Monthly Income Fund: retirement income for the long term

The value of an investment in the Fund, and any income from it, can fall as well as rise. Capital at risk. Past performance is not a guide to future returns.

Amy Maxwell (AM): Hello and welcome to this live programme from Baillie Gifford. The latest in a series of webinars where we talk to the managers of the business’ different investment trusts and funds. Today, we’re talking to Steven Hay, comanager of the Baillie Gifford Monthly Income Fund.

My name is Amy Maxwell of Citywire and I’ll be talking to Steven about how he runs the fund for about 25 minutes. We’ll then be taking your questions, which you can submit at any time via the Q&A box. Welcome, Steven, thank you very much for joining me today.

Steven Hay (SH): Thank you, Amy. Nice to be here.

AM: To start with, let’s learn a little bit more about the fund because Baillie Gifford is predominantly known for growth equities. How do you turn this heritage on its head for income?

SH: I think that’s right. Many of the strategies here at Baillie Gifford are what you might class as accumulation strategies. They’re trying to grow clients’ capital as much as we can and no requirement for income at all. Those are often in the best growth companies that we can find globally, and the likes of Tesla will be the names associated with some of those strategies in the past. What we’re doing here is, we’ve got an income strategy. Those types of equities don’t pay any dividends or if they do pay any dividends, they’re small and they’re very unreliable, inconsistent. They’re just not suitable for an income strategy.

What we’re doing here is, we’re running monthly income. It’s a strategy that pays a monthly income to people that should be at an attractive level. We’re aiming to grow that income in line with inflation and, also, grow the capital in line with inflation. To do that, we need to have some equities in there and about a third of the portfolio is in equities, but they’re a different type of equity than in other Baillie Gifford portfolios. We actually have an equity income strategy here at Baillie Gifford and we call it Responsible Global Equity Income and that’s available separately. We use that fund within monthly income to provide the equities.

Those types of equities are the very well-known global stable companies. They pay an income that is typically higher than the index and very stable and consistent and reliable and looking to grow their dividends over time. That’s what the equities are doing. Then we balance that third in equities with a third in real assets. Property and infrastructure and about a third in fixed income. It’s using the combination of all these asset classes, allows us to give a really nice reliable monthly income.

AM: Is it fair to say then, the portfolio ends up looking pretty different to many of the other funds and trusts within the group?

SH: Yes, that’s absolutely right. First of all, because it’s got that mix of asset classes, that’s quite different. A lot of our strategies are equity only, but it’s having that income objective front of mind for investors. It’s all about how you deliver that monthly income in a reliable and consistent way that can grow that income over time. It needs quite a different mindset than that of a growth investor who is less concerned about the volatility and about any income that might be derived from the whole thing. Yes, it’s quite different.

AM: Let’s hone into the macro side of things because you’ve alluded to the fact that it’s very volatile. This is a marked change in climate for companies and governments to operate in. You used to be a Bank of England economist. So, you have a fair idea of the inflationary risk. Do you want to talk us through your view of the macro situation and how that’s really impacting income investing for retirement?

SH: I think for an income investor, some things really have changed and are different and some things are still the same. In terms of what’s different, we are seeing more volatility in markets. There’s more uncertainty about the geopolitical environment and one person, in particular, is responsible for that, but it’s not just him alone. I think it is the world order that we are now in is a bit different and that’s causing people to be a bit more uncertain about what’s happening. Some of that volatility can make it quite difficult for a retirement strategy. Where you’re really prising the certainty of that income over time. When markets are volatile that presents quite a challenge.

I think you’re also being presented with an economic situation where we’ve had a bout of inflation, significant bout of inflation. We’ve had yields move up significantly. We’ve got a broader set of opportunities for an income investor than we had for some period because cash is now viable. Cash pays a reasonable level of income and bonds are paying a much higher level of income than they were before. Whereas before you might have really struggled to think about how you could earn a stable income for the bond side or a high enough income, you’ve got more options there. There’re definitely more opportunities available, but a lot more uncertainty.

