Global Alpha Research Agenda 2024

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In our search for outstanding growth companies, we are drawn to areas of innovation and enduring growth: pockets of economic, societal, or technological change that offer fertile conditions for companies to thrive. Our annual Research Agenda outlines the most promising of these areas of opportunity.

During periods of difficult performance, this exercise becomes more important than ever. It helps to ensure we remain reward-seeking in our outlook and focus our research productively.

We shared our first Research Agenda back in 2013. This is the 12th version. As ever, some of the areas included look to build on previous work – for instance, assessing how the opportunities in healthcare have evolved amid recent upheaval. Others are more counterintuitive. The challenges arising from a changing geopolitical order, or a shift from abundance to scarcity in a range of key resources, are well covered in the daily market noise. Less obvious are the emerging beneficiaries of these trends. Domestic champions grow stronger; access to scarce resources becomes a powerful competitive advantage.

If equity market returns in the pre-pandemic decade were dominated by ‘technology’ companies, we may be heading into a new era of more diverse winners. As artificial intelligence (AI) diffuses intelligence ever more broadly throughout our economy, we must cast our net wide in the search for businesses possessing the right qualities to harness this paradigm shift. Our Research Agenda helps us focus our time and attention on the crucial task of identifying the companies on the right side of these changes and ensuring our portfolio remains in vigorous long-term health.

Generative AI – the next frontier

We are witnessing the dawn of a major technological revolution. Like previous revolutions, it will precipitate profound social and economic changes. Unlike previous revolutions, the pace
of diffusion will surely be rapid.

It is difficult to overstate advancements in AI. It was only a year ago that ChatGPT exploded into our collective consciousness, becoming the fastest growing consumer application in history. It’s ludicrously easy to use and embodies more knowledge than any human could. The ability to converse at a human level, combined with extraordinary powers of data processing, has captured the public imagination.

In the 15th century, the Gutenberg printing press took a limited set of letters and symbols and recombined them in unlimited ways to create the modern world. It changed almost every aspect of life: it helped scholars accumulate knowledge, disseminate ideas, standardise language, and increase literacy. In turn that changed the relationship between man and God, individuals and society, and the past and the present.

Generative AI is not a new algorithm. It is a new paradigm.

What might generative AI be able to produce from a recombination of all human knowledge?

Unlike the printing press, which can only copy content, generative AI can create it. It might be used to generate movies on demand, provide tutelage to children, or teach cars to drive themselves. It can do all this without requiring a single new line of code. Generative AI is not a new algorithm. It is a new paradigm. A new way of developing software, by ‘training’ rather than ‘coding.’ This may sound futuristic, but the future is here. Tesla will soon release a new version of its self-driving software. It is end-to-end AI – and it can match human driving performance without anyone coding traffic rules for it.

Software has been an accelerant to growth. It democratised the tools to entrepreneurship and created a new economic model where success of a company scales with its user count. Many of the largest companies today – Microsoft, Apple, Alphabet, Amazon, Meta, Tesla – are all in essence software companies. It’s no wonder that there has been fierce competition for software talent.

Generative AI acts as an accelerant to software. Just like it can create new images, music, and videos, so too can it create new software. It democratises programming talent. Already programmers on GitHub, an open-source coding site, use AI-based co-pilots to produce half their code. Tesla’s AI-generated self-driving software replaced over a decade of engineering work and over 300,000 lines of code.

Rather than seeing the end of the software-driven growth era, could we be entering a period of even faster development? What are the new scarce resources? Which companies will capitalise on them? It is clear that we are at the beginning of something big. The pace of progress is far beyond what Moore’s Law dictates, and there is no clear upper bound to what might be possible.

What’s less clear is the impact this might have on companies and societies. Any technology that holds such disruptive potential is bound to cause unease. AI raises difficult questions about the labour force, data privacy, safety, bias, and more. But it is also an engine of progress, and progress powers prosperity. What problems can it solve? Who will be the beneficiaries? And how can we harness this technology to live healthier, safer, and more fulfilling lives? An exploration of these questions will help us identify the winners of tomorrow.

Infrastructure upgrade and the resurgence of the domestic champion

AI captures the imagination. But not all opportunities today are yesterday’s science fiction. Some are familiar, even mundane – but could be equally rewarding.

In last year’s Research Agenda, we highlighted businesses positioned to benefit from the repair and enhancement of physical infrastructure. Developed nations have underinvested for decades. Resilience and longer-term economic growth have suffered. Roads need repaired; bridges rebuilt; power grids upgraded; advanced manufacturing installed. Our conviction that we are witnessing the early stages of an industrial super-cycle across the western world has deepened further.

Two other factors are emerging that will accelerate the trend. Firstly, the pandemic and erupting regional conflict have exposed the vulnerabilities of globally distributed production. This has caused a drive to reinforce domestic supply chains. As geopolitical fractures spread, nations look to their supply of resources – both natural, such as energy and metals, and manufactured, like semiconductors.

