Print article

Positive Change annual investor letter

Kate Fox, Investment Manager

Key Points

  • Long-term performance remains strong in absolute terms and relative to the benchmark. The portfolio returned to positive performance in 2023
  • Looking at the world, we see significant environmental and social challenges – and opportunities for companies that address them
  • We are at a watershed moment. 250 years after the first industrial revolution, we are on the cusp of a second 'deep transition' toward sustainability

All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk.

 

“It’s not what you look at that matters, it’s what you see.” – Henry David Thoreau (1817–1862), American naturalist and philosopher.

 

Anyone can look at inflation figures, the Fed’s most recent meeting minutes or reports of global conflict. Anyone can look at charts illustrating the rise in global temperatures or the spread of viruses. But more than simply looking, investors such as ourselves must see and try to understand the consequences of these factors.

Looking around us, we see a world facing significant environmental and social challenges. We also see individuals and businesses developing products and services with the potential to address them.

We see investment opportunities in companies that are challenging the status quo. And we believe that looking through a long-term lens helps us to see what matters most. This corresponds with our dual objectives: to contribute towards a more sustainable and inclusive world while generating attractive investment returns for you, our clients.

Technological developments have led to wonderful new possibilities, but they have also added to the complexity and fragility of the world. In a complex system, individual variables interact in ways that can lead to non-linearity and randomness, opportunities and threats. Thus, complexity can surprise us. In such a complex world, having a strong ‘north star’ philosophy to guide us is vital.

We believe capital allocators can help to address global challenges by channelling money towards businesses striving to create a more inclusive, healthy and environmentally stable world with their products and services. We believe that our two objectives are complementary and that we can help you, our clients, benefit from attractive financial returns while channelling your capital purposefully.

Performance

The Positive Change portfolio delivered positive returns for the year. As to be expected from our concentrated, high-conviction portfolio, performance against the benchmark was volatile, with Positive Change delivering both relative underperformance and outperformance over short periods. Returns over the most recent quarter were particularly strong, for example, while relative performance mid-year was weak. Overall, returns for the year were behind the benchmark.

Cumulative returns since inception* (net)

Source: Revolution, MSCI. As at 31 December 2023. USD. The Positive Change strategy is more concentrated than the MSCI ACWI Index.
Benchmark: MSCI ACWI Index. *31 January 2017. Rebased to 100.

 

Encouragingly, long-term investment performance remains strong, with returns comfortably ahead of the benchmark over our time horizon of five years, and since inception.

Companies that have thrived this year include MercadoLibre, the Latin American ecommerce and fintech business. This was our highest conviction holding at the end of the year. Recent earnings surpassed expectations, with revenue growth accelerating and margins expanding despite increased spending on logistics and the relaunch of the company’s MELI+ loyalty programme.

Unlike some competitors (eg Shopee), which have started to conserve capital, MercadoLibre’s continued investment has helped to strengthen its competitive advantage, resulting in market share gain and higher profits. MercadoLibre is now the main source of income for more than 1.8 million families who run businesses on its ecommerce platform. In 2023, it contributed strongly to expanding financial inclusion in Latin America, with 54 per cent of its users using its Mercado Pago fintech platform to access digital payments for the first time.

Another top contributor to performance was Duolingo, developer of the popular language learning app. The company has gone from strength to strength since it was added to the portfolio in 2021, adding over 40 million monthly active users to reach 83 million in 2023, with very low customer acquisition costs. It has successfully integrated artificial intelligence (AI) into its product line up to offer a higher-function subscription tier, as well as introducing mathematics and music courses. This demonstrates its ability to adapt and progress. As the company has grown, margins have improved and free cashflow has been positive for the past seven quarters. All this progress has been achieved while staying true to the core mission of developing the world’s best universally available education.

It would be remiss not to mention that, after over a decade of easy monetary policy and favourable conditions for businesses to secure financing, invest and grow, the last two years have brought a rapid increase in interest rates. This has had a stark negative impact on short-term financial returns. Higher interest rates mean a higher cost of financing for companies and lower valuations for long duration growth stocks, ie, companies with a share price skewed towards future cashflows. 

