International Alpha: investor letter Q1 2025

Your capital is at risk.

 
 
We have been making the case for some time that US equity outperformance is unsustainable and that current valuations for international equities compare very favourably to the US. However, there were two unexpected developments during the quarter that triggered the recent partial correction.

First, in late January Chinese firm, DeepSeek, launched an open-source large language model with impressive results, achieved at a fraction of the cost incurred by US peers. This has upended assumptions surrounding large-scale investments and infrastructure required for cutting-edge AI systems and challenged the case for US technology exceptionalism. With the Chinese authorities also adopting a more accommodative stance towards private company leaders, and stimulus measures aimed mainly at stabilising the property market and improving sentiment continuing, it was a strong quarter for many Hong Kong-listed and Chinese domestic names, whilst the Magnificent Seven US stocks lost some of their lustre.

A second development worthy of note is that economic activity and sentiment indicators have improved in Europe and Japan whilst they have deteriorated in the US. Germany has lifted its debt ceiling and announced a major stimulus package focused on infrastructure and defence. At the same time, faster interest rate cuts and higher real wage growth across the region has boosted activity and sentiment. Economic activity in Japan has also improved, boosted by rising wages and a rebound in tourism. In the US growth forecasts have been cut, whilst projections for inflation have risen.

Although returns for the international equity asset class provided encouragement during the quarter it was a challenging backdrop for growth stocks, which underperformed the standard benchmark. Stimulus announcements and improved economic activity across much of the region provided a shot in the arm for many lower-quality, more cyclical companies. In contrast, there has been a rotation out of risk assets, especially those businesses that are reliant upon global trade for their growth and stand to lose out from US tariffs. Growth equities under performed during the quarter and have struggled over the past twelve months. Fortunately, our diversified approach has provided some insulation and resilience, and the overall trajectory of performance for the portfolio continues to improve.

Evidence shows that share prices follow earnings over longer, more meaningful, time periods such as five years. The portfolio exhibits a distinct earnings growth bias when compared to the benchmark index and there were numerous examples during the quarter of impressive execution from holdings across a range of different countries, sectors, and shades of growth.

Whilst its shares fell in value during the quarter, in common with other semiconductor-related names, Taiwanese chip manufacturer TSMC continues to distance itself from its competitors and deliver exceptionally strong earnings growth. Having tripled in 2024, AI-related demand now accounts for 15 % of total revenues and is forecast to grow at 40% per annum until 2029. We made a well-timed reduction to the position in January after a strong share price run but it remains a high conviction position, which epitomises what we mean by a through-cycle winner.

Another large holding for the portfolio that delivered results that exceeded expectations was Latin American e-commerce and fintech platform Mercado Libre (Meli). It reported a 37% year-on-year increase in revenue and record levels of quarterly income. Although it has now surpassed 100 million marketplace buyers and 61 million monthly active fintech users we believe there is much further to go in the Meli growth story. Ecommerce penetration across the Latin American region is 13%, which compares to 22% globally and 25% in the US. Through a combination of innovation, infrastructure build-out and introducing new categories Meli is gradually closing this gap as well as providing finance products to an underserved population. Although it has been held in the strategy since 2010 it still meets all the criteria we look for in a rapid growth stock.

Turning to our European holdings there is much to be lauded. UK-listed credit and data analytics bureau, Experian, may not sound as exciting as TSMC or Meli but its technology leadership and sticky customer base lends itself to consistent profitable growth. During the six-month period to end of December 2024 Experian delivered mid to high single-digit revenue growth across all regions and business segments. It also reported an improvement in profitability.  

Swiss luxury conglomerate, Richemont, known for its timeless heritage brands such as Cartier and Van Cleef & Arpels, saw its sales recover strongly this quarter, putting a more challenging period behind it. Revenue expanded 10% to a record level with all regions, except Asia, boasting double-digit growth. 

Finally, German enterprise software business, SAP, keeps going from strength to strength. Momentum remains strong in cloud-based sales, with a 27% year-on-year increase recorded during the final quarter of 2024 and the order backlog is at record levels. Whilst Experian, Richemont and SAP are very different businesses they all demonstrate the merits of owning quality compounders in the portfolio.

In a diversified portfolio invested across the international landscape there are always names that disappoint. Within the portfolio’s capital allocators TFI International and DSV fit into this category. Each of these logistics businesses are exposed to general levels of trade, therefore the uncertainty surrounding US trade policy, combined with depressed freight rates has weighed on earnings and sentiment. In the case of TFI it has also taken longer than anticipated to turn around one of its recently acquired companies. As a reminder, TFI has delivered exceptional shareholder returns over three decades by buying niche logistics businesses cheaply, making operational improvements, and using the cash generated to fund further deals. Although it has been a frustrating start for this holding, our long-term thesis remains unchanged.

DSV has featured as one the strategy’s top performing holdings over the past decade. Instead of making regular bolt-on acquisitions it embarks upon a transformative deal every four or five years, stripping out at much cost as possible and bringing the acquired business in line with its practices and systems.  