That’s probably the differences that are there. You’ve got the same old problem for an income investor and thinking hard about how you deliver that reliable income and what is your strategy with dealing with that uncertainty and generating the income. Do you prise the certainty and retreat into cash and safe bonds or do you try and stomach the volatility of the equity markets and have it all in an equity strategy which you cash out? These problems have been there before, but I think at the moment it’s probably even more obvious that those are difficult challenges. Our approach is definitely to be very fully invested in asset classes, but have a very diversified portfolio. That makes it easier to generate the reliable income.

I think it’s quite a good time to be an income investor because there are more opportunities. I don’t think you should be too scared of the volatility. Have the right approach, but the same old questions arise about how best to manage that.

AM: You talked there about safe bonds. I suppose if we’re looking at developed world economies now servicing huge debt burdens at higher interest rates, where are the safe bonds? Are they still with developed world governments or should we be looking to corporates and different areas there?

SH: I think you have to be pretty selective these days, increasingly so. You’re absolutely right, you’ve hit the nail on the head. What we’ve seen in the last few months has not been quite a Liz Truss moment in the US treasury market, but there’s been echoes of that. I think it’s now front of mind for-, I’m a fixed income investor by background and I think it is front of mind for bond investors that yes, do you remember that we used to have bond vigilantes who used to run the show? For 15, 20 years, they didn’t do anything. They had no power because there was very low inflation and there was QE, quantitative easing to buy bond supply.

That’s now gone. You’ve got higher inflation. You’ve got no QE. In fact, it’s gone into reverse. Who’s going to buy all these bonds out there? That’s been a bit of a problem. You saw only yesterday, the Bank of England announced they were going to start selling more short or the debt management office in the UK are going to sell some shorter dated bonds. Most of them rather than the longer dated because if people are buying the longer dated bonds, they want an additional yield premium. You’ve seen long dated bond yields rise in most of the developed markets. Japan’s actually led the show recently. It’s really been quite volatile. It’s probably changed the most.

Even in the US, you’ve seen that as well. Seen yields rising. So it’s a very valid question. Certainly, within our strategy, we haven’t had much in the developed market. Government bonds haven’t seen much attractiveness there. We’ve seen more attractiveness in the corporate landscape where you can buy corporates that are much more solid, we think, in terms of balance sheets and safety of that coupon. Also, in the emerging market world. I was just looking at the forecast for inflation for the developed world and the emerging market world. Usually, the emerging market world is a percentage point or two above the developed world. Actually, for this year, it’s forecast to be just below the developed world. So lower inflation, but higher growth and lower debt levels.
 
Overall, the emerging market world actually looks in quite a good relative position and yet, you get much higher yields in the emerging markets than you do in developed markets. If I could buy a US treasury, ten-year treasury for 4.5 per cent, I can buy a Mexican treasury for 8 per cent, 9 per cent and inflation’s lower. There’s definitely an attraction there. For some of our income needs in the strategy, that’s where we go. We do to a select middleclass of emerging markets where they’re very stable. The fundamental metrics are better than in developed world, but you get paid a higher yield for investing. Absolutely, I agree your point.

AM: We’ve just talked there, about the deficits being the risk and they’re coming home to roost in some respects. You also talked earlier about not being too scared of volatility. Of course, we’ve got the ongoing trade tariffs which are causing an immense amount of volatility. You also mentioned diversification as a way of mitigating that risk. Can you talk us a little bit more about how you would smooth that journey for investors?

SH: I think it’s very natural. One thing we hear a lot from investors is that they just want to stay in cash at the moment because it’s too uncertain. I think it’s a very understandable desire, especially if people are either approaching or in their retirement. The safety of cash is understandable, but for me I can see why that could be fine in the short-term, but a lot of people, they need their pension pots to keep working for them. They need to keep growing those pension pots because they’re not big enough. Actually, the challenge is how do you stay invested, but do so while having the comfort that your income is going to be nice and stable so you can get what you need in terms of the income for your retirement.