This tougher backdrop, combined with a reversal of pandemic spending themes, has been particularly bruising for the healthcare sector. One of the bigger detractors from performance over the last year has been Moderna, a biotech firm. The company’s phenomenal success in developing a Covid-19 vaccine accelerated its progress beyond our most optimistic scenarios when we invested at initial public offering (IPO) in 2018.

Moderna’s financial characteristics completely transformed, from making losses to generating billions of dollars of free cashflow. However, as we have transitioned from pandemic to endemic, revenues have declined by more than predicted.

Other market participants might look at Moderna and see a business with a single revenue stream and a cash pile that’s rapidly depleting due to the billions of dollars it invests in research and development. We see something quite different. We see a company that has successfully executed under extreme pressure, adapting itself from a research organisation to a commercial business. We see a company that is broadening its clinical pipeline at a remarkable pace, with 47 development programmes (six in phase 3 and seven in phase 2); a company transforming the success rate for developing new drugs and vaccines; a company with a strong balance sheet, investing in its future with financial flexibility. This is to say, we see something that others don’t. And this excites us – we have added to your position.

Illumina was also a negative contributor to short-term (12-month) performance. Illumina is the leading provider of sequencing tools used to help us better understand, diagnose and treat diseases. Other market participants might look at Illumina as a company with questionable governance that is facing stiff competition. They might consider it to have destroyed shareholder capital through its attempted acquisition of Grail.

We also recognise these features. However, we believe clinical sequencing technology is in its very early innings and is thus a fantastic opportunity for growth. We see a company with a near-monopoly position and the capacity to invest 25 per cent of revenues (over $1bn a year) in research and development, a significantly greater amount than its smaller competitors. And, following extensive engagement, we see a company with a refreshed board and a new CEO who is determined to restore its reputation and performance. We see a company providing the infrastructure of the genomics revolution. For these reasons, we have continued to hold it in your portfolio.

Positioning

“You have to keep learning if you want to become a great investor. When the world changes, you must change.”Charlie Munger (1924–2023), American businessman, philanthropist and former vice chairman of Berkshire Hathaway.


Our philosophy remains unchanged, but that doesn’t mean we don’t adapt in our bid to become better investors. We have a growth mindset in two ways: we seek growth companies and we have a hunger to keep learning. Indeed, the last two years have provided reason to reflect on how we might adapt. 

One of our key learnings has been that, even if a company has a great growth runway and ambitious management team, execution counts. A handful of companies fall into the bucket of 'great opportunity, great vision, poor execution’. These include recent sales, such as interactive fitness company Peloton and virtual medical company Teladoc.

Learning from these less successful investments, we have decided to sell our position in renewable energy company Ørsted. Our original investment thesis was based on offshore wind becoming an important energy source for many countries, and our belief that Ørsted’s scale and expertise would enable it to capitalise on this opportunity. Unfortunately, recent events have reduced our conviction. The company incurred significant losses in 2022 due to poor hedging policies and recognised a reduction in the value of its US business. While the growth opportunity remains, we have lost confidence in the management’s ability to allocate capital effectively and generate long-term value for shareholders. 

Another Charlie Munger quote is relevant here: “Don’t bail away in a sinking boat if you can swim to one that is seaworthy.” We redirected the proceeds of this sale to companies we deem more seaworthy, including design software firm Autodesk and Indonesia’s Bank Rakyat.

Joby Aviation is another recent buy which displays encouraging early signs. Joby is a US-based company developing electric vertical take-off and landing (eVTOL) aircraft intended to operate as a taxi service in metropolitan areas. The company has developed a production prototype and is currently progressing through the Federal Aviation Administration certification process.

The adoption of battery-powered eVTOLs could lead to substantial environmental benefits through lower emissions and reduced demand for personal vehicles. There may be social benefits in the form of improved mobility and reduced traffic congestion. While success is far from guaranteed, we believe that Joby is one of the leaders in its field, and the investment upside could be very large if it is to achieve its vision. We therefore decided to take a small holding.