Secondly, national security is threatened by something other than rival countries: climate change. It is difficult to underestimate the scale, and the unpredictability, of the implications of a warming world. Risks to physical assets are rising. Billions of dollars need to be spent on everything from the electrical grid to stormwater drainage.

Of course, even without these factors, ongoing investment is needed simply to maintain ageing infrastructure. Some argue that political cycles can stall even essential infrastructure projects. This is an election year after all. However, both geopolitical and climate concerns are issues of national security. Such worries are seldom put off. These trends will be persistent.

Several companies in the Fund's portfolio already benefit from these themes. They include the building materials businesses, Martin Marietta Materials and CRH, ground water management company, Advanced Drainage Systems, power management firm, Eaton, and the mechanical electrical contracting business, Comfort Systems. We expect to find many more opportunities, in the US and abroad.

Capital cycles and emerging scarcity

In the years following the Global Financial Crisis of 2008–09 capital was cheap. Indeed, so inexpensive, and so abundant, that some market participants seemed to forget it had a cost. Starting in 2022, central bank rate moves – in the US, the fastest rate-hiking cycle in 50 years – have provided a rude awakening.

The impact of higher rates in some ways was immediate and obvious. Long duration assets – such as high growth equities – became less valuable. We have certainly felt that. However, in others, the impact has been slower to materialise. Changes to the supply side take time. Yet in the long run the impact of capital scarcity on spending, and therefore competition, should be far more impactful than merely a higher discount rate today.

We have already seen signs of changing competitive dynamics and shifting capital allocation. The US oil and gas sector has entered a period of mega-mergers. Streaming companies – Netflix, Disney, Amazon – have become more restrained in content spending now that such investment has a cost. Tech companies globally are focused on profits, not merely revenue growth. The margins of some of the Fund's holdings, such as Shopify and DoorDash, are already benefitting. Moreover, capital may not be as geographically free flowing as it has been. Protectionism is growing, while whole economies are perceived as unsafe homes for capital investment. The UK and China spring to mind.

We are alert to the possibility that 2024 might bring the first flowerings of a more benign supply side. Our research will unearth areas in which rational competition will allow for higher profits, or where sound capital allocators with good balance sheets can take advantage of low valuations. Areas as diverse as telegraph pole manufacturing and British house builders are already on our radar.

Capital is not the only area of emerging scarcity. A key skill of a fund manager is not just to ask questions of companies, but to listen. Our holdings have repeatedly highlighted other areas of shortage to us. Semiconductors have been a headline grabbing example. A new crisis may emerge as a result of the energy transition – is there enough copper, lithium, specialist components (and political will)? Another intriguing bottleneck is labour: both knowledge professionals and blue-collar workers are in short supply. The problem only gets worse. Labour’s share of Gross Domestic Product has seldom been lower, but it is likely to change.

Which companies have access to these resources? Which ones can work around the problem? Those able to attract and retain workers – through compensation, mission, or a loyal workforce or who have a process that requires less labour – will have a burgeoning competitive advantage. We are looking for scaled players rolling up fragmented industries, robotics and automation companies, and, of course, AI leaders.

Capital and labour shortages may spell trouble for many. But for some, it will be a huge benefit. These big winners should be very profitable investments. We intend to find them.

Healthcare – a year of healing

We are drawn to areas of structural growth that are temporarily, and unfairly, out of favour.

In 2023 healthcare companies underperformed the wider global market by 20 per cent. This reset was the worst result in 20 years. A decade’s worth of cumulative outperformance by the sector was wiped out. Relative valuation measures are close to 10-year lows. So, healthcare is out of favour – but is it unfairly so?

The long-term drivers of demand growth are intact. Firstly, the population continues to age. The World Health Organization (WHO) forecasts that the global number of people aged over 60 will double by 2050. The number of people over 80 will triple. As we age, we consume much more healthcare. A 90-year-old Brit incurs approximately 10 times the healthcare costs of someone half their age.

The number of FDA-approved drugs last year… was the second highest in a generation.

Secondly, we are rapidly expanding the boundaries of medicine. More areas are being ‘medicalised’ and previously incurable diseases are becoming controlled with long-term therapies.

Third, biological innovation has accelerated. The number of Food and Drug Administration (FDA)-approved drugs last year – a leading indicator of future industry revenue growth – was the second highest in a generation.

If demand growth is so obvious, what’s the problem? Several waves of fear have built up to create a near-perfect storm. The list below is not exhaustive. However, a common and intriguing thread is that each headwind is lessening.

