Sustainable Growth: investor letter Q2 2025

Your capital is at risk.

 

This quarter demonstrated how preparation meets opportunity. The portfolio resilience we've been building for over two years proved its worth amid tariff uncertainty, while our parallel investment in artificial intelligence (AI) capabilities helped us navigate tariff complexity faster and more comprehensively than ever before. Both initiatives reflect the same philosophy - that superior long-term returns require continuous evolution in how we identify, analyse, and monitor exceptional companies.

 

Word on the street 

When we meet company management teams, we sometimes catch them off guard with the topics or time horizons we want to discuss – we’re longer-term and bigger-picture than most investors they speak with. But sometimes it can be instructive to see what’s coming up in those other conversations, to give us an idea of what the market’s currently obsessing over and test our points of difference. 

Earnings call transcripts provide a unique window into market discourse. Our analysis of trending phrases in the year so far shows 'tariff', 'geopolitics' and 'budget deficit' featuring prominently. Tariff-related discussions surged in April as management teams sought to reassure investors they were ready to adapt to President Trump's 'liberation day' announcements. This linguistic shift indicates that supply chain resilience has moved from a routine consideration to an immediate operational imperative for corporate leaders.

These comments coincided with extremely choppy market conditions, with global equities falling more than 10 per cent in US dollar terms in the week following the presentation of the now-infamous tariff billboard. US equities bore the brunt of this, with the market interpreting tariffs as both inflationary and bad for business confidence, and therefore growth. If we were to run a similar analysis of the phrases present in the economic forecasts posted over the past three months, 'stagflation' would likely feature prominently.

While trade tensions have de-escalated significantly since early April, the 'universal' 10 per cent tariff imposed by the US on all trading partners remains. Along with those levied on steel, aluminium, and the special rate applied to China, the average effective tariff rate now sits at 15 per cent – the highest since 1937. And, perhaps even more pernicious, the lack of visibility has dampened animal spirits. This explains why the US market has lagged its European counterpart significantly this year, with an 18 per cent gap in US dollar terms. It's also why Apple, which is not held in Sustainable Growth, was the top contributor to relative returns this quarter. Before ‘liberation day’, Apple was the single largest company in the US and constituted over 4 per ent of MSCI ACWI, but, as a big importer of Chinese-made electronics, it has a lot to lose from a trade war. 

We’d been discussing the potential for a trade war since the election in November, but still, the tariff levels announced in the Rose Garden surprised us. While we moved quickly to analyse the portfolio’s exposure to this latest crisis, we felt more confident after two years in which our focus has been on bolstering resilience and diversification. This meant Sustainable Growth entered this latest crisis in the best possible state, as evident from balance sheet strength (debt to equity levels are around a quarter of index levels) as well as indicators of pricing power such as gross margins (around a third higher than the index). It has been pleasing to see this reflected in performance this quarter, with the fund outperforming the index by more than 1 per cent in US dollar terms.

That’s not to say that all our companies are immune. We analysed company-specific impacts through the lenses of supply and demand risks. This helped us identify holdings such as Yeti – which manufactures drinkware products in China to be sold in the US – for further investigation. The company initially estimated that each 10 per cent hike to tariffs on Chinese imports was worth an additional $10m in cost of goods sold. However, management is working quickly to source materials elsewhere and expects to reduce China exposure to less than 5 per cent by year-end. We’ve remained in close contact with the company throughout this period, including a visit to its Texas HQ.

For the most part, though, we judged the portfolio to be well insulated from the risks of a full-scale trade war, assessing nearly half of the portfolio as low risk on both the supply and demand side. MSA, which produces safety equipment for firefighters, is a good example. Most production takes place domestically, and demand is extremely resilient due to the essential nature of its products. 

And of course, more than half of the portfolio deals in services, not physical goods, so tariff impacts are limited. One exception to this is logistics provider DSV, which is directly affected by global trade levels. The stock sold off sharply in early April, though there is also a positive scenario in which more complex trade routes require greater intermediary support from freight forwarders. 

As we approach the end of the 90-day pause in tariff negotiations in July, along with details of the ‘big, beautiful bill’ which will add nearly $3tn to the US’s debt pile over the next decade, we expect resilience to be a valuable portfolio trait.

If there’s one portfolio holding that exemplifies resilience, it’s TSMC, one of our best-performing holdings this quarter. Even President Trump couldn't challenge its dominance in advanced semiconductors, exempting the industry from tariffs rather than risk falling behind in the AI race. While TSMC benefits from AI spending, it's well diversified across mobile phones, automotive, and internet-of-things applications. 

Results announced in April showed more than 40 per cent growth in revenues and 60 per cent growth in earnings compared with the same quarter last year. Here, geopolitical risk is the biggest threat, but the company is actively addressing this, committing $165bn in total US investments including three new fabs, two advanced packaging facilities, and an R&D centre in Arizona. This will reduce its reliance on its Taiwan base and further align it with major US clients like Apple and Nvidia.