Seeing the opportunity

Our thesis is that companies whose products and services are helping to resolve global challenges will thrive in the long run – be it electric cars, cancer vaccines or accessible financial products. At Baillie Gifford, our long-held belief is that growth in sales and earnings will drive long-term financial returns.

Source: Baillie Gifford & Co, FactSet, MSCI. US dollar. As at 31 December 2023. Based on a representative Positive Change portfolio. Excludes companies with negative earnings.

 

For example, over the past five years, the portfolio has delivered earnings growth of 11.5 per cent per annum in USD, compared to 6.7 per cent for the index. That is pleasing, but what is exciting is the strength of operational performance that we anticipate across the portfolio in the coming years. Consensus estimates place three-year earnings growth at 12.0 per cent, almost double that of the index.

Reinvesting for the future*

Net debt to equity**

Source: Baillie Gifford & Co, FactSet, MSCI. US dollar. As at 31 December 2023. Based on a representative Positive Change portfolio. *Excludes financials. **CAPEX – Depreciation + R&D/Buybacks & Dividends.

 

Companies in the portfolio are focused on growing and are reinvesting for future growth. They are spending more than double the proportion of sales revenue on research and development than the average company in the index, and they are doing so without taking on excessive debt. Importantly, valuations remain attractive. Companies in your portfolio are trading on a price/earnings premium of around 1.5 times the market. Opportunity abounds.

A watershed moment

We have been working with the University of Sussex and Utrecht University on Deep Transitions, simply put are a series of changes that herald a new phase of industrialisation, modernity or consumption. The thesis behind this work is that we are on the cusp of a second Deep Transition. The first started over 250 years ago with the Industrial Revolution. The second is about addressing the negative effects of the first – climate change and rising inequality.

This resonates with us as growth investors seeking to drive positive change. It could be said that we are at a watershed moment, faced with the choice of continuing along our current path or plucking up the ambition, optimism and determination needed to steer us onto a more sustainable trajectory.

This watershed moment should be rich with investment opportunities. We are excited to continue our search for companies that address our portfolio’s 'environment and resources’ theme. These include equipment manufacturers helping to electrify the mining industry, which will play a vital role in the energy transition. We are excited to explore how AI could be deployed to address our 'healthcare and quality of life’ theme, and how platform businesses are creating opportunities for inclusive economic growth in developing countries. To do this, we will need to make sure we see what matters most, rather than try to predict short-term sentiment at a glance.

Thank you for seeing what we see in our philosophy, and believing we see things that others don’t. Thank you for sharing our excitement.

Annual past performance to 31 December each year (net%)
Annualised returns to 31 December 2023 (net%)

*Inception date: 31 January 2017.
Source: Baillie Gifford & Co and MSCI. USD. Returns have been calculated by reducing the gross return by the highest annual management fee for the composite.

 

Past performance is not a guide to future returns.

 

The objective stated above is aspirational and is not guaranteed. A single objective may not be suitable across all vehicles and jurisdictions. We may not meet our investment objectives if, for example, our investment style is out of favour, or we misjudge the long-term potential of our holdings.

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

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 February 2024 and has not been updated subsequently. It represents views held at the time and may not reflect current thinking.

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.

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.

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) 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”). The representative office is authorised by the Swiss Financial Market Supervisory Authority (FINMA). The representative office does not constitute a branch and therefore does not have authority to commit Baillie Gifford Investment Management (Europe) Limited. 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.

Hong Kong

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.

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 Limited 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.

 

88454 10044303

Author

Kate Fox

Investment Manager

Kate is an investment manager and decision maker in the Positive Change team. Kate joined Baillie Gifford in 2002 and became a partner of the firm in 2020. She is a CFA Charterholder and graduated MA in Economics and Maths from the University of Edinburgh in 2001.

Kate believes the financial community plays a crucial role in creating a more sustainable world for future generations. Kate’s experience analysing smaller companies has left her with a natural enthusiasm for businesses that address unmet needs or challenge the status quo, as well as an appreciation of their long-term potential

Back to top