You’ve also got a collection of assets that should be relatively stable when there’s a lot of volatility out there. That’s exactly what we’re trying to do in this strategy. We’ve got nine different asset classes and broadly speaking, a third in equities, a third in different types of fixed income and a third in property and infrastructure or so-called real assets. The point of doing that is exactly that. To get the diversification. So, we’ve done a lot of modelling, historically, to look at what happens to one asset class during any kind of shock or volatility. We’re looking for asset classes that do other things during that time. You diversify away the risk and that’s how we ended up coming up with that mix of asset classes.

You see it’s much more stable, both in terms of the capital, but really importantly in terms of the income because you’re able to harvest the natural income from the portfolio and you’re not forced to sell any assets when markets are down. That’s a really important point. We lagged a little bit last year, in terms of performance because we don’t have a lot of the US tech names. They don’t pay much income, so they’re not part of this portfolio. We did lag a little bit last year, but you’ve seen this year-to-date, we’ve held in really well. Our fund’s been really resilient. Done well because it’s more stable and that’s because it’s the type of assets and the diversification we have in there.

AM: In your literature you define it as resilient income. You’ve mentioned that in practice that’s down to that nine different asset class mix. How often are you rebalancing that or how often are you looking at the individual line items and moving them around?

SH: We have a strategic asset allocation. That third, a third, a third I mentioned roughly. We do that every two years. We don’t do that every day. We’re looking just to capture the big strategic changes. That’s where we’re really focusing when we do that every two years, but we are very active in terms of thinking about how the portfolio should be changed at any point. Although we have a quarterly asset allocation process, we really discuss that every day around the desk. What should we be doing tactically? Is there an area that looks more attractive? We know that strategic won’t be the right asset allocation at all points, so we need to try and work out what the best one is.

We will be allocating actively away from that strategic asset allocation. For example, at moment we’re overweight property and infrastructure. That’s two areas we really like at the moment. That’s what we’ll be doing. What we’re trying to do here is, as I was saying, get a really resilient income that is growing in line with inflation. We think that’s what people want in their retirement and how do we achieve that? One of them’s diversification. Having lots of different asset classes is crucial to that. Different things are happening at different times and that’s also a global diversification. We’re not a UK based fund. We’ve many investments outside of the UK, very global.

It's the type of investments we’re looking for within each asset class. I talked a little bit earlier about the types of equities we would hold and more resilient, stable equities that pay a dividend and they’re not going to cut that dividend. It’s similar across all the asset classes. Within emerging market bonds, I mentioned we’re looking for that middleclass of emerging markets. The ones that are more stable. That’s what we’re looking for. Similar within property. We’re looking for those REITs that have a nice steady growing income, are not going to cut their dividend. That’s absolutely key. We’ve got bespoke directly invested portfolios within each asset class here at Baillie Gifford with teams looking at all these.

They’re investing and that’s really the key, I think, for resilience. Making sure that they know each underlying investment really, really well. An example would be, through COVID. We’ve got a high yield element to the portfolio. Around 10 per cent, 12 per cent of the portfolio’s been in high yield. Everybody was scared of high yield during COVID, not knowing which bonds would default. Which companies were going to be okay. We knew our companies really, really well and we had the absolute confidence that these guys are going to be okay. We can still hold this portfolio. Rather than some index holding in high yield where you wouldn’t know all the companies. That’s the kind of investment we’re doing.

We also spend a lot of time forecasting the econ income. So, we’ve got a very complex system to forecast the income across all the different asset classes so that we have the visibility on what that monthly income will be and we can tell our clients that.

AM: Is that in different scenarios as well? Stress testing for weaker.

SH: We do, do stress testing, yes. Absolutely, we have a stress testing-, twice a year we will do that for different environments. How the portfolio will perform and that can be really useful. What I was referring to was the forecasting of what our expectation is for income and it’s pretty accurate. The last thing on this one was that we did a massive stress test of this approach during COVID and we guide our clients that we wouldn’t expect our income to fall by more than 10 per cent in any one year. We know it’s not an annuity. We know it’s not guaranteed income. We are investing in a whole range of asset classes, but from talking to clients, that was the kind of level that was acceptable to them. Anything less than 10 per cent is not perfect, but it’s okay.

