Managed Fund roundtable.

July 2022

Key Points

  • Iain McCombie, Steven Hay, Andrew Stobart and Lucy Haddow discuss volatility and growth opportunities for the Baillie Gifford Managed Fund
  • Sticking to fundamental analysis and checking the resilience of holdings is critical, rather than reacting to short-term events
  • We’ll continue to invest for the long term in growth businesses. We can’t predict the future, but we think that our process and philosophy have a great chance of being able to continue to produce good returns in the future

Lucy Haddow, Andrew Stobart, Iain McCombie and Steven Hay, discuss opportunities for 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.

With inflation at its highest since 1982, and significant stock and bond market volatility since the turn of the year, Lucy Haddow sat down with three members of the Policy Setting Group (PSG) – Andrew Stobart, Iain McCombie and Steven Hay – to discuss how the team handles volatility and where they see opportunities for future growth. As a reminder, the PSG has responsibility for the asset allocation of the Baillie Gifford Managed Fund.

PSG discussion panel

Iain McCombie, co-manager of the Managed Fund, PSG member and Partner

Steven Hay, co-manager of the Managed Fund, PSG member and Head of Income Research

Andrew Stobart, Emerging Markets equity manager and PSG member

Lucy Haddow, Client Service Director and Chair of the PSG

We are focused on the fundamentals of each of the companies that we own and on the new ideas that might be thrown up in a significant market dislocation. It’s key to have that blend of experience, of age, of grey hairs even, in each of the teams, and we do have that.

Learning from experience

Haddow: Clearly none of you were at Baillie Gifford in the early 1980s when we last saw levels of inflation that we are seeing now. But, with a combined investment experience of 87 years, 77 of which have been at Baillie Gifford, you’ve seen ups and downs in markets before. Andrew, you have seen more than most with your focus on emerging market equities. What have been your biggest learnings?

Stobart: In emerging markets we’ve seen our fair share of crises! I joined Baillie Gifford in 1991, about two weeks before Operation Desert Storm.

There are some learnings from these experiences. No two crises are ever the same. That is perhaps a truism, but worth remembering. Another is that the recovery from these dislocations, whether it be war or otherwise, can take time.

The main learning though is that sticking to fundamental analysis and checking the resilience of the holdings you already have is critical – it’s about not just reacting to short-term events.

In the emerging markets portion of the Managed Fund, we have been doing very little trading. We have bought a couple of new holdings including First Quantum, a miner of copper which is critical to the energy transition. The other is Banorte, one of the leading Mexican banks.

Haddow: Iain, you’ve seen a lot going on in the UK in recent years. I presume the messages from Andrew resonate?

McCombie: I started in ’94, so he’s got more experience than me, but Andrew is absolutely right. It’s very easy when you get a period of volatility and poor performance to question, ‘What do you actually believe?’

Our core belief is that share prices follow fundamentals and, therefore, we’re going to keep sticking to our process, finding companies that we think have above average growth potential over the long term.

If you get distracted by trying to predict recessions or inflation rates, you do a disservice to your core, long-term purpose, which is to try and allocate capital to businesses that could be bigger in the long run.

It’s also easy when things are going wrong to be negative, but we have to keep looking for opportunities. The paradox is that when things look a bit bleak, that’s when the opportunities start coming for stock pickers.

Like Andrew, we’re finding opportunities in the UK market. Babcock, for example, which is a defence and engineering business, and Sabre Insurance, a specialist motor insurer where, paradoxically, inflation is going to help it by getting prices going up.

Haddow: Andrew, you and Iain have both talked about focusing on company fundamentals. How do you ensure the team doesn’t get distracted by noise and negativity?

Stobart: On the investment floor there is a blend of experience and diversity. That’s critical to making sure we don’t get obsessed with short-term performance.

We are focused on the fundamentals of each of the companies that we own and on the new ideas that might be thrown up in a significant market dislocation. It’s key to have that blend of experience, of age, of grey hairs even, in each of the teams, and we do have that.

McCombie: I think the other point is having a patient corporate culture. Management are supporting us in what we’re trying to do.

We will potentially see long periods where performance is not good, and clients will be wary and ask what’s going on. However, the biggest killer of fund managers is style drift – clients invested in us because we’re going to invest in growth companies, which we think are going to offer great rewards in the long run.

If we suddenly start buying stocks because we think they’re cheap and they’re not growth opportunities, well that’s not what clients bought us for.

In our team we got rid of our Bloomberg screen during the pandemic and we’ve not brought it back. It’s actually great because you don’t sit there staring at the screen and worrying. Our job is to go and find great companies. You don’t find them on Bloomberg screens.

