And the way I looked at it was actually inspired by Kahneman’s book, thinking about base rates. So, let’s look at the past 30 years of the S&P 500. What can you say about stock returns? And there was one rule that you missed which is actually quite consistent through time which was that in any five-year period, about 5 percent of stocks go up fivefold, at least fivefold.

And so, one of the things we focused on is how this company got the potential to go up at least fivefold and why is it more likely for this company than a stock picks at random.

And the implication of that for portfolios is quite interesting because what you’re saying is that if you have a buyer (ph) in the whole portfolio, a huge proportion of the return is going to be concentrated in the top two or three successful holdings. So, come back to — come back to this point about what is a mistake? People rightly focused on cell discipline and what cause you to sell a stock?

But actually, the biggest danger for long-term buy-and-hold investor is that you sell a stock prematurely and that you don’t capture that outside impacts of that small number of companies.

There’s a really interesting piece of work done by an academic Arizona State University fairly recently, Professor Bessembinder and he looked 90 years of U.S. stock market data. And what that showed is of this 26,000 companies that you could have invested in over that period, all of the return came from just four percent of the companies.

But in fact, it was even more concentrated than that. So, there was about — I think it’s almost where there was about $32 trillion of excess value created by the U.S. equity market over that 90-year period. And of that half of the excess value creation came from just 90 companies.

So, stock markets are driven by a really small number of exceptional companies. And so, what we mustn’t do as long-term investors is truncate the impact of those big winners. So, go back to talking about it in both the specific examples, since buying Tesla seven years ago, I don’t know how many times I’ve been told to sell.

It’s had seven or eight drawdowns of at least 30 percent in that period. And every time it goes up, people are going when are you going — when are you going to sell? But it’s actually not unusual to see a big winner like Tesla. If you look at over that timeframe.

That’s being the case of Amazon over the past 15 years. That’s been the case for us with Tencent, the Chinese gaming company over the past 12 years. Maybe we have not quite the same attraction of headlines that Tesla has had but it — the structure of returns is clear. It’s that small number of big winners.

And so, we — to directly answer your question about the structure of the portfolio, where we still see a path to significant upside, where we see an evolving opportunity were very low to sell stocks that we think of capitalizing on the opportunity in front of them and we allow them to become a big part of the portfolio.

RITHOLTZ: Quite fascinating. I know I only have you for a limited amount of time, so let’s jump to our favorite questions that we ask all of our guests and — and since we’re just talking about Netflix and Amazon, let’s start with that. Tell us what your streaming these days. What are you watching? What you listening to while we’re all stuck, sheltering at home?

SLATER: Yes. And I think like most people, I am enjoying the fourth series of “The Crown” on Netflix at the moment, addressing a really interesting period and — in the British monarchy. I’ve also been enjoying “Ted Lasso” on Apple TV and just a great, great commentary on the power of positive thinking.

I think — I think we’re in just a fortunate position that there’s so much great content out there at the moment. I think one — the piece that I — that I’m really looking forward to this been delayed by the coronavirus is Denis Villeneuve’s adaptation of the “Dune” which I think is coming next year.

But one of my favorite science fiction books and we were in Jordan a couple of years ago and (inaudible) where the film is set, so I think that is going to be an spectacular movie.

RITHOLTZ: Yes. I believe that’s teed up for HBO Max if I — if I recall what I — what heard about it most recently. And I loved the first book. Had a hard time getting through some of the latter books. But it has defied an outstanding film version. Hopefully, this is the one that will break that unlucky streak.

So, let’s talk about mentors. Who are some of the people who helped shape your career?

SLATER: Well, you mentioned I — so first of all, I unlike most of the investment partners at Baillie Gifford, I’ve spent my whole career at this. And starting back in the U.K. department with In Iain McCombie and Gerard Callahan, Charles Plowden who — I think our U.K. team back at that point was just a powerhouse in the U.K. equity market and embrace the tools of free cash flow yields, et cetera, that was effective through the 2000s.

