Tilting the odds in your favour

Investors should consider the investment objectives, risks, charges and expenses carefully before investing. This information and other information about the Funds can be found in the prospectus and summary prospectus. For a prospectus and summary prospectus, please visit our website at bailliegifford.com/usmutualfunds. Please carefully read the Fund's prospectus and related documents before investing. Securities are offered through Baillie Gifford Funds Services LLC, an affiliate of Baillie Gifford Overseas Ltd and a member of FINRA.

Spoiler alert! In the classic Western of the same name, four of ‘The Magnificent Seven’ died. Being magnificent or considered the best of the best was not enough to save them.

It just goes to show that you are only ever as good or bad as you perform in your current shootout. Odds are, someone is going to come along at some point who is a better or faster shot than you.

That’s part of the reason why, while the US domestic market is home to some exceptional companies and offers excellent investment opportunities, you should not overlook international markets.

US stocks currently represent approximately two-thirds of the global equity market in terms of market cap. At the same time, the S&P 500 stock market is approaching its highest concentration level in history.

Dominating it are the ‘Magnificent Seven’ – technology companies Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta and Tesla. They account for an extraordinary 17 per cent of the MSCI All-Country World Index, more than the combined weighting of Japan, France, China and the UK.

Therefore, investing globally results in a significant home bias and an unintended level of vulnerability. Markets are inherently cyclical. The odds are that individual companies, no matter how dominant they currently are, will ultimately lose their lustre. During the past thirteen years, high exposure to US equities has been greatly beneficial, but it was a different story in previous decades.

Weighting in the MSCI All Country World Index

Consider, for example, the ‘lost decade’ for US stocks: between 2000 – 2009, the cumulative total return for the S&P 500 was -9.1 per cent versus +30.7 per cent for the MSCI ACWI ex US.

There’s a long history of throne-swapping between US and International stocks (see chart below). This is one of the most prolonged periods of relative strength in the past 20 years, and after such a lengthy period of outperformance for US stocks, history suggests this will change.

Therefore, investors should think twice before giving ex-US assets the cold shoulder. Trying to time regime changes is very difficult, and without the benefit of hindsight, it might be wise to consider both US and ex-US equities within your asset allocation.

The relative performance of US S&P500 versus international developed markets based on five-year rolling returns*

Having an overweight position in US equities is also at odds with the shifting tectonics of gross domestic product (GDP) growth relative to index representation. The US represents 64 per cent of the MSCI universe yet accounts for only 25 per cent of global GDP. Would you bet against this reversing, given that previously stable beliefs regarding global supply chains, the unrestricted movement of goods, individuals, capital, trade policies, and global legislation continue to shift against greater globalisation.

Disparity between Index representation and economics

This will increase the opportunities to invest in domestic champions on the right side of regulation, serving their local markets. New factories and manufacturing facilities also mean more equipment in more places for those companies within their supply chain.

However, investment managers with strong research capabilities focused on company specifics may be able to spot these opportunities in the broader opportunity set that international equities offer.

Expanding opportunity set beyond the US

Critics often argue against international diversification by pointing out that many US corporations generate significant revenue from abroad, suggesting that the international exposure of these multinationals might suffice.

We contend that relying solely on these companies does not generate the diversification benefits of investing directly in select international businesses that benefit from unique business models and growth drivers.

Moreover, these US multinationals are often concentrated in specific sectors, such as technology, and are generally larger, as evidenced by our ‘Magnificent Seven’. This concentration and preference for larger businesses might lead to an underrepresentation of smaller companies and other sectors that are less well-represented by US domestic opportunities, which could increase the risk profile unnecessarily.

Diversification

Diversification is a fundamental principle of investing.

The universe of US large and mid-cap stocks, represented by the MSCI USA Index, comprises over 600 securities. So, US investors might assume there are ample opportunities for diversification and potential risk reduction in the domestic market. But is this assumption correct?

The exhibit below shows two concentration measures for US and global developed-market (DM) equities: the weight of the top-10 constituents and the number of effective constituents in the MSCI USA and MSCI World ex USA Indexes.

Top 10 constituents by weight (%)

Effective number of constituents*

By both measures, US market concentration was the highest it has been for over two decades and is approaching the dotcom bubble levels of the late 1990s.