Haddow: Steven, there’s obviously been a huge amount going on in the bond market since the turn of the year as well.

Hay: Yes, lots of volatility. I would say that markets always overreact. It is about being patient and concentrating on fundamentals. What we’re going through now is more like a traditional business cycle that we have seen in the past, 20 or 30 years ago, just not recently.

We’re seeking opportunities, but a bit like on the equity side, we haven’t actually done very much in the portfolio because operationally a lot of our companies are holding out well.

On the sovereign side, what’s particularly interesting is that having had years of being completely unattractive, yields have moved up to the point where they’re worth thinking about.

McCombie: Steven makes an important point about markets overreacting. The difference between volatility and permanent loss of capital is really important. We don’t have to sell holdings. But if I do sell it, it is a permanent loss of capital potentially.

You have to have the experience and the discipline and I suppose the culture to support this approach. It’s not easy because there are so many people that will be saying ‘do something’, and actually, the best answer often is that you do nothing. That’s not laziness or a lack of dynamism or thought. If you see the fundamentals are still good, why would you sell?

Stobart: Thinking about the companies we own, many of them are pretty well placed. They have reasonable pricing power. Some are definitely taking market share and that’s part of the reason we’re making few changes.

I would pick out Reliance Industries in India, which has a significant retail business, but is also the leading 4G phone provider. As an aside, it’s also the biggest investor in India in the energy transition. It has a great capital allocation record over many decades.

Similarly, Tencent and Alibaba in China in terms of their market positions. And indeed MercadoLibre, the leading ecommerce business in Latin America. We think that pricing power is decent, but there will potentially be impacts from consumers facing higher prices in terms of some demand destruction. That might impact, for example, Samsung’s mobile phone business in the short run.

Haddow: It would be remiss of me not to ask about the broader context in China given you’ve mentioned Alibaba and Tencent.

Stobart: There have been some significant policy and regulatory changes in China and that has particularly impacted internet companies. We think these are still strong businesses.

We see the recent policy pronouncements from officials in the Chinese government indicating that there’s a bit of a softening in attitude towards the platform companies. They are integral to the government in how it manages the economy. If anything, we’re thinking of adding to some of these holdings given the valuations they’re trading at.

The Managed Fund has 75 per cent invested in equities because equities are a warrant on human ingenuity and you bet against that at your peril.

Thinking about inflation and the opportunities ahead

Haddow: Steven, so much of what we’re talking about is in your domain as head of income research: inflation, changes in central bank policy. Is there light at the end of the tunnel here?

Hay: There’s a good chance we’re seeing a peak in inflation soon. We’ve had two big supply shocks and one-off increases in inflation coming from that. We would expect that to fade over time.

That said, the outlook for inflation once it’s fallen is a bit more uncertain than it has been for the last couple of decades.

Bonds are held in the Fund to provide balance and diversification. It’s been a more difficult argument to make for government bonds over the last few years because yields have been so low. I think the outlook is much more symmetric now.

If I’m right and inflation does start to fade from here, then it may well be that yields stabilise. If growth did fall significantly, actually, yields could fall and bond prices could go up and provide a good hedge once again for equities.

On the credit side, companies we invest in have proven to be resilient. We think about pricing power very carefully as part of that resilience test. The additional yield from these bonds makes them look attractive.

Haddow: I hear a lot about pricing power, how are you sufficiently critical of company’s pricing power?

McCombie: It’s a good question. I think partly you’ve got to keep thinking about what it means. At some point, if everybody is putting through double-digit price increases, there’s going to be demand destruction.

That said, it’s interesting that you’re getting this doom and gloom from the market because when you speak to companies in certain areas demand is buoyant. I spoke to a recruitment company yesterday which said the biggest challenge at the moment is the business is quite hot. That’s why we’re always a little bit sceptical of making big, macro calls because it sounds very simple, but that’s not often what’s happening on the ground.          

Haddow: Agreed and it’s certainly not the approach that the Policy Setting Group takes when it’s thinking about asset allocation of the fund either. That’s very much led by the bottom up.

McCombie: Yes, but we’re open-minded. We think about inflation but it’s not about trying to find the right answer. Trying to be precise at times like this means you’re probably going to be wrong. Also, there’s lots of good things still happening in the world that nobody’s talking about.

When the markets are most negative, often that’s where the best opportunity is. I think it’s about being patient.

Stobart: Hans Rosling who sadly died in 2017 talked about the secret, silent miracle of human progress. The world is slowly but surely getting better. It is worth remembering this positive context, especially at times like now when there is plenty of negativity about.

