Edinburgh Worldwide: better days dawn for younger pioneers

Edinburgh Worldwide Investment Trust (EWIT) aims to understand how the world is evolving and what special companies are driving and riding these trends. Often they’re using new technology or novel business practices.

We're looking for smaller companies early in their lifecycle. We want to get the benefit of their mainly structural growth, and keep that access as they grow in scale.

To do this, we look a decade ahead and think about how the world could be different, while never losing sight of the here and now.

With that time horizon in mind, we think the prospects for attractive returns are tilted in our favour, with some exciting growth catalysts on the horizon. We’re optimistic that investors’ patience will soon be rewarded.

The last few months provide some clues about the long-term potential within EWIT’s portfolio. Yet they also remind us of current distortions in equity markets.

We own some of the most exciting – if still immature – businesses in the world. We hold them for their potential to transform their industries. We see them building great franchises and disrupting incumbents. As that potential turns to commercial progress, we see them generating asymmetric returns, where the upside gain far exceeds what we risked losing by investing. We own them based on what we think they can become, often by morphing into something different from how they look today.

Portfolio progress

The attractions of innovation lower down the market capitalisation scale won’t go unnoticed forever. Two of our holdings, HashiCorp and Shockwave Medical, have received acquisition offers, from IBM and Johnson & Johnson respectively. US cloud software company HashiCorp was at a 28 per cent premium to the price we paid 12 months earlier and Shockwave Medical, which makes cardiovascular devices, was over nine times our entry price. We wouldn’t be surprised to see this mergers and acquisitions theme growing, given the abundant opportunities.

The largest positive contributors to recent performance were Axon Enterprises, the dominant provider of Taser devices, body-worn cameras and digital solutions for law enforcement, and AeroVironment, the leading manufacturer of small-scale surveillance and military drones.

Both companies share attributes that could see them contributing more both near-term and longer-term, and joining  the largest listed positions in the portfolio. They benefit from:  

• Public sector customers embracing ‘better and cheaper’ technology, saving money and protecting frontline operatives
• Increasing intelligent automation, turning their products from nice-to-haves into something embedded in the ecosystem (eg Axon’s digital archiving solutions, AeroVironment’s drones’ autonomous flight and threat detection)
• Opportunities to capitalise on their strength in large and under-served markets beyond the US

Elsewhere, Alnylam, the US medical firm that finds ways to ‘silence’ disease-causing genes, has shared positive news from phase 3 trials of its drug vutrisiran, for patients with the deadly heart ‘stiffening’ disease ATTR amyloidosis with cardiomyopathy.

Its reported near-30 per cent reduction in symptoms in trial participants positions vutrisiran as the first RNA silencing therapy for this condition, challenging Pfizer as the potential lead therapy. More than half a million people worldwide suffer from ATTR-CM. If vutrisian gains regulatory approval, it could generate between $2-4bn in annual sales, a big increase on Alnylam’s current $1.5bn in revenue.

On another frontier of science, PsiQuantum announced it will build the world’s first utility-scale quantum computer near Brisbane. Linked to this, the Australian Commonwealth and Queensland governments will invest almost AUD$ 1bn (£524m) in the company through a financial package which will underpin PsiQuantum’s plan to have the site operational before the end of the decade.

GPU-derived AI chips are all the rage now, but developments in quantum computing represent a seismic shift in computing architecture that might be far closer than many predict. PsiQuantum could become the most valuable and socially impactful company we own, illustrating the opportunities in our ability to invest in private companies. EWIT’s exposure to private companies is currently 28 per cent of total assets.

We were pleased to see further progress from another private company, SpaceX, with a third successful test launch of its next-generation Starship rocket alongside further growth in the constellation of Starlink satellites.

Evaluating underperformers

The most significant detractors from recent performance were Ocado and Oxford Nanopore. Although Ocado has made improvements to reestablish the profitability of its UK retail operations following a period of overcapacity, we have been frustrated with the pace of the rollout of Ocado’s automated customer fulfilment centres with its international grocery partners.

Oxford Nanopore flagged that slow research budget growth, alongside a curtailing of its UAE genome sequencing project, would drag down 2024 revenue growth. These issues are unhelpful but transient. They distract from the compelling evidence for Oxford’s novel technology in clinical and applied sequencing usecases. These were previously rendered off-limits to DNA sequencing by cost and practicality. The company has an increasing pool of industry partners and collaborators with whom it is looking to develop new applications, including:

• Biomerieux in antimicrobial resistance
• Lonza in quality testing of mRNA therapeutics
• Guy’s & St Thomas’ NHS Foundation Trust in pathogen identification

In time, such opportunities could support a market opportunity for Oxford Nanopore far bigger for DNA analysis than that represented by the conventional academic-skewed research market.

New buys and exits

Notable transactions undertaken in the interim period included the new purchase of Aehr Test Systems, SkyWater Technology, Silex Systems, RX Sight and dLocal.

Aehr Test Systems develops and sells testing equipment to the semiconductor industry. Its unique wafer-level testing solution enables early detection of faulty transistors and reduces the cost and time wasted packaging these into modules. Aehr’s solution is well suited to the growing silicon carbide industry, where output remains low, and Aehr has already seen traction with leading players.