And I think I learned a lot about the morality of investing from them. I think become the deputy manager and then co-manager of the Scottish Mortgage Investment Trust and I’m working with James Anderson who’s been at Baillie Gifford for 36 years and just what I’ve learned from him about both — retaining just absolute curiosity and focus on companies and focus on process and differentiating process and having ambition in what we’re trying to do, such an important mentor for me.

As well as, in fact, Max Ward who si the manager of Scottish Mortgage before James. And again, exemplified that the power of positive thinking and optimism which I think is so crucial to generating long-run (ph) investment returns.

Quite interesting. Let’s talk about everybody’s favorite question. Tell us about your favorite books. What do you like to recommend, what are you reading right now?

SLATER: Well, I think — when it comes to investment, I believe some of the best books about investing aren’t written about investment at all. It’s getting to read about people interacting with complex systems and lots of other settings. So, “The Psychology of Military Incompetence” by Norman Dixon and “Deep Survival” by Laurence Gonzales or some of Atul Gawande’s books of medicine.

I think there’s lots of interesting bits in there for an interested investor. But this is one crucial point to remember which that in investment, the upside is unbounded and the downside is constrained. Where, then, I think all of these other settings, the downside is catastrophic.

You kill the patient, you die in a survival situation, you lose the war. So, long as you can make that mental lead, I think that’s some of the most interesting literature on an investment. In terms of what I’m currently — currently reading to — the just finished Reed Hasting’s book on the culture of Netflix, some fascinating observations in there.

I’m reading Linked at the moment which is by the impacts of complex networks and so many fields of endeavor. But all of those, I listen to on audible when I’m out running. That’s become my reading time these days.

RITHOLTZ: Quite interesting. What sort of advice would you give to a recent University graduate who was considering a career in either finance or growth investing?

SLATER: I worry about graduates who are considering a career in finance or growth investing. I think being interested in financial markets is not likely to be a good indicator that somebody is going to be good investor. I think a much better indicator is whether they’re interested in companies, whether they have that curiosity about business models, what makes a company work fascinating entrepreneurs.

I think all of the piece around interacting financial markets, there’s a sort of — there’s skills that you can teach someone. But financial markets are intrinsically interesting in and of themselves. What’s much more interesting at the underlying companies. And if you can — if you can make good judgments about those things, I think the finance piece looks after its — after itself.

I used to — I used to run the graduate recruitment for investors at Baillie Gifford and one of the things we tried very hard to get away from was in business — business studies or economics graduates and try to get much more into the liberal arts where I think you could get people with curiosity but that weren’t consumed at that ambition to work in finance.

RITHOLTZ: Quite interesting. And our final question, what do you know about the world of growth investing today that you wish you knew 20 or so years ago when you were first getting started?

SLATER: I think it’d be the extent to what — that what you do influences your views. It’s the wrong way around to think you can sit and think about things and then that should influence what you do. Instead, it’s — you’ve got — you’ve got to — you don’t sit behind your desk and pontificate, you’ve got to get out into the world.

There are so many interesting sources of information. Some management is — it gets most of its information from a very small number of people, situated mainly on London and New York. But there’s a whole world out there. I’ve moved my family out to Silicon Valley on three different occasions and done extended trips.

And the people that you meet, the entrepreneurs, the investors, they — they can shape the way you view the world in a way that’s — that’s extremely helpful to the job. So, get out and do things and meet people.

RITHOLTZ: Quite interesting. We have been speaking with Tom Slater. He is the Head of U.S. Equity Growth Investing at Baillie Gifford.

If you enjoyed this conversation, well, be sure and check out any of our prior, nearly, 400 such discussions. You can find them at iTunes, Spotify, wherever you get your podcast fix filled.

We love your comments, feedback, and suggestions. Give us a review at Apple iTunes. Write to us at mibpodcast@bloomberg.net.

You can check out my daily reads @ritholtz.com. Check out my weekly column on bloomberg.com/opinion. Follow me on Twitter @ritholtz. I would be remiss if I did not thank the crack team that helps put together this conversation every week. Maru Ful (ph) is my audio engineer. Michael Boyle is my producer. Atika Valbrun is our project manager. Michael Batnick is my head of research. I’m Barry Ritholtz, you’ve been listening to Masters in Business on Bloomberg Radio.

 

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