Sustainable Income Fund Q4 investment update

As with any investment, your capital is at risk. Past performance is not a guide to future returns.

Tom Danaher (TD): Welcome to the Sustainable Income Fund update for the final quarter of 2024. My name is Tom Danaher. I'm an investment specialist here at Baillie Gifford. I'm delighted to be joined today by Steven Hay, one of our co-managers. Sustainable income invests in listed equities, bonds and real assets companies, all with the aim of providing clients with an attractive and resilient monthly income stream, which grows with inflation over time. So Stephen, before we get on to performance, there is one administrative point to address. From the end of January, the fund will be renamed the Baillie Gifford Monthly Income Fund. Could you tell us why this is happening?

Steven Hay (SH): Sure, Tom. This change is really necessary because of the new UK regulations governing the use of various sustainability terms. The word sustainable is encompassed within that. And so faced with changing the fund's investment approach or changing the name, we've decided to take the name sustainable out and change the name, as you said, to the Baillie Gifford Monthly Income Fund. A client should be clear that nothing in the investment process is changing. In particular, with regards to the way we approach sustainability matters, it remains unchanged.

TD: That boxes off that administrative point, Stephen. Thank you. We'll come on to the market backdrop now. And this was a quarter where we saw really mixed performance, both between asset classes and between different regions as well. So how did the Sustainable Income Fund fare?

SH: The fund was down 3.4 per cent during the quarter. And I think that comes from two main reasons. It was equities that did well in the fourth quarter, in particular US equities. And partly because of the very low yielding nature of US equities, we are underweight that region. And also we had a slightly lower than average allocation to equities. And there was a big pullback in property and infrastructure stocks and our combined allocation to those stocks caused about two-thirds of the drop in performance, a reasonable allocation to those stocks.

TD: Okay. So, we'll delve into those areas in a bit more detail. And as you say, the fund invests heavily in property and infrastructure and it does so through listed shares. So, it does feel some of that short-term volatility. Could you reflect on some of the reasons behind the weakness that we've seen lately?

SH: Sure. I mean, I think it's really an interest rate story. So property and infrastructure stocks are much more responsive to interest rates than the normal equities. They're more bond-like, if you like. And what we saw during the fourth quarter was the market moved to expect less interest rate cuts in 2025. So interest rates generally moved up. And that was the main reason behind the fall off in prices for property and infrastructure stocks generally. On top of that, in the UK and Europe, as well as the interest rate moves, there was a slight cooling in the growth expectations in both those regions. And so stocks in those regions had a double whammy from both growth and interest rates. Now, our job is to find resilient companies that are able to withstand different growth and interest rate environments. So operationally, we're not concerned by any of this. But even the resilient companies have been caught up in this market sell-off.

TD: So that explains the property and infrastructure. And you also touched on the underweight to US equities as well. All of that coming together caused the fund to give back some of the gains that it enjoyed earlier in the year. Taking a step back now, perhaps you could just touch on last year overall now that it's behind us. How do you reflect on the fund's performance in 2024?

SH: Well, we saw very encouraging progress on the income front. So we saw income growth well ahead of UK inflation, which is great to see. We know a lot of our clients really care about that income. Total returns were more modest, 2.5 per cent for the year as a whole, which is maybe a little bit disappointing given the positive market backdrop. And I think as we reflect on that, the extent of the equity outperformance that we saw, especially from US equities, took us a bit by surprise. And in hindsight, we trimmed our equity allocation down to just below our typical average, maybe a little bit early. So I think we have to be aware of that. But we are very aware that our clients really care about income. And by diversifying away from those equities into other asset classes, we have been able to raise the income in the fund. So that's been a positive factor.

TD: As you say, it’s quite hard to resist some of those yields on offer in other asset classes at the moment. Let's come on to positioning now. Can you just touch on some of the asset allocation changes that you've made in the last few months?