SkyWater is a Minnesota-based semiconductor foundry specialising in mixed-signal integrated circuits. It has developed its ‘technology as a service’ model to target prototyping and production opportunities. It specialises in projects requiring high levels of customisation and engineering expertise to translate concepts into physical designs. This offers advantages in terms of speed-to-market, technical skills and US domestic production.

Silex Systems is commercialising a more efficient laser-based approach to enriching uranium fuel for nuclear reactors. Having developed the technology over the last 20 years, in partnership with key industry players and supported by the US government, it is well positioned to help address a growing supply chain problem for the sector. The company is on track to complete a scaled system demonstration this year before breaking ground on a large production facility in Kentucky.

Medical technology company RxSight has developed the world's first adjustable intra-ocular lens. The implanted lens allows surgeons to customise patients’ clarity of vision after cataract surgery. The patient benefits and absence of the side effects of existing premium lenses have enabled RxSight to reveal latent demand beyond the existing premium intra-ocular lens market.

dLocal is a payment processor company focused on emerging markets, most notably Latin America. Cross-border ecommerce in these regions is fraught with challenges – most payments are local, credit card fraud is rampant, and the regulatory and tax landscape is constantly evolving. dLocal eases a significant pain point for global merchants wishing to do business in these markets. Penetration of ecommerce across emerging markets remains low, creating a long runway for growth.

More generally, we sought to better manage smaller holdings in the portfolio, balancing patience against the need to divert capital to companies already performing well. Consequently, we exited the positions in Liverperson, Agora, Huya, Fiverr, Monotaro, Rightmove, Victrex and Base. We also sold the Telemedicine business Teladoc following a very disappointing growth outlook from the management team. We added to our positions in American Superconductor and Nanobiotix as both these exciting companies raised additional capital to bolster their growth. We also further added to Oxford Nanopore given the disconnect between the long-term growth potential, its strategic positioning and the very undemanding valuation.

Asymmetry and other themes

While outsized stock returns are key to our style of investing, the current stock market risks misinterpreting the dynamics of asymmetry, principally on gains delivered versus the potential for more.

If you follow stock markets, you will have heard of the Magnificent 7 (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla) which are all attracting investors based on their potential to benefit from AI. These are exceptional companies. They have come to dominate their respective areas, and several have become digital utilities through which large chunks of commerce and data now flow.

But early in the millennium, these companies were the upstarts. They were the ones that naysayers doubted. They were pioneering new solutions, embracing digital tools, expanding their relevance and skillfully executing while avoiding pitfalls. Their prize has been outsized equity returns and handsome profits to those – including EWIT with Tesla – who owned them throughout that journey.

The case for future deeply asymmetric returns is fundamentally different from those already delivered. Both should be respected but the former represents opportunity whereas the latter is diminishing. If that latter case is taken too far it could be damaging as the inescapable law of large numbers catches up.

The adage that it’s better to travel hopefully than to arrive is critical to maximising asymmetry – just make sure the journey is a long one. That’s why we hunt for such businesses when they’re immature and below the radar of conventional investors.

Momentum, positive and negative, has a pendulum effect on equities, whether that’s from fear or FOMO (fear of missing out). Periods of momentum are unavoidable for long-term growth investors, and many of our best investments have benefitted and suffered for short periods. But there are themes at play in stock markets through which momentum takes on gravitational force, sucking the air out of the market and blinkering investors to opportunities beyond.

We see a great opportunity for AI to transform swathes of business and consumer activity. Markets have too crudely assigned the benefits of these changes to a handful of winners – roughly the Magnificent 7 plus a handful involved in semiconductor production outside of the US.

We see parallels with this dislocation in healthcare, where the arrival of GLP-1 obesity drugs has monopolised the innovation debate. We get that dominant businesses deserve their rewards – our owning Tesla for a decade is testament to this – but there must be easier ways to make money in today’s bifurcated stock market.

When a hot contemporary theme meets a momentum-craving stock market, warning lights flash. In the current atypical business cycle, this dynamic is exacerbated by the interest rate waiting game playing out in financial markets.  

This backdrop has been deeply unhelpful to investors in earlier-stage, growth-hungry companies. Shortened investor time horizons and higher interest rates alongside mega-company-skewed themes, have deprived our preferred hunting ground of the attention it deserves. Many have shunned it.

We don’t know when these dislocations will correct themselves, but things are starting to change, partly because all the above themes have already been pushed quite far. The realisation that high inflation isn’t endemic, plus a global economy that appears resilient despite all that has been thrown at it for the last four years, creates a solid foundation for investors to begin projecting out over longer-term time horizons.

Most importantly, the relevance of the companies we own is increasing as their offerings improve and resonate more with customers. Not all our holdings will be outlandishly successful, but several have the potential to be just that. When combined with the reset in growth equity valuations lower down the market capitalisation spectrum, this creates a highly attractive foundation for thoughtful long-term growth investing. We continue to believe it’s as attractive as at any time in recent memory.

The value of the trust's shares and any income from them can fall as well as rise. Capital is at risk. Past performance is not a guide to future returns.

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

For a Key Information Document for the Edinburgh Worldwide Investment Trust please visit our website at www.bailliegifford.com

This communication does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

Baillie Gifford & Co and Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA).

The investment trusts managed by Baillie Gifford & Co Limited are listed UK companies and are not authorised or regulated by the Financial Conduct Authority. 

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.

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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