During COVID we saw UK equities dividends feel by over 50 per cent and yet, our income kept within those guidelines. So didn’t fall by more than 10 per cent. We felt that was a massive stress test of the approach. We feel confident to say we’ve demonstrated that this approach brings a resilient income.

AM: I suppose, you don’t actually need to do a rehearsal, the market has given you enough at the moment with these tariffs and COVID and Ukraine. There’s a lot going on.

SH: There’s always something to worry about. You find that everyone loves to worry about something and the challenge is sometimes, just to look through the noise and actually see what underlying of what is going on and try and avoid some of that noise.

AM: I notice in the Q1 update, you noticed a shift away from equity led returns. You’re pivoting more towards those real assets and bonds, which are showing more resilience. You mentioned the property is also via REITs. Maybe you could talk about some of the resilience of the bonds and the real assets and maybe some liquidity comments.

SH: That’s an important point. Our property and infrastructure is listed property and infrastructure. It’s not directly invested in private markets. It’s listed in REITs for property and in infrastructure companies. That’s an important point to note. Very liquid, no issues in liquidity whatsoever in the portfolio. I think I wouldn’t describe it as a pivot away from equities too much, but it was more a case of where do we feel really attracted to?  It was other areas then equities.  Our property and infrastructure specialists were really enthusiastic about the opportunities in both those sectors. It was that, rather than really not liking equities that was the driver for that. Equities were the lowest yielding part of the portfolio, but we expect them to be the fast growing.

So that’s the function it performs in the portfolio. We felt the valuations were maybe a little bit high. It was attracting us, whereas, the valuations in property and infrastructure were much cheaper. Those two asset classes had had a tough time over the last few years. They’ve suffered from interest rates going up. They’re a bit like bonds to some degree because the cashflows are quite reliable and long- dated. They suffered a bit like bonds suffered and they look pretty cheap. They haven’t really recovered from that yet. That was the attraction. Our specialist teams had found a collection of investments in these asset classes that they really liked. They’re doing really well, the market doesn’t like them at the moment, but we think they’re great.

So that’s something that we think we should add to. The infrastructure space, for example. It’s funny because in the utility space or in utilities within infrastructure, they might be seen as a bit dull and I think it’s probably fair to say they have been a bit dull over different periods in history. That’s why people like them because they pay 4 per cent to 5 per cent yield and the cashflows are very reliable. It’s almost like a bond. Some of them are inflation linked, a lot of them are inflation linked actually. There’s a lot to like from a retirement income point of view. Maybe a little bit on the dull side, but actually, the prospects if you pick the right ones are actually a bit more exciting than that. They have the nice dullness, but they also add-on some additional interesting features.

It's to do with the allowed investment. If an infrastructure company, a utility is allowed to invest more by its regulator, then it’s allowed to earn a higher return overall. That’s an attractive feature. If you find an area of utilities space that’s investing a lot and is allowed to invest, then that’s attractive. In the water industry in the UK and, also, some very negative press to do with Thames Water and that affected the whole sector to some degree. That was the opportunity for us. Seven Trent and United Utilities, much better run than Thames Water and yet, in that sweet spot of very reliable cashflows, but an opportunity to invest and get higher returns. That’s the example of something that’s attractive in that sector. Well run with a really good runway for growth.

AM: Digging beneath the headlines in a sector with headline risk. Doing your homework.

SH: That’s often the opportunity, yes, because people tar everything with the same brush. That’s often the opportunity to get in there if you know the companies really well.
 
AM: You’ve mentioned a couple of times throughout, that the fund is global in reach, but when it came to listed properties, the UK in particular, was looking attractive. Can we spend a couple of minutes understanding the investment case there?

SH: I think it’s the value opportunity we’ve been attracted to. It’s been a difficult few years adjusting to higher rates that I mentioned earlier. It’s in particular in the UK, but the discounts to net asset value that these REITs are pricing at is really attractive and the UK, probably the most attractive region globally. I just think there’s too much negativity priced in. These businesses are really well managed. Their leverage is well-controlled. The assets are marked to market regularly. Rents are growing. Balance sheets are strong, but yet you’re seeing the likes of-, I don’t know if you know Shaftsbury. Shaftsbury owns much of prime assets in London. It’s the best portfolio of assets there is really. Covent Garden, Carnaby Street. All this really prime real estate.