SH: Relatively marginal allocation changes during the quarter. After a good performance from infrastructure through the late summer, we took a little bit off the table there as we were thinking some concerns about what the US policy might change after the election. And we've added to emerging market debt where many countries have fundamentals that are actually better than the developed world. Take one example, Peru, where growth is good and improving. Inflation is below target. Debt-to-GDP is only 35 per cent, which is unheard of now in the developed world. And the yield on offer is 6.7 per cent, so well above what you might get from another government market. Adding to the likes of Peru does seem attractive given the state of yields across the world.

TD: As you say, I think developed market policymakers would envy some of those fundamentals. So modest asset allocation changes overall, a bit out of infrastructure and a bit into emerging market debt. But that masks what has been quite a busy quarter under the bonnet from the bottom up. You know, we talk about this fund being the fund that brings together the best of Baillie Gifford's income ideas across all asset classes. Could you touch on perhaps one new addition to the portfolio?

SH: Yeah. As you say, lots going on within all the different asset classes. But if we just pick out one, Grainger from our property portfolio. We added to Grainger, which is the UK's largest listed residential landlord. And at the moment it's trading at about a 25 per cent discount to net asset value, which for us seems an exceptionally good entry point for such a quality company. And they're selling their legacy assets and investing in new-build residential private property, which has double the yield of the legacy assets. So we see a really good growth in dividends, growth in profits coming ahead from this investment. And more generally, the rental growth there is usually linked closely to wage growth and wage growth usually keeps pace with or exceeds inflation. And so, for a fund that really cares about matching or beating inflation over time, it's an ideal investment for this fund.

TD: Grainger, one of many interesting new additions to the portfolio lately and as you say, an ideal candidate for the fund. Many of those watching will be curious about the outlook for income growth during the year ahead as they rely on the fund's monthly payments to meet their expenditure needs. So could I ask you to reflect on that outlook for distribution growth this year, but also perhaps to touch on the outlook for total returns as well during the year ahead?

SH: So, 2024, as I mentioned, was a good year for income growth. So, income grew 4.3 per cent over the year, comfortably ahead of UK inflation. And for 2025, we expect a similarly strong level of growth, maybe even a little bit higher. So, expecting between five to six per cent in distribution growth through 2025. So, a very positive outlook there. On total returns, I think it's also a very positive outlook. Clearly, 2024, equities were the only game in town, and US equities in particular. So the big questions for 2025 are really, does that performance extend beyond equities to other asset classes? And, within equities, does it extend beyond to other markets, other countries? I think for us the answer to both those questions is yes, we think it will. Not least because valuations in other markets are just much more compelling than they are in equities, in particular US equities. So we do see that broadening out. And if that happens, the Sustainable Income Fund is well placed to benefit from that. And I think it's a great point to be invested in a fund which is really well diversified by both asset class and by geography.

TD: A strong case set out there, Stephen. So thank you for your time. 2024 was a year where equities outperformed almost all other asset classes. And as Stephen has set out there, we think that there's a really strong case for diversification today, particularly for those looking to achieve an attractive and resilient income. To that end, the fund currently has a yield of 4.4 per cent and its monthly income distributions are expected to grow by between five and six per cent in 2025. That brings our quarterly update to an end. We hope you'll join us next time after the fund has been renamed the Baillie Gifford Monthly Income Fund. Thank you for joining us.

Annual past performance to 31 December each year (net%)

Source: FE, Revolution. Net of fees, total return in sterling.

Past performance is not a guide to future returns.

The Fund has no target. However you may wish to assess the performance of both income and capital against inflation (UK CPI) over a five-year period. In addition, the manager believes an appropriate performance comparison for this Fund is the Investment Association Mixed Investment 40-85% Shares Sector. 

Risk factors

This communication was produced and approved in January 2025 and has not been updated subsequently. It represents views held at the time and may not reflect current thinking.

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 contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, and Baillie Gifford and its staff may have dealt in the investments concerned.

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.

Investment markets can go down as well as up and market conditions can change rapidly. The value of an investment in the Fund, and any income from it, can fall as well as rise and investors may not get back the amount invested.

The Fund’s share price can be volatile due to movements in the prices of the underlying holdings and the basis on which the Fund is priced.

Further details of the risks associated with investing in the Fund can be found in the Key Investor Information Document or the Prospectus, copies of which are available in the documents section of the relevant fund page.