Positive Change: investor letter Q3 2024

Your capital is at risk. 

Positive Change is based on a steadfast belief in the ‘secret, silent miracle of human progress’, a simple but profound concept articulated by Professor Hans Rosling, which speaks to the positive long-term structural trends that society can often miss amidst short-term noise. We have written before of the power of this concept in helping us to identify impactful trends, but it applies equally to simple operational delivery of the portfolio.

Looking back over the past three months, the sound and fury of markets has remained largely centred on a handful of AI-related names, and we saw a sharp drop and quick correction in markets in early August. Against this noisy backdrop, Positive Change delivered muted returns that were behind the index. However, the share price returns over the quarter belie the real and steadfast progress being made at a portfolio level.

Excitingly, underlying fundamental growth in the Positive Change portfolio is accelerating. Predicted three year forward earnings growth for the portfolio stands at 19.8 per cent per annum ^[1] compared to 13.4 per cent a year ago, nearly double the predicted earnings growth for the index. Against this burgeoning growth, valuations remain reasonable. Price to Earnings on a one year forward looking basis is 28.1x for the Positive Change portfolio compared to 17.4x for the MSCI ACWI.

This quiet progress has not yet been rewarded fully by markets, but experience tells us in no uncertain terms that rewards will follow.

We are seeing recognition of progress for some portfolio companies. Duolingo, the mobile learning platform is one of the top contributors to performance over the period. It now has over 100 million monthly active users (a 40 per cent increase year-on-year) and has signalled that it expects over 38 per cent revenue growth this year. Most strikingly at its recent ‘Duocon’ (Duolingo’s annual virtual event) its CEO, Luis von Ahn, and his team introduced ambitious new features.  These features are reminiscent of the Benjamin Franklin quote: “Tell me and I forget, teach me and I may remember, involve me and I learn.” Using leading AI technology, Duolingo is introducing interactive features such as real-time conversations by video call with an animated character to enable language-learners to practice their skills. Such developments contribute towards long term progress in its mission to develop the best education in the world and make it universally available.

MercadoLibre, the Latin American ecommerce platform and fintech, was also a top contributor to performance as it continued to enjoy a period to remember with overall revenue growing by 42 per cent year-on-year to over $5 billion. Underpinning this, is growth both in its fintech services (monthly active users of their fintech services grew by 37 per cent to 52 million) and its ecommerce platform which grew in terms of all key metrics (gross merchandise volume, take rate and revenue). These attention-grabbing ‘headline statistics’ are of course pleasing but the long-term progress underpinning them is of much greater import. In 2023 MercadoLibre commissioned an impact study which found that 1.8 million families depended on the platform for their main source of income, and more than half of the SMEs (small and medium sized enterprises) which use the platform could have access to credit through its fintech services for the first time. 

In contrast, Dexcom, the manufacturer of continuous glucose monitoring systems (CGMs) for diabetics saw its share price fall sharply following an announcement of slower than expected growth and a reset of expectations for the rest of the year. Dexcom’s headache was related to disappointing execution following a recent reorganisation of its sales force, weaker than expected international sales and a softening of US revenue per customer. These missteps are somewhat out of character for a company such as Dexcom which has displayed impressive fundamental growth and is one of the top contributors to performance since the inception of Positive Change. We believe that there is a significant opportunity for CGMs and we remain optimistic about the potential of Dexcom’s new over-the-counter Stelo product. We are engaging with management to build conviction in their ability to overcome the current challenges and unlock the tremendous growth opportunity ahead.

Moderna, the innovative biotech company, has also had a difficult summer. In the face of weak Covid vaccine sales and a slow RSV vaccine launch, the company has decided to lower research and development (R&D) spending and focus its pipeline while pushing out cash-break-even until 2028. We met with Moderna CEO Stephane Bancel following this announcement to discuss these developments in more detail and will continue to engage with the company. Regardless of how exciting their technology platform is, its commercial engine has to function well in order for Moderna to achieve its potential. Moderna has made striking progress scientifically and commercially since we first invested in 2018 in (what was then) a small, pre-earnings biotech company. Over the subsequent six years, Moderna has hit numerous milestones along the way, not least successfully producing and commercialising vaccines for Covid. Looking forward, we want it to continue to harness the programmability of its mRNA technology to convert its rich pipeline into effective vaccines for a range of viruses and diseases, from influenza to cancer. We remain keenly vigilant for further progress.

An abundance of new ideas

Our ongoing quest to upgrade the portfolio can also be characterised as one of steadfast, but constant progress. In recent years, we have redoubled our focus on searching for new ideas.

This work has really begun to pay off, with seven new ideas entering the portfolio so far in 2024. Turnover has ticked up modestly to 22 per cent (still in line with our long-term holding period) Our own ‘Magnificent Seven’ of new ideas is diverse in terms of impact theme, geography, sector and maturity of business.

We have bought shares in US -based electric car manufacturer Rivian (founded in 2009) and Swedish mining equipment company Epiroc (which can trace its roots to 1873). We have invested in innovative Boston-based healthcare company Vertex, which has been focusing for the past 35 years on transforming the way serious diseases are treated. Also new to the portfolio is South-East Asian super-app Grab – a business founded just over a decade ago, but already building up dominance in its key markets and providing economic opportunity for over five million solo, micro and small entrepreneurs.

These four companies: Rivian, Epiroc, Grab, and Vertex, have been discussed in previous quarterly letters this year. So, let’s focus on the three companies that have entered the portfolio in recent months: Schneider Electric, Soitec and Insulet.

