1. Island Time

    Slow Bond Investing

    Torcail Stewart, Investment Manager. Third Quarter 2019
  2. All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk.

  3. “Isolation, by checking immigration and consequently competition, will give time for any new variety to be slowly improved; and this may sometimes be of importance in the production of new species.”
    Charles Darwin, On the Origin of Species
  4. Islands have captivated the human imagination since time immemorial. In the 8th century BC, Homer related the epic journey of Odysseus. A tale populated with various magical beings, each living in their own unique island world. 

    Three millennia later, Charles Darwin, travelling on HMS Beagle arrived in the Galapagos, to a world of giant tortoises, marine iguanas, and the bizarre blue-footed booby. At a similar time, another British naturalist Alfred Russel Wallace’s trip to the Malay Archipelago saw him encounter flying frogs, paradise kingfishers and the majestic red ape. Islands have acted as evolutionary laboratories of nature – and the imagination – for centuries. Building on their island experiences, Darwin and Wallace, evolved similar theories of evolution through natural selection. Islands offer time for evolution to occur free of competitive distraction. 

    A similar principle applies in investment. Whilst our fixed income approach is certainly neither exotic or magical, it is nevertheless distinctive. The Strategic Bond Fund’s approach has been incubated within the supportive island environment of Baillie Gifford for over two decades. The result is a unique methodology. So what are our tips for island living?

  5. GO OFF GRID

    Be free in your thought and action. Island Time implies thinking time. A well-considered decision is always better than a rushed one. Frenetic trading is not our style. We typically lend to companies for between 3 to 5 years. Therefore, choosing to whom to lend is not a decision that is taken lightly. Our bond net is cast wide as we seek to identify the most promising global opportunities. The fund can invest in multiple currencies including: sterling, dollar, euro or Canadian dollar denominated bonds. To keep it simple, we aim to remove unwanted currency risk and focus purely upon credit selection. As a consequence, all foreign denominated bonds are hedged back to sterling. The Baillie Gifford Strategic Bond Fund is a best ideas fund. It seeks to identify the best income-generating bonds that we can source from both the global investment grade and high yield corporate bond universes.

    12-Month Rolling Turnover

    Source: Baillie Gifford & Co.

     

    Global Opportunity Set

    Source: Baillie Gifford & Co. Based on Baillie Gifford Strategic Bond Fund. Data as at 31 December 2018.

  6. PLAN AHEAD

    Fruitful island living requires one to think ahead and plan for forthcoming seasons. Similarly, we also follow a long-term approach both with individual bond selection and asset allocation. Our focus is upon companies’ long-term fundamentals. We seek to lend to those businesses that are growing and have a sustainable competitive advantage.

    Planning ahead also means one has to be cognisant of the global macroeconomic environment. We use our understanding of the broader macro context to shape portfolio asset allocation and thereby avoid areas of potential future market volatility. Our risk-budgeting approach considers various measures including: asset class, industry, geography, time to maturity, cyclicality and scenario testing. The Baillie Gifford Strategic Bond Fund seeks to offer clients a through-the-cycle bond solution.

     

  7. FIND YOUR NICHE

    In an island community, everyone has a specific role and a specialism. Choosing the right role is likely to dictate your prosperity.

    With the world as our oyster, to render such a broad bond universe manageable, our prospecting efforts target areas of bond inefficiency.

    The credit quality of companies which issue bonds varies greatly. Intuitively, those companies operating at the low quality CCC end of the ratings scale may not be the most attractive investments. However, the same may also be true of those companies with high quality AAA ratings. We believe that the most attractive investment opportunities are traditionally found between these two extremes, specifically those companies rated BBB and BB. This belief is based upon observation over the years that the rewards frequently overcompensate for the risks that these businesses present.

    Other areas of inefficiency that we target include: Out of favour sectors, mis-rated bonds with upgrade potential, large unrated bonds, management turn-around investments, likely sector consolidation targets and high yielding convertible bonds.

  8. EAT WHAT IS IN SEASON

    In bond markets, as with islands, it is usually good advice to tailor one’s gastronomical choices to what is in season. Namely, seek to lend to those companies that are structurally growing and avoid those in structural decline. A company that is structurally growing, in a time of cyclical weakness, is much more likely to receive capital support from its shareholders, than one whose business model is increasingly obsolete. The latter variant carries the added risk that you never really know when growth may step-change downwards. Why take the risk?

    The majority of companies that we lend to within the Baillie Gifford Strategic Bond Fund have strong long-term growth potential. Indeed, the weighted average annual sales growth rate of companies we lend to in the fund is greater than 10 per cent per annum.

    The other aspect to eating what is in season, involves directing our prospecting efforts to those geographies and sectors where we see the best risk-adjusted returns residing. In times of fear, we often find that for out of favour sectors, strong companies bonds sell-off at the same time as the weak. To the bond selector, focused upon long-term fundamentals, rich pickings can be made in such an environment.

  9. SOME PEOPLE FEEL THE RAIN, OTHERS JUST GET WET

    If the songwriter who penned that famous lyric were a bond investor, he’d no doubt advise perspective.

    Bonds don’t have to be boring. The key differentiating feature of our approach is identifying companies whose balance sheets are likely to improve. Bond prices appreciate when yields reduce. The stronger the balance sheet of an issuer, typically the lower the yield offered by its bonds. Consequently, seeking bonds issued by companies where one believes the balance sheet will improve is often an apt strategy.

    Indeed, as shown in the chart below, if we break-down the gross income and capital return of the Baillie Gifford Strategic Bond Fund versus the income and capital return of its comparative benchmark, it is intriguing to note that the greatest portion of fund outperformance has been through capital, rather than income return.

    Bond selection, through identifying bonds issued by companies where balance sheet improvement occurs, may offer the bond investor meaningful potential capital growth.

    Baillie Gifford Strategic Bond Fund
    Gross Excess Income & Capital Return vs. Comparative Benchmark Income & Capital Return (%)

    Source: Baillie Gifford & Co, ICE BofA ML

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    At Baillie Gifford we follow a distinctive approach to credit markets. Focused on long-term fundamentals, we seek to lend to growing companies with sustainable or improving balance sheets, that will deliver a resilient income stream through the cycle.




    Background Image: The official flower of the Galapagos is the passion flower. Passion flowers can be found across South America, but only those growing on the Galapagos are white – others are purple or red.

     

     

     

  11. IMPORTANT INFORMATION AND RISK FACTORS

    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.

    The views expressed in this article are those of Torcail Stewart and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

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

    Stock Examples

    Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.

    This article 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.

    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.


    Standardised Past Performance to 30 June each year

     

    2015

    2016 2017 2018 2019
    Baillie Gifford Strategic Bond Fund (%) 4.2 3.4 10.7 1.8 7.2
    Comparative Benchmark (%)* 5.4 7.1 7.2 1.1 6.2


    Source: FE and underlying index provider(s). Class B Inc shares, single pricing basis, total return. Returns reflect
    the annual charges but exclude any initial charge paid. * 70% BoA ML Investment Grade, 30% BoA ML European Currency High Yield Const.

    41870 INS WE 0494

  12. Torcail Stewart

    Investment Manager

    Torcail joined Baillie Gifford in 2008 and is an Investment Manager in the Credit Team. Prior to joining Baillie Gifford he worked as an Investment Analyst for the Alliance Trust’s UK Large Cap Equity Fund. Torcail graduated BA in Geography from the University of Cambridge in 2002 and MPhil in Management, Economics and International Relations from the University of St Andrews in 2005. Torcail is a member of the UK Society of Investment Professionals (UKSIP).