UnitedHealth was added to the portfolio for its resilience, but this has not been borne out by the share price performance, making it the biggest detractor this quarter. That said, few organisations could have withstood the extraordinary series of challenges it has faced over the past 18 months. The company has endured a cyber-attack, an antitrust investigation, the assassination of an executive, unprecedented cost inflation and, most recently, the ousting of its CEO. Several disappointing earnings announcements have compounded these shocks, resulting in significant share price weakness. From here, our attention is firmly on understanding the underlying causes to assess the ongoing prospects of the business model.

Two issues are particularly pressing. First, medical loss ratios have remained elevated as the cost of providing services has continued to rise faster than they assumed when pricing policies. Second, and more concerning, UnitedHealth has taken substantial losses on new customer cohorts acquired from competitors, who turned out to be sicker than their records suggested. While it is positive to see the company gaining market share, its recent inability to price risk accurately is a fundamental threat to the business model. 

Our original investment case centred on the idea that a shift to value-based care and greater vertical integration would give UnitedHealth better control of risk and costs, while also raising the standard of care. So far, this has not materialised as expected, and we will be monitoring closely for improved execution under the new CEO. We’ve also had the opportunity to hear from the board, which gave us some comfort that appropriate oversight is in place.

Returning to the theme of resilience amidst tariff uncertainty, new purchase Kinaxis is particularly well-positioned. It provides specialist software to help large manufacturing companies create efficient, flexible supply chains and minimise disruption when things go wrong. Its main product, Maestro, is a tool that allows a supply chain planner to consider a wider range of possible scenarios and responses, and to make better decisions on how much to make and where to make it, ensuring more efficient use of resources. 

We’ve been researching this company for nearly a year, and as part of that process we’ve spoken with many customers, partners and executives at the firm. We learned that supply chain planning is often a very manual process, rooted in Excel spreadsheets. An alteration to sourcing can take two or three weeks to model, but with Maestro’s concurrent system, this can be shortened to as little as 30 minutes. This is a compelling value proposition, and after the various disruptions to supply chains seen over the past few years – from pandemics to trade wars – the incentive to modernise these systems has never been greater. For many firms, this is the second fastest growing area of their business spending after AI.

 

Word at Baillie Gifford 

While words like ‘tariff’ have dominated headlines and company updates this year, the conversations that shape our investment decisions focus on a very different set of priorities. In our own research library, the trending topics for 2025 include weight loss drugs, energy storage solutions, and cybersecurity - areas where innovation is addressing some of society’s most pressing challenges. This highlights the difference between the immediate concerns that preoccupy markets and the structural changes that will define the next decade.

It’s easy to be distracted by short-term volatility, especially when headlines are dramatic and recent returns for sustainable strategies have lagged the broader market. But history – and our own experience – show that long-term investing rewards patience and discipline. The companies facing real-world problems today are likely to be the growth leaders of tomorrow, even if their progress is sometimes masked by near-term market turbulence. 

For us, sustainable investing is not a passing fad nor a regulatory tick-box. Rather, it's a disciplined framework for identifying well-governed, adaptable businesses positioned to benefit from powerful secular shifts and elongated competitive advantage periods. This is why we expect it to be a source of long-term outperformance. 

We are convinced that long-term societal progress – healthier populations, a stable climate, and safer lives – will ultimately be reflected in investment outcomes. This is especially true if you can look beyond the usual ESG darlings and find societal contributions in unexpected places. 

So as we move forward, we will continue to look beyond the headlines, stay patient through the noise, and build a portfolio that is resilient, forward-looking, and aligned with a more sustainable future.
 

AI-augmented research: sharpening our edge

It is said there are three distinct sources of edge in investment: informational, analytical and behavioural. An informational edge is where you know something material that others do not. Regulators frown on some forms of this, of course, and in any case, information has proliferated since the advent of the internet. Analytical edge comes from weighing that information differently from others, and uncovering insights as a result. Behavioural edge is perhaps the most durable, given the pronounced biases inherent within each of us.

At Baillie Gifford, we believe we have an edge on all three fronts. What’s more, we believe these sources of edge are growing stronger as more investors are drawn to the temptations of daily news flow and market myopia, and as passive investing amplifies herding effects. 

On the informational front, while access to information has become somewhat commoditised, we continue to seek different inputs, from our links to academia to our consideration of sustainability factors. On the analytical front, we use significant resources to go deeper than others in pursuit of an uncommon understanding of companies, going beyond traditional financial analysis to softer factors such as company culture. And on the behavioural front, our partnership structure continues to ensure our time horizons are longer than most, helping us avoid some of the most acute behavioural pitfalls of our profession.

Over the past year, the very nature of how we pursue these advantages has been transformed as we embrace AI at every stage of our process. We have been cautious in sharing this transformation, perhaps because there is a sense that using AI might be seen as cheating – a concern Ethan Mollick has clearly articulated. His studies suggest that employees often hide the extent of their AI use, fearing that productivity gains may simply translate into more work rather than greater insight. As fiduciaries, we are mindful of this dynamic – no one wants to appear to be taking shortcuts for clients. Yet, the power of these tools is undeniable. To ignore them is not just inefficient, it risks rendering any active manager obsolete.

