Your capital is at risk.
Accelerated growth is rightly prized by investors. Exceptional companies with the right wind in their sails can in some cases grow so fast that even disadvantageous economic conditions cannot knock them off course. A proven product with a strong market fit is one of the most reliable indicators that a company’s foundations are solid. Combined with great leadership, it puts a business in a good position to unlock benefits of scale, powering expanding margins and long-term profitability.
However, over a decade of government-distorted interest rates have tempted many to manufacture the illusion of growth. Some investors have come to rely on ever-falling refinancing costs to act as their return driver. Their strategies, fuelled by cheap debt and expanding valuation multiples, sailed alongside those powered by increasing demand and widening scale advantages for a time.
That tide has now turned. Central bank consensus points towards a decade of higher interest rates and tighter money supply, increasing the cost of capital. This is bad news for strategies relying on financial leverage and multiples momentum to set them apart. But by extension, it is also an environment that will allow companies growing at speed from a well-managed cost structure to distinguish themselves.
Engines of growth
The age of operating leverage – delivering value by widening the gap between rising sales and fixed costs – is upon us. While there will still be financial engineering aimed at lowering the cost side of the equation, that model will be under constant pressure in an uncertain rate environment. The clearest path to improving profitability in the coming years will be driven through topline growth. We are already seeing the differentiation in market valuations for companies that are adapting well to the new normal.
This is fantastic news for private growth investors. We invest in companies at growth’s inflection point, where value discovery is no longer a question of new product-market fit – the high-risk territory of traditional venture capital. Instead, these companies have transitioned to becoming engines of growth themselves, their leadership teams, cultures and ecosystems driving innovation and adaptability.
These businesses are well-positioned to enjoy years of steep growth. What they need is aligned investors who can support their long-term visions, helping them on the path to not only ultimately going public but also prospering in public markets.
Of course, public markets were originally invented to fund exactly these kinds of businesses. They are still the best places for liquid and cheap equity capital provision. However, companies have increasingly delayed their listings over the last two decades. Thanks to the internet revolution, it has never been easier for private companies to raise capital beyond their immediate networks. The best management teams can now seek and be sought by the best-suited investment organisations. The challenge and the opportunity here, therefore, hinge on access.
This points to the types of opportunities we are most excited about. On the one hand, structural trends coalescing in the form of companies capable of driving exponential growth. On the other, investment opportunities where our reputation as very long-term growth investors gives us unique access to companies that so far have had limited external capital. And ideally, a mix of both.
Structural growth
Many exceptional growth companies have one thing in common: while they are fantastic businesses in their own right, they get an extra push from structural demand growth driven by major societal shifts.
Until recently, software had only lightly touched many parts of the economy beyond communications, retail, and entertainment. Word processors, databases and other off-the-shelf products might be commonplace, but most businesses have yet to fully take advantage of digitisation’s potential to generate valuable insights.
In health science, our improving understanding of proteins and DNA promises to unlock countless medical surprises. Cell therapies (which use cultivated cells to address a genetic problem) and gene therapies (which involve changing a patient’s DNA on a cellular level) accounted for a combined 10 per cent of the US Food and Drug Administration’s novel drug approvals in 2023, up from 6 per cent in 2021.
Tempus AI is an example of a private company taking advantage of this. It has built one of the world’s biggest libraries of clinical and molecular data. It uses artificial intelligence to find insights, helping larger pharmaceutical firms develop new drugs and doctors to identify existing therapies that could benefit specific patients. The company is defying the current drought of IPOs, having listed in June this year.
But software isn’t the only catalyst for organic growth. The energy transition is set to affect a broad range of power-hungry activities, including heavy industry and transportation.
Northvolt illustrates how startups can benefit. It makes eco-friendlier battery systems for electric vehicles, as well as energy storage systems for other applications, by powering its factories with renewable energy. In addition to building additional plants of its own to meet demand, it has entered a joint venture with Volvo to construct a site dedicated to making power cells for the car maker’s vehicles.
Off the beaten track
We are also excited about opportunities outside of the traditional venture capital ecosystem – and often outside of the US. These companies have been flying under the radar and have grown using mostly their own resources, taking on no or limited institutional capital. This demonstrates their ability to create their own fortune through growth. These companies can also afford to be selective and pick only investors they judge to be the best partners for the next stage of their journey.
A great example is Oddity, a beauty company that uses insights from AI to launch online-only products, which it markets directly to customers. It has built a loyal following, especially among Gen Z customers, and has scaled to profitability with only limited funding from institutional capital. However, when the firm set its sights on a listing, it decided that Baillie Gifford would be the right partner to help it on the next leg of its journey.
Besides the value we can add to growth businesses scaling and professionalising their management, companies are also attracted by our reputation as long-term investors in public and private markets. While this is never a guarantee, we continue to hold Oddity’s shares following its listing in July 2023 across a number of growth portfolios.
A recent investment that might follow the same script is Bending Spoons, a fast-growing company based in Milan that even many Italian investors have never heard of. It has built the playbook for acquiring cloud-based software applications with sticky customer cohorts but oversized cost bases. By acquiring products – such as the note-taking app Evernote and Meetup social network – and moving them onto its cheaper and better back-end tech stack and engineering employee base, Bending Spoons can drive faster growth while lowering costs. In the process, it harnesses the magic operating leverage can have on its bottom line.
Time to turn to growth
The times have changed, highlighting that strategies relying on high levels of debt financing are not without cost – and risk – after all.
Not everyone can navigate these waters. But investors would be well advised to put financial leverage and momentum games back in their box for the foreseeable future and turn instead to growth.
We firmly believe that in an environment that has removed the support of cheap leverage, companies that can expand their revenues while reaping the economies of scale to push down unit cost and reap the benefits of operating leverage in the process will deliver superior outcomes for their backers.
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 June 2024 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
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.
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) Ltd (BGE) 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. BGE also has regulatory permissions to perform Individual Portfolio Management activities. BGE provides investment management and advisory services to European (excluding UK) segregated clients. BGE has been appointed as UCITS management company to the following UCITS umbrella company; Baillie Gifford Worldwide Funds plc. BGE 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.
China
Baillie Gifford Investment Management (Shanghai) Limited 柏基投资管理(上海)有限公司(‘BGIMS’) is wholly owned by Baillie Gifford Overseas Limited and may provide investment research to the Baillie Gifford Group pursuant to applicable laws. BGIMS is incorporated in Shanghai in the People’s Republic of China (‘PRC’) as a wholly foreign-owned limited liability company with a unified social credit code of 91310000MA1FL6KQ30. BGIMS is a registered Private Fund Manager with the Asset Management Association of China (‘AMAC’) and manages private security investment fund in the PRC, with a registration code of P1071226.
Baillie Gifford Overseas Investment Fund Management (Shanghai) Limited柏基海外投资基金管理(上海)有限公司(‘BGQS’) is a wholly owned subsidiary of BGIMS incorporated in Shanghai as a limited liability company with its unified social credit code of 91310000MA1FL7JFXQ. BGQS is a registered Private Fund Manager with AMAC with a registration code of P1071708. BGQS has been approved by Shanghai Municipal Financial Regulatory Bureau for the Qualified Domestic Limited Partners (QDLP) Pilot Program, under which it may raise funds from PRC investors for making overseas investments.
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.
104133 10047685