Print article

The changing face of growth

James Budden, Director of Marketing and Distribution

Key points

  • After a decade of strong returns, rising interest rates have created a wintery environment for investors
  • Success doesn’t depend on GDP growth – company characteristics and shifts in our technological and cultural landscape matter more
  • By investing in businesses that can exploit these shifts, we look past stock market noise for the chance of better returns

All investment strategies have the potential for profit and loss, capital is at risk. Past performance is not a guide to future returns.

Spring has arrived at last, but the investing environment remains wintery. Geopolitically, Russia is still assaulting Ukraine and tensions continue between United States and China. Economically, we struggle with inflation and its antidote of interest rate rises post the Covid era.

Consequently, the cost of living continues to be an increasing burden for consumers, with energy prices particularly inflated. It comes as no surprise that investors remain cautious and myopic in the sense that horizons shrink in times of adversity.

After a decade of strong returns, this confluence of factors has made things difficult for growth investors such as Baillie Gifford and for the people that invest in our funds and trusts. We can take some solace in the fact that, in most cases, 5 and 10-year performance is decent, but we must acknowledge that near-term numbers are unhealthy and that those who bought our funds and trusts during recent highs have had a tumbling experience.

Conventional thinking dictates that in a world of higher interest rates future cashflows should be discounted, meaning growth becomes less valuable and is marked down. As a result, it is the here and now that matters for investors.

In the last 18 months this theory has been applied indiscriminately across swathes of growth businesses. In some cases it’s justified, as companies have been addicted to cheap money, but in others we have seen downgrades regardless of strong operational progress. We’ve been here before, as the table below suggests.

 

These companies have been exceptionally successful investments in the long term despite significant periods of share price weakness. Growth stocks have been experiencing a knee-jerk response to rising interest rates. Hence extreme fluctuations in price terms, often based on crumbs of market intelligence.

For example, last year Netflix slipped by 40 per cent in two days after losing 200 thousand subscribers out of 200 million. Indeed, this construct that growth outperforms value when interest rates are falling and vice versa is a relatively recent phenomenon – in the long run, there is no clear evidence that this holds, perhaps because growth is not a generic thing.

The fundamentals of growth

Companies that rely on GDP growth to expand are not typically very interesting, and there are plenty of companies that can grow in a higher interest rate environment.

Growth concerns disruption, competitive advantage, market share and completely new business models. Companies engaged in these areas will happily flourish if they offer better, cheaper, higher quality ways to meet people’s needs than they have now. There is always considerable change within the structure of economies, and it is driven by innovation, technologies and behaviours.

However, in times like these, it is crucial to reflect. We certainly don’t know everything. What if the world has changed around us? We should never blindly assume that what worked in the past will work in the future. 

Nevertheless, as investors we keep coming back to the underlying reality: the things that ultimately matter are future earnings and cashflows, and share prices eventually reflect fundamentals. It’s about searching for the few great opportunities that drive outsized returns.

We have revisited the cashflow and competitive advantage profiles for all the companies we favour to understand if they can deal with a higher inflation environment. Can they exist in a more expensive funding environment? In most cases the answer is yes. Our portfolios have much higher cash balances, much higher competitive advantages and therefore better pricing power than the index. 

Growth can do just fine when interest rates rise. This is because not all growth companies are the same. Some float on a rising tide and then sink, while others have the power to plough through heavy seas.

New decade, new innovations

The past decade was a golden period for consumer technology. An era of connectivity heralded by the arrival of smartphones enabled a new generation of consumer platform companies, characterised by powerful network effects and increasing return to scale.

These companies digitised and transformed large swathes of the consumer economy including media, retail, social, entertainment and gaming, and they emerged as the new leaders. They grew from underdogs to incumbents, but now we must acknowledge that their best investment days are largely behind them.

In an ideal world, innovation should seek to create, not destroy. It should look beyond the confines of existing industries and seek to solve unsolved problems.

Viewing innovation through this lens, entrepreneurs should not merely look to displace existing markets, but to create new ones. They should not just seek to serve customers better, but to serve the underserved or unserved. Innovation should not be a zero-sum game of shifting market shares from incumbents to disruptors.

As we look forward to the next decade, we must look towards new growth frontiers. If the growth engines of the last decade were the internet, mobile and software, the growth engines of the next decade will be based on data and artificial intelligence.

These technologies are creating a bridge between the digital and the physical world. We already have self-checkout lanes in supermarkets and self-driving cars on the road. These are nothing more than robots becoming more intelligent over time. But if we have robots in retail stores and on the roads, why not on factory floors, in hotel receptions or hospital surgeries?

Today’s internet is largely two-dimensional and artificial intelligence is in the cloud. The next phase of the internet will be three-dimensional and artificial intelligence will migrate from the cloud to the physical world.

The themes of the future

Who are the likely beneficiaries of these new growth engines? Which applications will be transformed? How will this affect broader society? These are just some of the questions we continue to investigate. While we don’t have all the answers yet, we know we must approach this task with an open mind. These businesses may look very different to the winners of the past.

Indeed, it concerns us that, in recent times, commentators have badged Baillie Gifford simply as a tech investing company. We do, of course, invest in tech but not exclusively, and technology is now so ubiquitous that its use as a specific label is rather pointless. Every company is a tech company but not every company is a growth company.

Baillie Gifford is a long-term growth investor and, as alluded to, that growth comes in different forms over different periods.

Some 15 years ago our global portfolios held the likes of Vale, Petrobras and Rio Tinto as we rode the commodity supercycle sparked by China’s great urbanisation.

Then followed the decade of the internet platforms, which saw a small number of global players such as Facebook, Tencent and Alibaba scale up massively with little need for huge capital investment.

So where are we looking for growth now? We hold companies in our portfolios because we believe they will be able to meet substantial increases in demand for their products and services over the next decade.

A different category of winners

While the precise timing and form of change is impossible to forecast with any reliability, slow-acting structural change is much more predictable.

We can see that the green revolution will gather pace and that companies like Northvolt (battery storage) and Climeworks (carbon recapture) could become market leaders.

The challenges around aging populations and the cost of healthcare are evident. Here we hope that the confluence of data, artificial intelligence and genetics will find ways to prevent and cure disease, as exemplified by Moderna and its burgeoning MRNA platform which conquered Covid and has now moved on to cancer.

Ecommerce may have stalled post pandemic but the digitisation of services and the way we live is set to continue, powered by Moore’s Law. Amazon’s AWS Cloud offering, and Nvidia and ASML with their chip technologies sit in the box seats. Then there is Duolingo, a language learning app whose management predicts its product will achieve parity with human capacity within three to five years.

None of these shifts depend on the interest rate environment, the health of the US banking system or access to cheap capital. It is by investing in growth companies, that are the beneficiaries of relatively predictable structural changes, that we can look through the considerable noise of stock markets in pursuit of much greater returns.

Our job is to find the winners of the future. The best of these can generate substantial returns for shareholders who are patient enough to hold their nerve when winter comes.

 

Annual Past Performance to 31 March Each Year (Net %)
Annualised returns to 31 March 2023 (Net %)

Source: MSCI. 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 April 2023 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. 

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) 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.

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 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.

 

39210 10020013

Author

James Budden

Director of Marketing and Distribution

James is a director of marketing and distribution in the Clients Department. He joined Baillie Gifford in 2008 having worked at Witan Investment Trust and Henderson Global Investors. James graduated MA in Classics from the University of Cambridge in 1987.

Back to top