How Monks is playing the AI boom differently to Scottish Mortgage

In our latest Insider Interview, Kyle Caldwell speaks to Monks Ord (LSE:MNKS)’ co-manager Mike Taylor about how its £2.8 billion global portfolio is navigating the AI boom and how its approach differs from fellow Baillie Gifford investment trust Scottish Mortgage Ord (LSE:SMT).

Taylor explains his criteria for finding under-appreciated growth companies, how Monks combines different types of growth businesses, and how the trust aims to build a more diversified portfolio than pure-play AI strategies.

• Invest with ii: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

Kyle Caldwell, funds and investment education editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio, I have with me Mike Taylor, one of the fund managers on the Baillie Gifford-managed Monks Investment Trust. Mike, thanks for coming in today. 

Mike Taylor, fund manager of Monks Investment Trust: It’s great to be here. 

Kyle Caldwell: Monks’ approach is described as investing in high-quality global companies with superior but underappreciated earnings growth potential. How do you go about searching for companies meeting that criteria? 

Mike Taylor: Well, it starts with profit growth. At Monks, we take a long-term approach, and if you look at what really matters over the long term for stock level returns, it’s profit growth. So, we want to find companies with a sufficiently large opportunity to generate that profit growth and then we want some sort of unique driver behind that company, be it a competitive advantage or a particularly able management team that will propel them forward into that opportunity. 

But at Monks, we also believe that not all great growth businesses look the same. They can be found in all different corners of the market, the darker, stranger ones. So, what we need to do is cast the net wide, and, luckily, where Monks sits at Baillie Gifford makes that very easy. We’re at the heart of the investment floor. It’s our job to harness the best ideas of the 160 or so professional investors at Baillie Gifford. 

So, we have connections, say, into our regional teams. They might be specialists in the emerging markets or the Japanese markets, and we have connection into teams that take a more thematic approach. They might solely be focused on the fastest-growing companies or the most durable dividend-paying businesses. So, we’ve got that network around us that brings the ideas into Monks. 

I guess the last piece of the puzzle is that word ‘underappreciated’ that you used. It’s critical to us to have something about an investment case that we think we have a better understanding of than the market, some sort of uncommon understanding of an investment case.

Kyle Caldwell: Monks is viewed as a less [high]-octane version of Scottish Mortgage, which is also managed by Baillie Gifford. Is that a fair description? One thing that stands out for me is that Monks does have smaller individual position sizes.

Mike Taylor: When you think about what Scottish Mortgage does, it is to focus specifically on the fastest-growing, most transformational companies: the kind of businesses where you might make a great multiple on your initial investment over the long term through the means of explosive rapid growth. 

We do that on Monks and there’s many of the holdings you’ll see in Scottish Mortgage that are also in Monks. But we combine that with other types of growing business. We’ve got those rapid growers, yes, and we also invest in more mature companies that are a bit steadier, that can grow at a more modest rate for a very long period of time. 

And we invest in companies in more traditionally cyclical industries, like the energy industry or the financial industry. What we’re trying to do is combine those different types of growing businesses together to perhaps produce a less volatile outcome than you might get in a Scottish Mortgage. It’s growth-focused, but those different types of growth add up to something slightly different to investing in one [company] alone. 

• Fund Focus: four questions to ask Scottish Mortgage
• Is fund manager optimism faltering?
• Portfolio Dilemma: what to do after a 20% drop?

Kyle Caldwell: Monks has some exposure to private companies, although not to the extent that Scottish Mortgage has. Could you explain how you invest in private companies? Do you do it directly? I know you’ve also got some exposure to another Baillie Gifford investment trust called Schiehallion Fund Ord (LSE:MNTN). 

Mike Taylor: We do both. Private companies are around 10% of Monks, and you can think of about half of that being the Schiehallion trust and about half a limited number of direct investments. Why do we do that? Well, the way the markets have evolved to this point is such that many companies that in a previous era would be public are today private. 

So, if you think about a company like Space Exploration Technologies Corp Class A (NASDAQ:SPCX), which was, until very recently a private holding, that came to the market at approaching $2 trillion (£1.5 trillion) in market cap. You don’t have to go back too long when that would surely have been a public company. 

