Private investor forum: why growth is on sale

Your capital is at risk. 

Growth investors who back the disruptive, transformational technologies of the future are put to the test when – as inevitably happens – the tide turns against them.  

According to Baillie Gifford director James Budden, the right response is to stay focused on the fundamental qualities and operational successes of the pioneering companies, confident that they’ll reward patient investors.

Welcoming attendees at the firm’s 2024 Private Investor Forum in London, Budden cited inflation, rising interest rates and armed conflict among the factors shrinking investors’ time horizons and proving “pretty poisonous” for growth investors’ performance. But such factors, he noted, make no difference to the strengths of the businesses that Baillie Gifford-managed trusts are backing in areas such as artificial intelligence, synthetic biology, the digitalisation of commerce, the electrification of transport and the transition to renewables. 

All of these, he said, are likely to remain at the heart of global economic progress, whatever the macroeconomic or geopolitical picture. Investors should be encouraged that the companies pioneering this progress, however out of favour, are getting on with delivering.

The four speakers who followed each focused on different companies in diverse industries in widely dispersed parts of the world. But their theme was consistent.

As one speaker put it: “growth is on sale,” offering abundant opportunities for patient long-term investors.

The search for exceptional growth

In his presentation, Gary Robinson, joint manager of the Baillie Gifford US Growth Trust, acknowledged the forbearance of investors in the face of recent underperformance. He honed in on what it is that makes an “exceptional growth company”, that rare beast that can sustain high growth rates for long periods, often defying conventional wisdom about the natural lifecycle of businesses.

The key characteristics, Robinson said, were resilience – the ability to navigate short-term challenges based on strong balance sheets, a clear path to profitability and a competitive edge.

Digging deeper into the DNA of exceptional growth, he cited the influence of theorists such as Stuart Kauffman and Eric Beinhocker on a business’s fitness to navigate long-term market shifts by keeping different time horizons in focus. The firms he looks for, he says, can protect and optimise their existing business, extend their franchise into new areas, and make the longer-term, riskier investments in new opportunities.

As examples, Robinson cited an array of public and private US Growth Trust holdings, from ecommerce software giant Shopify to satellite launch business SpaceX to language-learning app Duolingo as change-making companies thinking in all three dimensions simultaneously.

Increasingly they are reaping the rewards: “We're back to the point where fundamentals of these companies can start to do the talking. Companies in the US Growth Trust are growing their revenue much faster than the market, and we know that over the long term, share prices follow fundamentals.”

Against the cycle

For Matthew Brett, manager of the Baillie Gifford Japan Trust, the need to address recent underperformance was made more acute in light of that country’s wider recent rally.

Brett acknowledged that the Tokyo Stock Exchange’s post-Covid surge has primarily benefited cyclical sectors like automobiles, traditional banks, and heavy industries, none of which the Trust holds and none of whose prospects inspire his confidence.

Turning to what does, the Japan Trust manager focused on three main interests of the trust, which collectively account for about half the portfolio.

These are digitalisation, featuring domestic internet giants such as Rakuten benefiting from the country’s catch-up on internet-based business, automation and robotics, where companies such as Fanuc are building on an established global technological advantage, and healthcare, where Japanese companies are pioneering therapies for global scourges, including Eisai in the case of Alzheimer’s.

Brett underlined how the Japan team's diverse background, and decades of experience, plus its reputation as long-term, supportive investors, all allow differentiated thinking and open up long-term opportunities others miss.  

He noted how the Japan Trust’s holdings, despite missing out on the recent stock market surge, had notably higher sales growth and earnings growth than the market overall.

He also cited the Trust’s low turnover (10 per cent this year) as an indicator of its faith in its own narrative:

“If some of you are thinking, I've heard you talking about the internet and robotics before you're right. The portfolio doesn't change that much. These remain the opportunities, and we’re sticking to them.”

Growth on sale

Iain McCombie, joint manager of the Baillie Gifford UK Growth Trust, began his presentation with the rueful acknowledgement that many see the domestic market as being incompatible with growth and innovation, one reason why it trades at a discount to the global market. Therein, he suggested, lies the opportunity:

“If you think share prices follow fundamentals, UK growth stocks are therefore looking cheaper than they have for a long time. Growth is on sale”

McCombie went on to identify several types of promising companies within the UK Trust’s portfolio. The first of these was established companies expanding into new markets such as Autotrader, already dominant in the second-hand car market and now expanding into car financing, while credit score company Experian and plant hire firm Ashtead which are growing their core businesses and expanding geographically.

Then there are world-class innovators such as Renishaw and Genus: leaders in precision engineering and animal genetics, respectively, and autonomous driving technology leaders Wayve.