As of December 2023, the top 10 assets accounted for 29 per cent of the weight of the MSCI USA Index. By contrast, measures of concentration in DMs outside the US have been stable and lower in recent years: the top 10 assets accounted for 13 per cent of the index weight.

Valuation

US equity markets have historically been valued at a premium to other markets based on their underlying characteristics and growth expectations. However, the current valuation disparity between US and international equities is much wider than usual.

The large-cap S&P 500’s price-to-earnings ratio, which measures a company's share price relative to its earnings per share (EPS), is 19.4x, above its 10-year average of 17.4x, which could suggest that US stocks are overvalued or that investors expect high growth rates. In contrast, other markets are trading well below. Indeed, various developed and emerging international markets have been trading at their most attractive levels in decades, despite an improved opportunity set and financial characteristics.

The US market’s valuation is above its 10-year average, whereas international is below average, driven largely by Europe.

Forward price-to-earnings ratios based on 2023 consensus forecasts versus the 10-year average*

An alternative to the ‘Magnificent Seven’

Returning to our opener, the dominant theme in equity markets over the past 12-plus months has been the rise of the ’Magnificent Seven’ US technology stocks.

Exposed to similar growth drivers of the rise of artificial intelligence and cloud computing, these tech behemoths delivered a median return of 60 per cent plus since the end of 2022 until the end of 2023. This has presented a significant portfolio challenge for US domestic and global investors. Those who didn’t own them at scale likely underperformed.

Technology consumed almost all net equity sector inflows in 2023, and ‘The Seven’ were the outstanding beneficiaries of this capital capture.

There is an equally attractive international opportunity set. Our experience managing international portfolios dates back to the 1980s, but investing overseas is more deeply embedded in our firm’s DNA. Indeed, our oldest client, which has been managed by Baillie Gifford for 115 years, has always included a global allocation.

As bottom-up equity investors, we invest in individual companies, not broad market indices. The international opportunity set is rich, diverse and home to many world-leading businesses. From quality engineering to disruptive medicine to durable luxury heritage and global leading digital payment systems.

A world of opportunity

OK Corral

The international opportunity set is a vast and exciting hunting ground for the bottom-up stock-picker.

Including ex-US equities in your asset allocation can dilute the level of stock concentration. It can also bring diversification benefits that cannot be achieved through investing in US equities alone, given the dominance of the ‘Magnificent Seven’ technology companies.

We aim to find and invest in world-leading companies that can significantly grow their businesses over the next five years and beyond. If you only invest in domestic equities, perhaps this is the time to consider saddling your horse and riding out of town.

The international companies we invest in on our client’s behalf indicate that there is a story to tell beyond the US’ Magnificent Seven.

Important information and risk factors

The Funds are distributed by Baillie Gifford Funds Services LLC. Baillie Gifford Funds Services LLC is registered as a broker-dealer with the SEC, a member of FINRA and is an affiliate of Baillie Gifford Overseas Limited. All information is sourced from Baillie Gifford & Co unless otherwise stated.

As with all mutual funds, the value of an investment in the Fund could decline, so you could lose money. International investing involves special risks, which include changes in currency rates, foreign taxation and differences in auditing standards and securities regulations, political uncertainty and greater volatility. These risks are even greater when investing in emerging markets. Security prices in emerging markets can be significantly more volatile than in the more developed nations of the world, reflecting the greater uncertainties of investing in less established markets and economies. Currency risk includes the risk that the foreign currencies in which a Fund’s investments are traded, in which a Fund receives income, or in which a Fund has taken a position, will decline in value relative to the U.S. dollar. Hedging against a decline in the value of currency does not eliminate fluctuations in the prices of portfolio securities or prevent losses if the prices of such securities decline. In addition, hedging a foreign currency can have a negative effect on performance if the U.S. dollar declines in value relative to that currency, or if the currency hedging is otherwise ineffective.

For more information about these and other risks of an investment in the Funds, see "Principal Investment Risks" and "Additional Investment Strategies" in the prospectus. There can be no assurance that the Funds will achieve their investment objectives.

Data as at 27 March 2024