Small but powerful: why disruption isn’t just for tech giants.
As the Baillie Gifford International Smaller Companies Fund marks its third anniversary, its managers explain how the Fund’s ‘radar research framework’ picks up the signals of small caps that can deliver growth.
The value of an investment, and any income from it, can fall as well as rise and investors may not get back the amount invested.
The biggest change in the global investment landscape in recent decades is that digital technology has reshaped stock markets. Where once they were dominated by oil companies such as Chevron and ExxonMobil, now they’re driven by tech giants such as Apple and Microsoft.
Yet tech doesn’t have to be big to be successful. In its first three years, International Smaller Companies (ISC) has invested in a host of companies at an earlier stage in their growth but still capitalising on the disruptive power of technology.
“We’re firm believers in the disruption that digitalisation poses,” Charlie Broughton, a member of the strategy's portfolio construction group (PCG), explained to clients in a recent webinar.
“Almost every legacy industry is seeing itself disrupted.”
Broughton pointed to the success of Avanza Bank, an online-only stockbroker and savings account provider that has disrupted Sweden’s banking sector.
Brian Lum, chair of the strategy's PCG, added: “Many of the themes present in the portfolio – whether it’s automation or digitalisation or healthcare innovation – remain very relevant and won’t go away, even if there’s a small element of bounce-back from two years of Covid.”
Culture is key
Technological disruption can also go hand-in-hand with cultural disruption, as in the case of Avanza Bank.
“Not only do you have disruption in the product they’re offering, but there’s a broader point around culture,” Broughton said.
“It’s a business that has incredible returns-to-scale. The bigger it gets, the more profitable it becomes.”
“But rather than returning all those earnings to us in the form of dividends, they are reinvesting them all into price.” In other words, as Avanza sees unit costs fall, it converts these savings into lower prices and better customer service, keeping prices low and customers happy.
Maytronics, the Israeli firm behind the Dolphin robotic swimming pool cleaner, is another company that combines technological and cultural disruption.
A 56 per cent stake in the business is owned by a kibbutz or collective community based around a citrus farm at Yizre’el in Northern Israel.
“For them, the survival and prosperity of Maytronics is intrinsically linked to the survival and prosperity of their entire community,” added Broughton.
“When it comes to long-term alignment, it doesn’t get much better than that.”
Using the strategy's ‘radar’
Lum estimates that there could be 20,000 or more companies within the small cap universe from which to select ISC’s stocks.
“It is a hopeless task to cover the universe, and we're not trying to do that,” he said.
Instead, the strategy's PCG uses what it calls its ‘radar research framework’ to select the right stocks. The radar (see below) is proving a vital tool in assessing potential small cap targets.
On our radar: How we assess potential small cap targets
“Over the past 12 months, we’ve put a lot of thought into specific spokes of our radar – particularly opportunity and sustainability,” explained Broughton.
“One of the big benefits of our universe is how poorly it is covered. This is a huge advantage for real bottom-up research.”
At the moment, Broughton, Lum, and their fellow PCG members are using the radar to examine companies in fields as diverse as video games, alternative proteins, and the energy transition.
“The video games industry is now bigger than the music and film industries combined,” explained Broughton.
“This offers an incredible opportunity for the owners of intellectual property. We have a number in the portfolio, including Team17, which publishes small independent games.
“We also think there are broader opportunities for businesses like Keywords Studios, which is an outsourcer for video games. It provides the ‘picks and shovels’ that big studios use to build the minutiae within their video games, like the character art for your Fortnite game avatars.”
Lum added: “We are primarily bottom-up stock pickers, but sometimes we do dive into themes a bit more systematically.”
Those themes currently include alternative proteins, with ISC subscribing for shares during the initial public offering from Veganz, a German plant-based food company.
Lum has also been carrying out research into companies that will benefit from the energy transition away from fossil fuels towards renewable power.