AM: Like playing a Monopoly board.

SH: Exactly that. It’s trading at 30 per cent discount to its net asset value where the mark to market value of the property is. It just feels way too cheap for us and we can get a 5.8 per cent yield on Shaftsbury. That’s a really attractive thing for us to be investing in, in the portfolio. Actually, it’s really interesting because you’re seeing a lot of the smaller REITs get taken out at the moment. There’s been a lot of M&A activity with private equity coming in.

The public markets are not as interested and these investments don’t seem to be paying what we think they’re worth, but the private market is. Private market’s coming in and they will correct over time. We’re very happy just sitting there holding that for the moment and we’ll see the market gradually correct. Property and in particular, the UK is probably one of our most interesting investments at the moment.

AM: On income distribution, you’ve indicated a 5 per cent increase in the fund’s income distribution for this calendar year. What is driving that growth and how sustainable is it in the current market environment?

SH: We’re trying to grow our income in line with inflation. UK inflation between 2 per cent and 3 per cent at the moment. We’d expect it at least that. To be fair, we’re actually catching up a little bit. We lagged the big burst of inflation, so we’re catching up with that. There’s a bit, our companies are just putting through price increases that are boosting their earnings. We’re seeing just good growth in earnings coming through the whole portfolio. Through the property and infrastructure space. We’re at 5 per cent earnings growth and dividend growth coming from all these investments. Within the fixed income side, there’s been a bit over the last few years of yields have risen and therefore, there’s a little bit of reinvestment coming in at higher yields.
 
That also has helped to boost the income a bit. Most of it is the natural income growth in the portfolio and absolutely, we think it’s sustainable. That’s what we’d expect to see over the years to come. That income growth beating inflation. Apart from the blip in inflation that we saw when it went very high for a year, that’s what we’ve seen every year.

AM: For investors nearing or in retirement, let’s discuss some implementation. What role can the Monthly Income Fund play in supporting their long-term income goals? Would you see it as a core solution or more of a complement within a wider portfolio?

SH: I think everyone’s got their own situation and own needs. For us, we see it as being a core solution for people. We see three key risks when you’re at that stage, looking at your retirement income. One of it is what’s known as sequencing risk and that’s when you have to sell assets to generate your income and you’ve got the risk that you have to sell when the market’s down. that can really affect the path of future returns as we call sequencing risk. That’s something that if your strategy is to have a portfolio of equities which you sell down to generate income, you’re running that risk. Especially when we see all the volatility in the markets at the moment.

That’s probably a bit more front of mind than maybe it was for periods in the past. That’s something that we avoid because we have a natural income being harvested from the portfolio. So, we don’t have to sell any assets at any point to generate the income. That’s one of the risks that we think we mitigate really well. Another risk is longevity risk, which simply put is a risk that your money runs out before you do. That’s a big fear for everybody and certainly, if you buy an annuity, I guess you know what that’s going to be, but you’re not making your assets work as hard as we think they should. You’ve got to be aware of sequencing risk, but you want to keep invested. You want to keep your assets working and generating a return for as long as you can.

That again, is what we’re doing here. We’re keeping our assets invested in what we think is an optimal mix of assets to give you that nice income. Currently, we yield about 4.4 per cent. So, looking to give that nice yield and growing that income over time and growing the capital. That helps alleviate as much as we think is prudent, that longevity risk. The third risk is the inflation risk. When we started the fund back in 2018, nobody bothered about inflation. Inflation has been low for decades, but actually, we all know inflation’s a bit higher or has been a bit more worrying. Inflation can be a really, really negative thing for your portfolio. If you have a nominal annuity, then inflation will just erode that significantly over time.