Electrification (replacing technologies or processes that use fossil fuels with electric-powered equivalents) is one of the most important strategies for reducing CO2 emissions from energy. This trend may fly beneath the market hype cycle, but it matters, and barriers to entry are high, so rewards will accrue to those with a strong competitive position. Schneider Electric, a French multinational is a leading provider of integrated electrification solutions for buildings, data centres, infrastructure and industries. It helps its customers manage the transition to a renewable dominant grid, and without Schneider, the pace of deployment of renewable generation infrastructure globally would be slower. Schneider is well-placed to benefit from the growing demand for electrical management products and services. Over the next decade and beyond, sales should compound at a mid-to-high single-digit pace, which, combined with margin expansion and sensible capital allocation, should result in attractive share price returns.

Coincidentally, in a summer when the eyes of many were focused on the sporting achievements of the Olympic Games in Paris, the second of our new buys is also French. Soitec is a designer and manufacturer of semiconductor materials, in particular engineered substrates for the semi-conductor industry. 

You may be asking yourself why its products are relevant for the Positive Change portfolio.

The answer lies in the company’s silicon-on-insulator wafers, used for semi-conductor production. These substrates bring quality, performance, and cost advantages, and crucially allow end-applications to be more energy efficient.  For example, Soitec’s wafers can be used in inverters for electric vehicle (EV) powertrains. Its wafers are cheaper than alternatives, can halve charging times and increase battery range by 10-15 per cent. It is exciting that Soitec’s product has the potential to address three important barriers to EV adoption – cost, convenience and range. This is just one application: structural growth for Soitec is underpinned over the long run by several megatrends including electrification, digitalisation, and the rise of Artificial Intelligence.

Unfortunately, not all progress in the world is so positive. The rising incidence of diabetes is a case in point: the International Diabetes Federation estimates that 537 million adults are currently living with diabetes and project that number is likely to rise to 783 million by 2045, driven by lifestyle factors, combined with ageing demographics. This may surprise those of us whose attention has been drawn by the omnipresent media commentary on GLP-1s.

The rise of non-communicable diseases and the ability of companies to help address the treatment, management and prevention of them has long been an active area of interest for the team, for example we made our investment in Dexcom back in 2017. New buy, Insulet, has a related technology, it makes insulin pumps that automatically calculate and deliver insulin to people with diabetes throughout the day based on their glucose level. Insulet is the only company with a tubeless design of pump. This makes the device more comfortable to wear and gives patients more flexibility. For example, patients can go swimming while wearing Insulet’s Omnipod device. Insulet has the opportunity to improve the lives of millions of diabetes patients while potentially saving healthcare systems significant costs.

Our new ideas were funded by trimming our positions in companies which have performed strongly, such as semi-conductor manufacturer TSMC, and by the complete sale of two companies where we have lost conviction in their ability to generate attractive investment returns over the long term: South African insurance provider Discovery, and Umicore, the Belgian recycler of metals and manufacturer of automotive catalysts and battery cathodes.

A change of perspective: from three months to three centuries

In our search for that ‘secret, silent miracle of human progress’, taking a step back provides us with invaluable perspective, and we prioritise taking time to consider the long-term so we don’t miss those trends that will deliver impact and investment returns, writ large, over the long-term.

During September, Impact Director Ed Whitten participated in ‘Engagement Week’ an event hosted in Barcelona by the Government of Catalan. At the three-day event TIPC (Transformative Innovation Policy Consortium) and Deep Transitions brought together the private and public sectors: investors, academics, and government policy makers from around the world to discuss systems transformation.

Deep Transitions is an ambitious, global, interdisciplinary research project looking at the transformations needed to combat the great challenges of our time. It is a collaboration between the University of Sussex and the University of Utrecht. Baillie Gifford has been a supporter since its early days.

Deep Transitions aims to learn from the past to shape the future. The first phase of the project looked at the ‘surges of change’ that we have seen since the onset of the industrial revolution in the 1700s. The introduction of steam power and the railways is a good example of such a surge. These surges of change have led to great industrial progress and created huge wealth. However, there have also been associated ills, including resource depletion, pollution, climate change, and exacerbated inequalities.

The second phase of the project ‘Deep Transitions Future’ uses the findings of the past to explore future scenarios that put socio-technical system changes at their core to address these harms. System change goes further than just improving the way we currently operate: it radically changes the norms. To take one small example, electric vehicles are an improvement to the current system, but autonomous vehicles could provide system change if they disrupt the current model of individual car ownership.

Profound system change will not be easy, but Ed found the commitment of the diverse range of participants inspiring and valued the exploration of practical models and actions for integrating system change into investment practices and policy making.

Poised for growth to remember

Baillie Gifford has been investing on behalf of clients since 1908, so has successfully invested in many of the ‘surges of change’ that the Deep Transitions research project has sought to understand: from the rise of automobiles and aviation in the early 1900s, to the information technology revolution later that century. Common to all ‘surges of change’ is the investment opportunity that accompanies them. Ultimately, it is well-run companies whose products and services are addressing the needs of the time that will see strong and rising demand which will fuel revenue and earnings growth. As growth investors, our fundamental belief is that it is precisely that fundamental growth in revenue and ultimately earnings that drives long term share price performance.

As we stated at the start of this letter, it is exciting that underlying fundamental growth in the Positive Change portfolio is accelerating. This great fundamental progress is not yet being fully recognised by the markets, but based on our decades of experience, we fully expect that recognition will come and that the rewards will be memorable.

[1] As at 30 August 2024 in USD

*Inception date: 31 January 2017

Source: Revolution, MSCI. US dollars. Returns have been calculated by reducing the gross return by the highest annual management fee for the composite. 1 year figures are not annualised. 

Past performance is not a guide to future returns.

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