From small cap to large cap
In 2020, ISC sold its stake in Li-Ning because the Chinese sports apparel brand’s market capitalisation broke through the strategy's $10 billion ceiling.
Li-Ning may have left ISC’s small cap universe, but the stock has since been bought by a number of Baillie Gifford’s large cap strategies.
“We fulfilled our role as an incubator within Baillie Gifford. Part of our purpose is to discover the great up-and-coming names before they’re picked up more widely,” said Broughton.
“Our goal is not to buy ‘small’ companies – we’re looking to find big businesses, just beforehand.”
Other companies in the portfolio are also fulfilling the growth potential we spotted in them from the beginning. These include the Italian digital consultancy Reply and Taiwanese pneumatic equipment manufacturer AirTAC.
Yet, with 20,000 or more small cap companies listed on stock markets, ISC won’t be short of choices from its ever-expanding universe to replace any departing stocks. As client director and PCG member Richard Gall put it:
“We’re still just scratching the surface of what is an incredibly broad and deep opportunity.”
Watch the International Smaller Companies’ three-year anniversary webinar.
|Baillie Gifford International
Smaller Companies Composite
|MSCI ACWI ex-USA
|Baillie Gifford International
Smaller Companies Composite
|MSCI ACWI ex-USA
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 was produced and approved in April 2022 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
Potential for Profit and Loss
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
Any stock examples and images used in this communication 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 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.
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.
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.
Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018. Baillie Gifford Investment Management (Europe) Limited 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. Baillie Gifford Investment Management (Europe) Limited is also authorised in accordance with Regulation 7 of the AIFM Regulations, to provide management of portfolios of investments, including Individual Portfolio Management (‘IPM’) and Non-Core Services. Baillie Gifford Investment Management (Europe) Limited has been appointed as UCITS management company to the following UCITS umbrella company; Baillie Gifford Worldwide Funds plc. Through passporting it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Similarly, it has established Baillie Gifford Investment Management (Europe) Limited (Amsterdam Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in The Netherlands. Baillie Gifford Investment Management (Europe) Limited also has a representative office in Zurich, Switzerland pursuant to Art. 58 of the Federal Act on Financial Institutions (‘FinIA’). It does not constitute a branch and therefore does not have authority to commit Baillie Gifford Investment Management (Europe) Limited. The firm is currently awaiting authorisation by the Swiss Financial Market Supervisory Authority (FINMA) to maintain this representative office of a foreign asset manager of collective assets in Switzerland pursuant to the applicable transitional provisions of FinIA. Baillie Gifford Investment Management (Europe) Limited 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.
Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 and a Type 2 license from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of collective investment schemes to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 can be contacted at Suites 2713–2715, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. Telephone +852 3756 5700.
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.
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.
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.
Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.
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.
Baillie Gifford Overseas Limited (‘BGO’) neither has a registered business presence nor a representative office in Oman and does not undertake banking business or provide financial services in Oman. Consequently, BGO is not regulated by either the Central Bank of Oman or Oman’s Capital Market Authority. No authorization, licence or approval has been received from the Capital Market Authority of Oman or any other regulatory authority in Oman, to provide such advice or service within Oman. BGO does not solicit business in Oman and does not market, offer, sell or distribute any financial or investment products or services in Oman and no subscription to any securities, products or financial services may or will be consummated within Oman. The recipient of this material represents that it is a financial institution or a sophisticated investor (as described in Article 139 of the Executive Regulations of the Capital Market Law) and that its officers/employees have such experience in business and financial matters that they are capable of evaluating the merits and risks of investments.
The materials contained herein are not intended to constitute an offer or provision of investment management, investment and advisory services or other financial services under the laws of Qatar. The services have not been and will not be authorised by the Qatar Financial Markets Authority, the Qatar Financial Centre Regulatory Authority or the Qatar Central Bank in accordance with their regulations or any other regulations in Qatar.
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.
Ref: 17969 10008604