LTGG Reflections: Risk

Your capital is at risk. This communication is for professional clients only, not retail.

Our task is clear. We seek to deliver exceptional returns for clients over the long term by investing in a concentrated portfolio of what we believe to be the world’s leading growth companies. To succeed in this objective, we pay very close attention to the following three observations from our 20 years of managing the LTGG portfolio:

1. The high-growth companies that deliver multi-bagger returns in the long term are also among the most volatile in the short term. The risk of bouts of volatility, while painful, is ultimately irrelevant to LTGG’s long-term objective.

2. Even for a portfolio of outliers like LTGG, only a few companies drive the majority of return. Most holdings don’t matter. While the permanent loss of capital on failed investments is a real risk, such losses are vastly outweighed if even just a few multi-baggers are held at scale and over time. Downside is capped; upside is limitless.

3. Considering the above, the greatest risk facing the LTGG portfolio is that of missed opportunity. Failure to identify and hold the multi-baggers of the future is what keeps us up at night.

Finding the next generation of outliers for the portfolio is no mean feat. As ever, we address the risk of missed opportunity by undertaking bottom-up fundamental analysis. Our 10 Question Stock Research Framework provides us with a prism through which to scan the universe for new ideas and ensure that existing holdings continue to justify their places in the portfolio.

But our efforts don’t stop there. We are forever harnessing different sources of insight and expertise, both external and internal to Baillie Gifford, to assist us – and challenge us – in the task of stock selection and portfolio construction. One such example is Baillie Gifford’s Investment Risk, Analytics and Research team, which (as the name suggests) goes beyond basic risk monitoring to provide portfolio analysis. Our interaction with that team has grown in recent years as it has leaned more heavily into its research capabilities.

Last year, for instance, we commissioned a piece of analysis to identify companies that have met LTGG’s return hurdle but aren’t held in the portfolio. Enphase Energy appeared in this list, its share price having risen 37-fold between 2019 and late 2022, as the company proved its business model viability. While Enphase had been on our radar, its appearance in the ‘missed growth’ analysis led us to conduct a full review using our 10 Question Stock Research Framework. With sufficient confidence in Enphase’s ability to grow several more multiples from here, we took a holding in late 2023 following a share price drawdown of two thirds from its 2022 peak.

The ‘missed growth’ analysis also revealed the enormous share price appreciation from incumbent pharmaceutical companies Eli Lilly and Novo Nordisk thanks to the success of their anti-obesity drugs (GLP-1s). This raised questions for existing holding Dexcom, the maker of continuous glucose monitoring devices, whose business – on the surface at least – appeared at risk of disruption. Consequently, we undertook a review of Dexcom while also exploring the upside potential of the GLP-1 manufacturers.

Another piece of recently commissioned analysis examined our trading behaviour in recent years. This showed that many of our additions to newer holdings during periods of share price weakness – notably those with a very vast range of potential outcomes – were value destructive. Examples included the likes of Peloton and Zoom, since sold from the portfolio. As a result, the LTGG team determined that we would only add to ‘R&D’ holdings of that nature if they meet pre-defined operational milestones. As ever, our focus is on the fundamentals. In the case of Joby Aviation, for example, we would expect to see full certification by the US Federal Aviation Authority before we may be minded to add to the holding. Meanwhile, Sea Limited’s demonstratable profitability of its e-commerce business and revival of its gaming business led it to ‘graduate’ from the ‘R&D’ bucket – we therefore added to the holding in late 2023 during a period of share price weakness.

We regularly invite perspectives from the Investment Risk, Analytics and Research team on valuation. We recognise that their analysis based on backward-looking data or forward-looking market estimates cannot adequately capture some of the growth potential we seek to find. Nevertheless, it can provide a helpful input (one of many) to our portfolio construction.

For example, in late 2023, their analysis of Tesla – referring to its forward price-to-earnings ratio and forward earnings expectations – suggested that the company was, optically at least, expensive. This echoed our thorough review of the holding’s fundamentals and stock discussion, in which we revised down our confidence in the company’s upside potential. Taking all of this information together, we trimmed the holding in late 2023 while we build conviction in Tesla’s possible second acts.  

BioNTech and Moderna also flagged as optically expensive in the quantitative analysis, given low forward expectations for sales growth. However, our fundamental research led us to believe that Mr. Market was fixated on their (deteriorated) Covid-19 revenues and was ignoring the companies’ increasingly compelling pipelines of other treatments. We therefore refrained from trimming those holdings. Taking a considered, longer-term view is a key component in our 10 Question Stock Research Framework.

Such valuation examples underline the fact that an optically expensive company (ie with high near-term multiples of sales, earnings or book value) may be just that – expensive. Or it may be a bargain. It all depends on the fundamentals and our degree of confidence in the upside scenario. For instance, we refrained from investing in Nu Holdings last year when its price-to-book ratio was over 4x. Based on the fundamentals at the time, it appeared expensive and we couldn’t make our upside scenario work. When we re-examined the case earlier this year, its price-to-book ratio had risen to closer to 10x. However, its business model and competitive advantage were more thoroughly evidenced, profitability was proven, and its product/market fit had derisked and repeated in multiple geographies – enabling us to answer our 10 questions with greater confidence than before. We therefore took a holding.

Interacting with any investment risk team is not without its risks (no pun intended). The potential trap is that it curbs risk-taking and thereby leads to style drift. The risk of low-risk would be immensely damaging to LTGG. Our relationship with Baillie Gifford’s Investment Risk, Analytics and Research team is designed with this risk in mind. The team has a deep understanding of LTGG’s philosophy. Its analysis only brings us questions to ponder, not answers, and certainly not instructions. Moreover, its longitudinal analysis – data spanning the 20-year history of the strategy – helps keep us aware of possible unintended deviations from LTGG philosophy and process over time.

Above all, its analysis helps us avoid missing opportunities. This supports us in doing what we’ve been tasked to do for our clients: deliver exceptional long-term growth.

Risk factors

The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in May 2024 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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