The firm’s mandates include all or portions of the underlying portfolios for several Vanguard funds. Coutts and Burns co-manage approximately two-thirds of Vanguard International Growth Fund, and Burns co-manages Vanguard Advice Select International Growth Fund.

Note: The interview was edited for length and clarity.

Burns: We’ve had a number of years of unprecedented challenges and volatility. It’s been crisis on top of crisis. On top of that, you’ve had an unusually high inflation environment like we haven’t had for a very long time. That probably would have happened anyway, as part of the reopening after the pandemic and supply shortages, but it’s obviously been exacerbated by Russia’s invasion of Ukraine.

Coutts: We’re in what historian Adam Tooze calls a “polycrisis.” Predicting the course of any crisis individually is difficult, let alone how the crises might all interact.

Burns: Dealing with inflation, it’s good for some companies that have pricing power. Those that don’t are facing difficulties. The other aspect, particularly for equities, is the time value of money, with discount rates a wild variable. You’ve got all of these things going on at once, making it very difficult to know what will happen. As Benjamin Graham used to say, in the short term the market is effectively a voting machine; you’re always guessing how other people react to that information.

We have to think about the environments companies have to operate in the short to medium term, but we continue to focus on where they might be in 5 to 10 years’ time.

In the long run, radical innovation will always matter, irrespective of the inflation environment. I think about MercadoLibre, which operates in Latin America with very difficult political and macroeconomic environments, including inflation rates that make ours look tepid by comparison. Because the secular shift toward e-commerce and online financial services has been so strong, it’s still one of our best contributors by far and it’s gone up many multiples in value despite that difficult environment.

As a fund manager, as an investor, you have to know what your circle of competence is, where you have a possibility of having an inside edge.

We’re focusing on the fundamentals of companies that are driving innovation and change, and with the help of others, we have some experience, some insights around that. Whether these companies are able to drive radical innovation, that’s the key thing that matters and should be valuable irrespective of the broader context.

Burns: The world is a very big place. There are a number of exceptional U.S. companies, some of which are genuine industry leaders and irreplaceable. But that doesn’t mean we’re not seeing radical innovation and exceptional outcomes elsewhere.

ASML in the Netherlands is one example. It’s not a company that many people have heard of. It is the sole supplier of EUV photolithography machines, which are needed for the most advanced processor chips. They’re integral in driving Moore’s Law—the doubling of computing power every two years—and ASML has a monopoly on a technology for an industry driving the bulk of the profits in the future. There is no U.S. equivalent.

We’re seeing places outside the U.S. building out their own venture capital ecosystems to help fund and create some of these great growth companies. We’ve seen that a bit in Europe, in particular around Berlin and Stockholm. We’re seeing it in the early stages in Latin America. There’s a range of different opportunities, and some of those markets will be growing faster than the U.S. both in population and in economic terms.

Coutts: We have two broad categories of growth companies that we invest in. We have adaptive growth businesses, which you might think of as consumer-based, franchise-type companies that have been around for many years and will continue to be around for many more. There are a small number of such high-quality businesses that do well no matter the economic environment. L’Oreal and Kering are examples of such companies that we’ve held in our portfolio for 10 years or more.

Then we have the areas of more extreme growth around continued technological innovation and disruption. We’re seeing Moore’s Law in effect broadening out over the next 10 or 15 years from largely consumer internet-based companies to other areas of the economy such as health care and, at an early stage, the energy transition.

Burns: If you stretch out Moore’s Law to a little over a decade, you get a sixtyfold increase in computing power, so that tells us that the world should look materially different. Growth investing is based on change—the more change you think there's going to be in the world, the more opportunities there’ll be around growth. 

Coutts: We think that there is a structural bias to short-termism in financial markets, particularly in equity markets. We deliberately try to push against that and take as long-term a view as we can. The work of people like Professor Hendrik Bessembinder at Arizona State has shown the value of compounding—of letting winners run for as long as you can.¹

Interrupting compounding is one of the worst things you can do as an investor. We think the bias should be to take a long-term view and to let innovative, creative executives find the new growth opportunities. Give them the time and patient support needed for the best chance of success.

Burns: We focus on the upside because mathematically that’s what’s going to matter more to client outcomes, because equities are asymmetric. Obviously, we don’t want to invest in a company and then find out it doesn’t work and lose money. If you buy something at $100 and it goes to $50, you’ve lost $50—that’s not good. But that will happen when investing within a large portfolio, and your job is to learn from it and try to reduce the risk of that happening again.

But the real risk is that you don’t buy a Tesla or a MercadoLibre. If you pass on a high-potential company at $50, then it goes up tenfold to $500, you’ve missed out on $450. So that’s a much bigger difference in terms of what determines long-run outcomes for clients.

What’s the biggest mistake we can make for clients? It’s not the sin of commission—buying something that doesn’t work out. It’s the sin of omission—failing to buy that next big asymmetric winner. That’s why we focus on the upside. Human beings and the financial industry tend to focus on the downside anyway. Most people don’t want to be wrong, so they focus on the downside to avoid that.

Coutts: You need a team of people who are absolutely philosophically aligned to the task we’re trying to do for our clients. You need clarity of alignment around the strategy or nature of the task you’re trying to do. Within that, it’s good to have a plurality of views, a diversity of perspectives around individual companies and the strengths or weaknesses of those businesses.

A challenge to successfully identifying and, more importantly, owning the outlier companies that Lawrence has talked about is groupthink. There are two aspects to getting something in the portfolio. There’s the analysis, and then there’s the advocacy part of persuading my colleagues; that’s an entirely different set of skills and an entirely different process. Ideally, you want to strip out the advocacy as much as possible and see if the analysis is so good on its own that I will back your judgment on this company.

Burns: One of the things the most exceptional outliers have in common is that they are controversial. That’s what gives you part of your upside when you first look at them—most people think they’re going to materially fail in some way and be embarrassing to own. Look at the more successful investments over the last 20 years, Amazon and Tesla among them. People took great glee in citing the many ways they might not work out. It’s the controversial ones that, more often than not, make the biggest difference to clients in the long run.

Coutts: There’s an important point here around what not to do as an investment team. One of the quickest ways for things to go wrong in a group is for people to start pointing fingers of blame. Now, with some of the stocks in the portfolio down 60% or 70%, there have been absolutely no situations where we sat around the table and said, “Why did you put this in the portfolio? Why did we own that?”

It’s about collective ownership for the entire portfolio. You need to create an environment of psychological safety where people are willing to take risks—to intelligently take risks—on behalf of our clients for the next great growth companies, while having the absolute certain knowledge that some of them will fail and even some of the most successful ones will have periods where they look like they’re failing. If you don’t have that environment of psychological safety and trust in the group, you will never get the next Amazon or Tesla.

Thank you for a great conversation.

• Baillie Gifford
• Vanguard International Growth Fund
• Vanguard Advice Select International Growth Fund