Legally bond: where our credit investors are finding underappreciated resilience
- Credit investors might be quick to dismiss unique business models
- In doing so, they could be missing out on opportunities – we recognise this and so take a different approach
- Rather than rushing to judgement, we believe that by looking closely at fundamentals we can deliver attractive returns
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.
The idea of judging a book by its cover is cautioned against in countless fables and works of popular fiction. When Elle Woods arrived at Harvard Law School, for example, everyone dismissed her. The glamorous lead character of the 2001 box-office hit Legally Blonde was judged as superficial by people who could not understand her and thus underestimated her talent.
Confronted with unusual business models, fixed income investors could fall into the same trap: jumping to conclusions about a company without considering it on its own merit. It can be easy to dismiss companies without giving them a fair chance. However, when we step back with an open mind and take time to explore the fundamentals, we can find some resilient business models and attractive opportunities.
Burford Capital and Veritext are two great examples. Their services contribute to the smooth running of the American legal system, giving them cash flows divorced from the ups and downs of the economic cycle.
Burford Capital is a litigation financing firm that funds cases for companies and law firms in return for a share of the eventual proceeds. It was initially dismissed by credit investors due to its novel business model which did not fit standard valuation approaches or sectors. But those investors overlooked a business with substantial scale, data-driven expertise and a human capital edge. Moreover, they missed a leading company revolutionising a sleepy industry and developing a new asset class with double-digit annual growth.
Strong demand allowed Burford to attract high-quality clients and use its legal expertise to pick winning cases. The company’s track record speaks for itself. It wins 91 per cent of the cases it funds, achieving, on average, an 88 per cent return on invested capital. Importantly for fixed income investors, this has led to substantial growth in cash flow.
At its core, this is a durable business model with cash flow generation uncorrelated to the business cycle. Burford’s management compares a case to a conveyor belt: once it has started it will progress regardless of what interest rates do. Indeed, the business model is arguably countercyclical, as economic downturns are correlated to bad decision making, which often drives an increase in litigation.
With its solid cash flow and appropriate leverage, the company represented a compelling investment idea for our credit portfolios yielding high single digits. Having invested in bonds of Burford Capital since March 2021, we looked for more exciting opportunities in what could be dismissed as a ‘boring’ sector.
That’s how we found Veritext, a niche business that brings scale and efficiency into a staid corner of the North American legal system. In the pre-trial phase, all legal testimony must be taken under oath by an ‘officiant’, recorded and transcribed. This service is often provided by tiny ‘mom and pop’ court reporting agencies. In that environment, Veritext’s strategy of acquiring competitors allowed the company to offer size and simplicity to its clients, and to embed itself into the infrastructure of the US legal system – all the while offering a 9 per cent yield.
Similarly to Burford Capital, Veritext’s business model defies the business cycle. This is demonstrated by its achievement of double-digit revenue growth during the global financial crisis. However, like many service companies, Veritext is exposed to disruptive technologies like AI. As long-term bond investors, we are looking for sustainable income, not short-term yield, so we need to ensure the company is innovating to keep pace with evolving technology.
Veritext’s management team has a good track record of anticipating change. The investment it made during the last decade in remote and digital testimony technology proved to be particularly beneficial in the face of restrictions imposed during the Covid-19 pandemic. Now, Veritext is already future-proofing its business model, developing its AI capabilities to help with transcribing depositions.
In current markets with uncertainty over economic growth, it is increasingly important to find companies that can generate solid cash flows whatever path the economy takes. Our investment process allows us to dedicate time to understanding niche business models with underappreciated sources of resilience, which should help us to meet this challenge.
Like attending Harvard, looking beyond established business models isn’t easy. But just as Elle defied stereotypes in Legally Blonde and proved the doubters wrong, we believe that our open-minded approach to investing in companies that break the mould will deliver durable income for our clients.
look to the future.
Not the past.
Risk Factors and Important Information
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 November 2023 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.
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”). 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.
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.
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 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: 75126 10040211