So, we want, through Monks, to deliver for our underlying investors the best growth companies in the world, and some of them at the moment are private, whereas they previously might have been public. So, taking a limited number of direct investments allows us to do that, through Schiehallion, you get a broader mix of private.

Kyle Caldwell: You mentioned SpaceX, does Monks still have a position in the company following its IPO? 

Mike Taylor: We do, we still hold a position in SpaceX. That’s one of our rapid growth businesses. We think they are essentially creating a new industry or they are revolutionising the space industry by lowering the cost of launch, getting things into orbit. That advantage is something no one else can really do nearly as well as SpaceX. And so that lower launch cost enables new industries, new and exciting things like data centres in space. SpaceX is going to be at the heart of that evolving industry, therefore we want to remain involved. 

Kyle Caldwell: You have lots of other exposure to technology, which is a key part of the portfolio. How do you approach positioning the portfolio against the backdrop we’re seeing of unprecedented levels of spending on AI infrastructure? 

Mike Taylor: AI is the great growth theme at the moment, and I’ll say at the start, that we think that AI will change the world. This is an extraordinary and revolutionary technology that has applications that we’re only just beginning to understand. 

We’re quite close to some of the large model providers and we know that, by far, the largest use case at the movement is in coding. So, we’re asking, what happens when you expand beyond that? Artificial intelligence through the enterprise, artificial intelligence in digital commerce, there’s a massive opportunity. 

However, for us, the key is to be selective. That is our job. What we want to understand is those businesses that are positioned relative to that opportunity in such a way that in five years’ time - our time horizon - they will still have a special advantaged position within the ecosystem. If you look at how markets have behaved recently, they’ve been strong, and AI has been propelling them forward. But it’s our view that it’s been somewhat of an indiscriminate rally.

Some of the lower quality, say, or less competitively advantaged companies have done extremely well. These things tend to end when competition heats up. So, you need to be positioned around companies that have some sort of special advantage. That’s what we’ve done. 

If you look at the Monks’ portfolio, we’re in companies like Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM). That’s a company which is extraordinarily capable at manufacturing complex semiconductors. We don’t think anyone’s going to rival their processes, ability and technology in five years’ time, therefore, they’ve got the right to earn superior profits for the long term. 

Kyle Caldwell: You also have exposure to Samsung Electronics Co Ltd DR (LSE:SMSN), and a recent position for Monks is SK hynix Inc ADR (NASDAQ:SKHY). Those three shares, they’ve had very strong share price runs over the past 18 months or so, so how do you weigh up whether the valuations are still reasonable? 

Mike Taylor: I mean, it’s a fair observation, those shares have been strong. But it’s interesting to consider that the valuations of those companies, as in the multiple of any dollar of profits that the market has been willing to pay, they haven’t rallied. In fact, they’re at extremely low levels. 

So, you mentioned SK Hynix, that trades at around four times earnings. The broad market trades at a much higher level than that. So, what the market is effectively saying with SK Hynix is: we don’t believe in the durability of those profits, we think they will normalise, they will come down. 

And that has been what has historically happened to the memory companies. But we think there is something changing. The products that they are making today, the so-called high bandwidth memory (HBM) products, are much more complex and much less commoditized than dominated profits previously. 

We also were close to those memory companies, to SK Hynix to Samsung and to Micron Technology Inc (NASDAQ:MU) in the United States. And we know they’re being much more disciplined in capacity additions. Companies like SK Hynix are now buying back shares. So, we don’t think the profit normalisation narrative that the market holds is right, and those companies have a right to make superior profits for the longer term. 

Kyle Caldwell: And how do you anticipate the emerging market exposure evolving over time? There’s often been talk of places like China rivalling the US West Coast for innovation. 

Mike Taylor: The emerging markets are our largest regional overweight and it’s interesting to consider how those markets have changed. If you go back 15 or 20 years towards the start of my career, emerging markets would be dominated by resources companies and mines, oil businesses and banks, whereas today they have world-leading technology companies. 