1. Waiting lists lengthened as procedures were postponed. Revenue from expected interventions never materialised. Non-urgent medical procedures, such as hip replacements, were crowded out by the pandemic, staff shortages, and then supply chain delays. The waiting list for elective treatments in England is almost three times larger than a decade ago. However, we will now need many years of above-average activity to clear the backlog – heralding a golden period of demand for medical device makers.
2. Similar disruptions caused inventories to be overbuilt for bioprocessing and life science products. The excess is being run down, temporarily depressing demand and near-term growth rates. We expect a return to more normal conditions in the west. In the east, a central clamp-down on purchasing saw life science and medical device demand fall very sharply. Normalisation will mean growth.
3. Falling risk tolerances resulted in companies requiring equity funding to significantly trim their ambitions and conserve cash. Pre-revenue biotech was hit hardest. Yet even the largest and most profitable pharmaceutical companies struggled as the Inflation Reduction Act raised fears of significant US drug pricing pressure. The funding environment now looks like it may ease, and worst-case pricing scenarios have not materialised.
4. Finally, a broad swathe of medical companies (and consumer goods businesses, like those selling chocolate and alcohol) found share prices under pressure as the efficacy of a new class of anti-obesity medicines become a market focus. We believe in the strong commercial potential for these drugs – but their long-term existential impact on demand for adjacent areas appears greatly overdone.

Our initial contentions are that structural demand drivers remain in place, valuations are strongly supportive, and several waves of fear are beginning to subside. Opportunities should be bountiful.

Conclusion

The world is beset with challenges. Conflict, scarcity, inflation, climate change. And yet, innovation and entrepreneurship are as alive today as they have ever been. The opportunity set before us is broad and deep. From AI to gravel, from biotechnology innovators to streaming companies – it’s a time to be excited. We look forward to a year of fruitful research.

Risk factors

This content 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.

As with all mutual funds, the value of an investment in the fund could decline, so you could lose money.

The most significant risks of an investment in the Baillie Gifford Global Alpha Equities Fund are Investment Style Risk, Growth Stock Risk, Long-Term Investment Strategy Risk and Non-U.S. Investment Risk. The Fund is managed on a bottom up basis and stock selection is likely to be the main driver of investment returns. Returns are unlikely to track the movements of the benchmark. The prices of growth stocks can be based largely on expectations of future earnings and can decline significantly in reaction to negative news. The Fund is managed on a long-term outlook, meaning that the Fund managers look for investments that they think will make returns over a number of years, rather than over shorter time periods. Non-U.S. securities are subject to additional risks, including less liquidity, increased volatility, less transparency, withholding or other taxes and increased vulnerability to adverse changes in local and global economic conditions. There can be less regulation and possible fluctuation in value due to adverse political conditions. Other Fund risks include: Asia Risk, China Risk, Conflicts of Interest Risk, Currency Risk, Emerging Markets Risk, Equity Securities Risk, Environmental, Social and Governance Risk, Focused Investment Risk, Government and Regulatory Risk, Information Technology Risk, Initial Public Offering Risk, Large-Capitalization Securities Risk, Liquidity Risk, Market Disruption and Geopolitical Risk, Market Risk, Service Provider Risk, Settlement Risk, Small-and Medium-Capitalization Securities Risk and Valuation Risk.

For more information about these and other risks of an investment in the fund, see “Principal Investment Risks” and “Additional Investment Strategies” in the prospectus. The Baillie Gifford Global Alpha Equities Fund seeks capital appreciation. There can be no assurance, however, that the fund will achieve its investment objective.

The fund is 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 and is current unless otherwise stated.

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

The Baillie Gifford Global Alpha Equities Fund

(Share Class K) as of December 31, 2023

Source: Baillie Gifford & Co

Annualised total return as of December 31, 2023 (%)

Source: Bank of New York Mellon, MSCI. NAV returns in US dollars.

The performance data quoted represents past performance and is no guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. For the most recent month-end performance please visit our website at bailliegifford.com/usmutualfunds.

Returns are based on the K share class from 28 April, 2017. Prior to that date returns are calculated based on the oldest share class of the Fund adjusted to reflect the K share class fees where these fees are higher.

The Baillie Gifford fund’s performance shown assumes the reinvestment of dividend and capital gain distributions and is net of management fees and expenses. Returns for periods less than one year are not annualised. From time to time, certain fees and/or expenses have been voluntarily or contractually waived or reimbursed, which has resulted in higher returns. Without these waivers or reimbursements, the returns would have been lower. Voluntary waivers or reimbursements may be applied or discontinued at any time without notice. Only the Board of Trustees may modify or terminate contractual fee waivers or expense reimbursements. Fees and expenses apply to a continued investment in the funds. All fees are described in each fund’s current prospectus.

Expense Ratios: All mutual funds have expense ratios which represent what shareholders pay for operating expenses and management fees. Expense ratios are expressed as an annualized percentage of a fund’s average net assets paid out in expenses. Expense ratio information is as of the fund’s current prospectus, as revised and supplemented from time to time.

The MSCI All Country World is a free float-adjusted market capitalization weighted index that is designed to measure equity market performance in the global developed and emerging markets, excluding the United States. This unmanaged index does not reflect fees and expenses and is not available for direct investment.

Top Ten Holdings to December 31, 2023

It should not be assumed that recommendations/transactions made in the future will be profitable or will equal performance of the securities mentioned. A full list of holdings is available on request. The composition of the fund's holdings is subject to change. Percentages are based on securities at market value.

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