Over longer periods it really play out so, you need to be mindful of that inflation risk. Again, that’s directly in our objective, to keep pace with UK inflation. We’re very mindful of that. We know our equities should have pricing power and they should keep pace with inflation. Property infrastructure, they’re real assets, they should keep pace with inflation. Our fixed income is there to provide that higher income over time, to get ahead of inflation. There are different approaches to these things. We think our approach stacks up really well in terms of how we go about it. I would class it as a core solution and we’ve got a fee of only 50 basis points in this strategy. We think it’s value for money, as well as being a very good core solution for people.

AM: Very much a three-pronged approach there. We’ve got to the end of our interview part of the session and I’ve got an inbox full of questions here. Let’s use the remaining time to work through some of those. The first one, “How does your fund differ from Baillie Gifford Defensive Growth?” We mentioned that quite up top, didn’t we. Just a few pointers on the key differences.

SH: Defensive Growth is actually one of our multi-asset strategies. It’s actually quite similar to Monthly Income in terms of the fact it’s diversified across lots of different asset classes. The difference there is, it doesn’t have an income objective. It’s not looking to pay a high income. It’s got a volatility constraint. It’s a total return strategy with a volatility constraint and so, they would have a lower income than we would have. 

As I said before, I think it’s really important if you want an income, you have to really focus from an investment point of view. We we’ll be doing slightly different things on the investment side, to make sure that we’ve got enough income being generated in the portfolio. Overall, actually not that dissimilar in terms of what those two funds are doing.

AM: We’ve got a very functional question here. “What is the full name of the fund? Is it an OEIC or an investment trust?” I know there was a name change recently, maybe we could just clarify the full name and the structure so everybody knows what they’re dealing with.

SH: It’s Baillie Gifford Monthly Income. Nice and simple. It’s a UK OEIC.

AM: “Could we have some examples of infrastructure investments?”

SH: I mentioned the utilities earlier. We’ve got a number of utilities. Terna is another one. Terna manages the Italian electricity grid, the transmission grid. As you can imagine, there’s a lot of investment in the grid to try and connect renewables and make it fit for a greener future. Terna is allowed to invest a lot and to earn a higher return on that. it’s an example, a bit like the water companies earlier, where there’s a very nice steady set of cashflows, but more of an opportunity for growth than you maybe have had in the past. Not a dissimilar story, but in the US, we hold quite a lot of US utilities as well. Again, that’s about the build-out of the grid.

It's about data. The need to power data and use of AI, etcetera and energy demands. So, there’s a bit of generation going on with those utilities as well. These have all done really well over the last four to five months because people like the reliability of the cashflows. Especially when general equity markets are a bit wobbly. That’s where people like to feel nice and safe in the utility space. Probably at the racier end of our utility exposure would be Greencoat Wind. So, looking at the UK renewable sector. These are trusts which have been a bit unloved by the market and they’re paying a yield of about 8 per cent.

Something we think these are very reliable cashflows over many years and market is again, making a mistake by not pricing these higher. In the meantime, we’re happy just to pickup the income and see what happens. A variety of things in the infrastructure pace.

AM: This is a similar question tapping into those same themes, “Are you invested in energy companies that are at a discount that are paying high dividends?”

SH: No, renewable energy would be the only space we’d be in. We have a few holdings within our infrastructure space. NextEra is one in the US that’s in Florida. Power generation with a big renewable part to it. Then we have some in the UK which I mentioned, UK wind, Greencoat Wind. A few holdings in the renewable space and a bit of generation coming through in the US utilities, but not just energy companies on their own, no.

AM: There’s a question here on yield. “It was mentioned earlier that the income distribution will be 5 per cent higher than last year. Is that the fund’s yield?”

SH: This is a great question because it allows me to tackle one of these things that people tend to get confused about. I don’t think the investment industry does a great job of explaining it. Often people will look at-, if they’re interested in income, they will simply look at the yield in the strategy. Now, that tells you what your income is going to be when you buy it for the next year. Our yield at the moment is 4.4 per cent. If you invest 100, you will get 4.4 per cent income in that first year. What you really care about for your retirement income is what you’re going to get in year two, year three, year four, year five. What we’re about is growing that 4.4 per cent every year. We’re looking for that grow at least in line with UK inflation every year.