 

Informational edge: widening the funnel of inputs

The first and perhaps most critical decision in research is where to focus your attention. AI tools now allow us to thin-slice dozens of companies at an early stage, helping us determine whether a company is worth meeting at a conference or spending time researching. We have trained these tools on our investment philosophy and process, enabling them to spot potential 'fits' much faster. AI-powered screening identified Intuit as a potential holding in January and it is now one of our top ten positions. AI also helps us identify issues that could break an investment case sooner – red flags in governance or financials that might have taken days to uncover. The days saved by avoiding blind alleys are invaluable.

 

Analytical edge: challenging assumptions

Many of us now use AI-powered search engines such as Perplexity and ChatGPT as gateways to the power of this technology. These tools are not without their quirks – we have followed our share of citations to non-existent academic papers. However, AI accuracy is improving rapidly (hallucination rates of the latest models are around 1 per cent) and the quality of our analysis is improving with it. It helps us digest the contents of 40 customer interviews and extract comments on sales force effectiveness, reducing the risk of anchoring on the first few responses and providing a more holistic picture. 

OpenAI's Deep Research function is an early example of an 'agentic workflow'. It enables us to commission a deep dive analysis of how a company competes in the Indian market in 20 minutes – a task that would previously have taken days and might never have been prioritised. We can effectively commission high-quality custom research on any topic of our choosing.

But the real value lies not in information, but in how AI helps us think through possible outcomes. Claude, from Anthropic, is particularly adept at this. We may, for example, ask it to walk us through a scenario from the perspective of a company, its competitor, a key customer, a management consultant, and an AI visionary. These imagined conversations – set at a conference or in a bar – are not only engaging but genuinely sharpen our thinking. They help us play through the 'what ifs' that matter over our five-year horizon and highlight gaps in our thinking. 

It's important to stress here that humans remain in the loop, and indeed, we are the final arbiter of the output. But as information becomes ever easier to access, the ability to engage with ideas from multiple perspectives is more valuable than seeking out marginal extra detail.

 

Behavioural edge: unbiased pattern recognition

Pattern recognition is at the heart of our work as investors. Recently, while discussing a discount retailer, we asked ChatGPT to provide a history of similar models in other markets, highlighting factors that led to success or failure. The result was a watchlist of risks and opportunities. We were familiar with some of these examples, which would likely have resulted in anchoring bias, but the AI was able to digest lessons from more examples, across more continents and time periods, enriching our discussion. It became another voice of experience in the room. A colleague is now working on a project to help us better understand what shapes 'outliers' over different time periods, using these patterns to inform our decisions.

Finally, when we own a company, our workflow for monitoring its progress has changed. After results announcements, we upload our company research to a data-protected version of ChatGPT and ask it to read the full statement, conference call, and even those of competitors. The AI then highlights anything that supports or contradicts our hypothesis or materially impacts our key questions, providing verbatim quotes. Post-earnings analysis now delivers unbiased scorecards calibrated to our key investment questions, reducing noise and preventing ‘thesis creep’.

 

Sharpening our edge 

If there is a theme to this story, it is that our use of AI is not just about efficiency. It is about unlocking deeper sources of insight that were previously out of reach. In each case, these tools raise the probability of generating insight – which is our definition of research quality – with the ultimate goal of adding value for our clients. That insight is less likely to come from information alone – that's why we increasingly outsource the gathering of this data to our digital assistants – and more likely to emerge from a better analytical framing of a problem, combined with the behavioural advantages of our patience and partnership culture. 

Where efficiency gains free up time, we reinvest it by considering problems more holistically, putting more ideas in the funnel, or spending more time on the road – as three of us have been this quarter – engaging in the human interactions that AI cannot replicate. 

We are conscious that all of this will date quickly. Readers in 2027 will find this narrative quaint; by 2030, it may seem as archaic as reading a physical newspaper. As investors, we must embrace change, while retaining the ingredients that give us an enduring edge. Our organisation is committed to celebrating experimentation, encouraging everyone – especially leaders – to maximise the use of these tools and share their experiences. We are investing heavily in R&D and helping our team integrate new tools, while ensuring our path remains aligned with our distinctive philosophy.

Sustainable Growth

Annual past performance to 30 June each year (%)

	2021	2022	2023	2024	2025
Sustainable Growth Composite (gross)	-	-	-	9.1	13.1
Sustainable Growth Composite (net)	-	-	-	8.5	12.4
MSCI ACWI Index	-	-	-	19.9	16.7

 

Annualised returns to 30 June 2025 (%)

	1 year	5 years	Since reorganisation*
Sustainable Growth Composite (gross)	13.1	-	15.7
Sustainable Growth Composite (net)	12.4	-	15.1
MSCI ACWI Index	16.7	-	20.7

* 31 December 2022

Source: Revolution, MSCI. US dollars. Net 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.

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