I have a question for Steven - we’ve all got used to a world where inflation has been low and/or falling. We’re probably going to be in a period where there are still several deflationary forces battering inflation, but there are also other forces which are more inflationary. How do you think about that relative to your more alternative view about bonds?

Hay: I think the big forces beating down inflation for the last two or three decades are stabilising – even perhaps going into reverse. Globalisation has been an important factor but I think it has stalled, if not gone into reverse. Partly politics, partly supply chain resilience, partly sustainability. I think that’s a really important point that will keep inflation from being as low as it’s been in the past.

Labour markets will be also tighter. There’s a smaller working age population than in the past. That again is working for a little bit higher inflation.

We know from the equity side that there’s a lot of technological change and that continues to be a big disinflationary force.

The question is how much central banks are willing to do what’s required to bring inflation back down to target. I think they will hesitate and that inflation will be a bit higher than we’ve been used to, but we’re probably overdoing the inflation concern right now.

McCombie: My view is that companies will invest in technology to offset this. The Managed Fund has 75 per cent invested in equities because equities are a warrant on human ingenuity and you bet against that at your peril.

If certain costs become a problem, they will find a way to offset it.

There’s so many examples I could point to here, some of our Japanese robotics holdings, for instance. Nobody talks about the next industrial revolution anymore. It’s boring and passé. However, it’s still happening. Nobody’s going to be shouting about some of our engineering companies becoming a bit more efficient, but actually, from a shareholder’s perspective that’s the thing that really matters.

Haddow: And those marginal gains compound over time.

McCombie: Absolutely. But we’ve got to keep re-examining investment cases. In any environment some of the stocks held will not pan out. We’ve been making mistakes for 35 years.

But the asymmetry of return that you get from equities (the worst you can lose is 100 per cent of your money whereas you can make unlimited multiples if you’re right), still plays, and we’re still focused on that because it’s how we expect to get big rewards for Managed Funds clients in the future.

Stobart: You talked about human ingenuity and innovation. I think that’s really critical. We are seeing it increasingly in the emerging world. We call it ‘the democratisation of entrepreneurialism.’

I think India in particular is a country where the advent of the 4G phone system has enabled lots of different business models – and individuals – to prosper.

That’s another example of how human ingenuity can spawn new businesses and therefore investment opportunities.

Hay: Look at sustainability. At the moment it feels like it’s all about cost. The cost of change and regulation, plus at the moment energy is expensive. But there will be a point at which there are efficiency gains that will be felt, plus the cost of energy will fall with renewables. We will get to a more optimistic point.

Stobart: Yes, Putin’s invasion of Ukraine has accelerated the energy transition as it has accelerated pressure on Europe to switch to renewable energy. This is ironic given Russia is one of the world’s biggest energy producers.

Hay: I think inflation has often been prompted by an oil price shock. We’ve seen it before. We’re seeing it again. If you get to a point where you have lots of renewable energy, you’ve consigned that source of a shock to the dustbin.

McCombie: These are long-term trends that we’ve been talking about for a number of years, Andrew’s mentioned the digitisation of the economy. Now at the moment the market is jittery about online retailers because everybody’s rushing back to shops but does it mean the long-term e-commerce trend is going to go away? I don’t think so.

Maybe we’re wrong, of course, but to us, the powerful long-term demographics and industry trends are still there. We can’t think of share prices and fundamentals as the same thing, they’re not. Instead we have to keep thinking about where the world’s going to be in the next five to ten years.

Final messages

Haddow: What would your final message be?

Hay: When the markets are most negative, often that’s where the best opportunity is. I think it’s about being patient.

Stobart: I would reiterate that, and that our process and philosophy won’t change.

McCombie: What can I add to that? Look, for the investors who have been in the fund for the last couple of years, they see disappointing performance. We’re very aware of that and know it will be unsettling. Believe me, we are working hard. We’re always working hard to try to do good things. But I’m not going to say we’re going to change what we’re doing. The right thing to do at points like this is to stick to our knitting. We think in the long run clients will be well rewarded for that.

Important information and risk factors

The views expressed in this article 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 July 2022 and has not been updated subsequently. It represents views held at the time of writing 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.

Custody of assets, particularly in emerging markets, involves a risk of loss if a custodian becomes insolvent or breaches duties of care.

The Fund invests in emerging markets where difficulties in dealing, settlement and custody could arise, resulting in a negative impact on the value of your investment.

The Fund’s share price can be volatile due to movements in the prices of the underlying holdings and the basis on which the Fund is priced.

This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research 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 article 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.

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