We’ve talked about SK Hynix and Samsung. We could talk about some of the extraordinary innovation in China. We would expect that to continue and to the extent that they continue to be at the front of technological innovation, we’ll be interested in taking positions in those companies. 

It’s also worth noting that the emerging markets have moved beyond even those technology leaders. They now have leading consumer brands. We have a position in a company called Nubank (parent company: Nu Holdings Ltd Ordinary Shares Class A (NYSE:NU)) in Brazil. This is an exciting fintech. Founded about 12 or 13 years ago, that now has over 100 million customers for its digitally native bank. So, to the extent that the emerging markets will produce technology leaders and leading consumer franchises, we’ll be very interested. 

• Fund Focus: what next for Seraphim space trust?
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis
• Portfolio Dilemma: have my tech winners become too big?

Kyle Caldwell: If we look past AI, what exciting themes or trends do you expect to drive returns for Monks in the coming years? 

Mike Taylor: I think that’s a critical thing. Your starting point is right: a critical thing to do [is] to look beyond AI. The market has been very much driven by artificial intelligence and by the companies that are generating outsized profits within that. But the world is not just AI. That high proportion of profit growth does not represent the proportion of the opportunity. So, in Monks at the moment, there are a number of areas that are really interesting to us. I’ll highlight two quickly. 

One is healthcare. As you look around the world, populations are ageing and our understanding of our own genomics is increasing. Therefore, our ability to develop novel therapies is getting better, and we want access to that. So, in our portfolio, we have companies like Chugai Pharmaceutical out of Japan, which has an extraordinary research and development function. It’s actually the company responsible for developing GLP-1, the weight-loss compound sold by Eli Lilly and Co (NYSE:LLY) in a pill form. We’re excited there. 

We’re invested within the healthcare space in some of the tool providers like Thermo Fisher Scientific Inc (NYSE:TMO), which is providing the machines to do these innovative pieces of research that are going on throughout the world. So, we are very excited about healthcare.

Another area of opportunity for us at the moment are digital companies that have been unfairly sold off this year. The flip side of the artificial intelligence trade, where everyone’s been excited about silicon chips and hardware, is that many digital businesses have been sold off because there is a perception that they are under a competitive threat by AI-enabled competitors. 

For some companies, that’s right, for some companies it is simply wrong, and there are great opportunities in those businesses. Just to highlight one quickly, this year Monks took a position in a business called Axon Enterprise Inc (NASDAQ:AXON). It makes tasers and cameras for police forces, and is an American business expanding into Europe. 

The market saw that business and thought - part of it is analysing the data from the tasers in the cameras - isn’t that under threat by artificial intelligence? That’s not right in our view. It’s largely a hardware provider, and we think it’s got a protected position within that ecosystem. The fact that the shares fail 50% for us was a tremendous opportunity. 

Kyle Caldwell: And if AI does turn out to be a bubble that ultimately bursts, will the holdings that you have that are not part of the AI trade give the portfolio enough protection? 

Mike Taylor: There are two points. First, you’re right, there are a number of growth drivers within Monks that are not artificial intelligence. That could be healthcare or digital businesses, or it could be some of the brilliant idiosyncratic growth opportunities that the markets throw up at you. 

For example, we own a position in a company called Games Workshop Group (LSE:GAW) from Nottingham, and they make the little figurines associated with the tabletop Warcraft games. A very loyal following there, and an opportunity not at all related to artificial intelligence. 

So, lots of growth drivers within that. And not all AI businesses are the same. We think we’re positioned within the most durable artificial intelligence companies. They probably would be hit in a downturn, but not as severely as some of the more marginal ones, and I would expect those companies and those management teams to be able to take advantage of weakness in the market, either by acquiring competitors or investing to expand.

So, I think that combination of being selective in the right AI companies and having sufficiently diverse growth drivers in the portfolio adds up to a picture of resilience. 

Kyle Caldwell: Mike, thanks for coming in today. That’s it for our latest Insider Interview. For more videos in the series, do hit the subscribe button and I’ll hopefully see you again next time.