We are confident in the portfolio, but we will continue to pursue new ideas with the aim of upgrading its growth and quality characteristics. During the quarter we maintained our progress in widening the funnel of ideas, discussing a leading manufacturer of biosimilars, a global drinks company, a disruptive Chinese ecommerce platform, a collection of telecom infrastructure businesses and a global healthcare giant among other opportunities.

We also revisited a number of existing holdings to ensure that they still justify their place in the portfolio or their position size. The outcome of this work was the purchase of two new holdings, funded by some reductions to existing positions. We reviewed the investment case for leading Danish healthcare company Novo Nordisk in August last year and, whilst concluding that it remains a special franchise targeting a large and growing addressable market in obesity, we decided not to take a holding on valuation grounds. Following a 50% fall in the share price since then we decided to take a starter position for the portfolio. 

Similarly, there was a positive reception to Chinese industrial national champion, Midea Group, when it was discussed around nine months ago but trepidation surrounding the macro backdrop in China prevented us from taking action. Amidst clear signs of an improvement here, and with little change in the price we were being asked to pay, we initiated a holding for the portfolio. 

Now more than ever it is important that we avoid knee-jerk reactions to policy announcements and stay the course as long-term growth investors. The portfolio contains a diversified collection of resilient companies run by able management teams that benefit from long growth runways. At the same time, we remain excited about the international opportunity set and there are signs that the market is coming round to our view.  Equity investing is never a smooth ride, however, we are confident that the portfolio will deliver attractive returns over the next five years and beyond.

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.

Legal notice: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

Risk factors

This communication was produced and approved in April 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, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.

All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.

The images used in this communication are for illustrative purposes only.

Important Information

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.

Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.

Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.

Financial Intermediaries

This communication is suitable for use of financial intermediaries. Financial intermediaries are solely responsible for any further distribution and Baillie Gifford takes no responsibility for the reliance on this document by any other person who did not receive this document directly from Baillie Gifford.

Europe

Baillie Gifford Investment Management (Europe) Ltd (BGE) is authorised by the Central Bank of Ireland as an AIFM under the AIFM Regulations and as a UCITS management company under the UCITS Regulation. BGE also has regulatory permissions to perform Individual Portfolio Management activities. BGE provides investment management and advisory services to European (excluding UK) segregated clients. BGE has been appointed as UCITS management company to the following UCITS umbrella company; Baillie Gifford Worldwide Funds plc. BGE is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co. Baillie Gifford Overseas Limited and Baillie Gifford & Co are authorised and regulated in the UK by the Financial Conduct Authority.

South Korea

Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.

Japan

Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.

Australia

Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth) and holds Foreign Australian Financial Services Licence No 528911. This material is provided to you on the basis that you are a “wholesale client” within the meaning of section 761G of the Corporations Act 2001 (Cth) (“Corporations Act”).  Please advise Baillie Gifford Overseas Limited immediately if you are not a wholesale client.  In no circumstances may this material be made available to a “retail client” within the meaning of section 761G of the Corporations Act.

This material contains general information only.  It does not take into account any person’s objectives, financial situation or needs.

South Africa

Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.

North America

Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005 and is registered with the SEC. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in North America. Baillie Gifford Overseas Limited is registered with the SEC in the United States of America.

The Manager is not resident in Canada, its head office and principal place of business is in Edinburgh, Scotland. Baillie Gifford Overseas Limited is regulated in Canada as a portfolio manager and exempt market dealer with the Ontario Securities Commission ('OSC'). Its portfolio manager licence is currently passported into Alberta, Quebec, Saskatchewan, Manitoba and Newfoundland & Labrador whereas the exempt market dealer licence is passported across all Canadian provinces and territories. Baillie Gifford International LLC is regulated by the OSC as an exempt market and its licence is passported across all Canadian provinces and territories. Baillie Gifford Investment Management (Europe) Limited (‘BGE’) relies on the International Investment Fund Manager Exemption in the provinces of Ontario and Quebec.

Israel

Baillie Gifford Overseas is not licensed under Israel’s Regulation of Investment Advising, Investment Marketing and Portfolio Management Law, 5755-1995 (the Advice Law) and does not carry insurance pursuant to the Advice Law. This material is only intended for those categories of Israeli residents who are qualified clients listed on the First Addendum to the Advice Law.

Singapore

Baillie Gifford Asia (Singapore) Private Limited is wholly owned by Baillie Gifford Overseas Limited and is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence to conduct fund management activities for institutional investors and accredited investors in Singapore. Baillie Gifford Overseas Limited, as a foreign related corporation of Baillie Gifford Asia (Singapore) Private Limited, has entered into a cross-border business arrangement with Baillie Gifford Asia (Singapore) Private Limited, and shall be relying upon the exemption under regulation 4 of the Securities and Futures (Exemption for Cross-Border Arrangements) (Foreign Related Corporations) Regulations 2021 which enables both Baillie Gifford Overseas Limited and Baillie Gifford Asia (Singapore) Private Limited to market the full range of segregated mandate services to institutional investors and accredited investors in Singapore.

145124 10054073