But McCombie stressed that the best UK growth prospects are not always in glamorous or hi-tech areas. He cited 4imprint, which makes promotional gifts for the corporate merchandise market, and Games Workshop, which makes tabletop fantasy characters for global game franchises such as Warhammer. For those who might consider that an unpromising niche, McCombie noted the Nottingham-based £500m in annual sales (70 per cent outside the UK) and a pending TV tie-in with Amazon that is “not yet in the price”.

The common characteristics of this diverse group of holdings, he said, were solid foundations and margins that outstrip the index, resilient financials with most companies being earnings-positive, and compelling growth expectations in both sales and earnings. All of these McCombie believes add up to significant growth potential.

Small but exceptional

The final speaker at the London event was Bill Chater, who set out to answer the question he gets asked frequently: where has the “small-cap premium” gone? If the historical tendency for small-caps to outperform large caps seems to have been broken, should I bother with small caps anymore? Chater, an investment specialist with Edinburgh Worldwide Investment Trust, presented a comprehensive argument for the continued relevance and potential of small-cap investments, despite recent underperformance and increased wider market scepticism. Like the preceding speakers, he presented this sentiment as a unique opportunity for long-term growth investors.

Chater’s point was that the underperformance of small caps is a market phenomenon unrelated to fundamental issues. He acknowledged that the average small-cap company may be of lower quality, but it was the job of the good active manager to spot the exceptions: "Most small businesses are rubbish. Most of them are low-quality, undifferentiated, and don't have capable management. We don't want to own those companies at all. We're looking for the exceptional few, those with the potential to be much larger."

As Chater described it, the small caps field remains a fertile ground for disruptive innovation and "just because the technology sector is showing higher returns to scale, it doesn’t mean opportunities for, disruptive innovation are dead. Far from it.”

What are the best qualities associated with company immaturity? Chater listed innovating to solve large problems; establishing dependable competitive advantages; possessing management teams with vision and grit, and business capabilities that improve with scale.

To illustrate his proposition that, far from being in decline, that asset class contains deep and broad opportunity, Chater cited several Edinburgh Worldwide holdings, glucose-monitoring pioneers Dexcom, law enforcement technologists Axon and gene-editing pharmaceutical pioneers Alnylam.  

Chater concluded that while the small-caps may seem to have underperformed, the asset class remains attractive for long-term investors such as Edinburgh Worldwide with a proven “hit rate” in identifying exceptional companies that speaks for itself, whatever the prevailing sentiment towards the world in which the Trust looks for long-term gains for shareholders.

That theme, of Baillie Gifford investment managers’ proven ability to spot the disruptive growth companies of the future, was, James Budden noted, a good one with which to leave attendees. What’s more, he said, the wide discounts across the Baillie Gifford trust portfolio, made this a good time for investors to consider “getting back on board the growth train”.

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Important information and 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 October 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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A Key Information Document is available at bailliegifford.com.

The aim of the Trusts are to achieve capital growth and it is unlikely that the Trust will provide a steady, or indeed any, income.

Share prices may either be below (at a discount) or above (at a premium) the net asset value (NAV). The Company may issue new shares when the price is at a premium which may reduce the share price. Shares bought at a premium may have a greater risk of loss than those bought at a discount.

The specific risks associated with the US Growth Trust include: 

— The Trust invests in overseas securities. Changes in the rates of exchange may also cause the value of your investment (and any income it may pay) to go down or up.
— Unlisted investments such as private companies, in which the Trust has a significant investment, can increase risk. These assets may be more difficult to sell, so changes in their prices may be greater.
— The Trust's exposure to a single market and currency may increase risk.

The specific risks associated with the Japan Trust include: 

— The Trust invests in overseas securities. Changes in the rates of exchange may also cause the value of your investment (and any income it may pay) to go down or up.
— The Trust's exposure to a single market and currency may increase risk.

The specific risks associated with the UK Growth Trust include: 

- Unlisted investments such as private companies can increase risk. These assets may be more difficult to sell, so changes in their prices may be greater.
— Market values for securities which have become difficult to trade may not be readily available and there can be no assurance that any value assigned to such securities will accurately reflect the price the Trust might receive upon their sale.
— The Trust's risk is increased as it holds fewer investments than a typical investment trust and the effect of this, together with its long term approach to investment, could result in large movements in the share price.
— The Trust's exposure to a single market may increase risk.

The specific risks associated with the Edinburgh Worldwide Investment Trust include: 

— The Trust invests in overseas securities. Changes in the rates of exchange may also cause the value of your investment (and any income it may pay) to go down or up.
— Unlisted investments such as private companies, in which the Trust has a significant investment, can increase risk. These assets may be more difficult to sell, so changes in their prices may be greater.
— Market values for securities which have become difficult to trade may not be readily available and there can be no assurance that any value assigned to such securities will accurately reflect the price the Trust might receive upon their sale.
— Investment in smaller, immature companies is generally considered higher risk as changes in their share prices may be greater and the shares may be harder to sell. Smaller, immature companies may do less well in periods of unfavourable economic conditions.

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