That 4.4 per cent should be up to 4.5 per cent, 4.6 per cent. The more the better. This year we’re looking at 5 per cent. Last year it was about 5 per cent growth as well. Whereas many strategies in the market, especially just a bond fund will show you a nice high yield and they’ll pay you that nice high yield the first year, but that will drop over time or at least drop in real terms. It won’t keep pace with inflation. You’ve got to be very careful. What you care about as an investor, is what income you get. The actual money you get in your pocket. That’s what you care about. Don’t look too much at the yield, but look at what income and what the income growth is likely to be for that strategy. 

That’s why we don’t hold all our money in high yield bonds. We could do that, but if we did, we would see our income decline in real terms over time.

That’s not what people want. They want to keep pace with inflation. That’s why we have to invest a third of it in equities because that’s the only way we can get the growth of that income coming through. Infrastructure and property can also grow the income, maybe a little bit less, but they can keep pace with inflation. That’s why we have that mix in order to grow that income over time.

AM: I imagine those holding period then, in order to generate that income are quite long.

SH: It should come through every year. We’re expecting 5 per cent every year, but typically we’re quite a long- term holder. Most of our investments, we don’t flip them. We’re looking to a be a long-term investor for many of these companies and many we’ve held for the five, six years of the strategy already. That’s typical, but what we’re looking to do is find companies and investments that we can rely on to pay that income. Whether it’s the coupon of the bond or the dividend in the company and just looking for, what we really don’t want in the strategy is dividend cuts. A company that’s in a really volatile sector or it’s badly managed. You’ll see dividend cuts and that’s what we don’t want.

That’s what our clients don’t want. Same with the bond. We don’t want bonds to have to default on their coupons. That’s the last thing we want. We want to be in nice stable companies or countries that are going to consistently pay their bonds, pay their coupons.

AM: There’s a two-pronged question here. “Many REITs and investment trusts, in general, are currently suffering from a significant discount. How do you mitigate this?” Then the second question is, “You mentioned nine different asset classes for diversification. Can you list them, please?” Let’s tackle the first one with the REITs and investment trusts and the discount.

SH: It’s not really for us to tackle in a sense. That’s just a fact they’re trading at a discount. I think for us, it’s not really a sustainable longer-term position. I think it comes about because you saw a lot of generalist investors come into the property sector a good number of years back. They’ve come out and haven’t gone back in again. The reaction to rates going up was quite negative in the property world. You did see REITs have a bad couple of years and I think that’s scared some people off. Generalist investors. We’ve got specialist investors who are involved in this all the time. I think it’s maybe a bit that generalist market hasn’t come back. What you’re seeing is that private equity is coming in and that’s now in the discounts.

They’re coming in and doing M&A and taking these REITs private. That’s the process that’s undergoing. It will probably be quite slow, but we’ll see these discounts narrow. In the meantime, we’re buying these assets that are generating a really nice rental income. There’s no concerns about the businesses, it’s simply the valuation of them. They’re generating a nice high rental income and that flows through to us. REITs have to pay out a high proportion of their rental income. We can effectively buy that rental income cheap. That’s a good situation for us. That’s something we’ve done. We have about 12 per cent of the portfolio in REITs.

On the second question, on the nine different asset classes. Equities, property, and infrastructure. That’s three. Then we have five different bond asset classes. Government bonds, investment grade corporates, high yield corporate bonds, emerging market local currency bonds. Issues in their own currency and then emerging market hard currency bonds, which is issued in dollars or euros. Then we have cash. That’s the nine different asset classes.

AM: Of course, within that there’s nothing in there to say unlisted securities or private equities. “What’s your exposure to unlisted securities/private equity?”

SH: Zero.

AM: Maybe some comments on why it’s not suitable for income generation.

SH: Look, it may be suitable. It’s not a real judgement on that. We just wanted this fund to be really simple and very liquid. We feel we have lots of opportunity to get exposure to enough growing income and resilient income. We don’t feel we need anything else from those sectors and we acknowledge that there’s less liquidity and it’s a bit more complicated. We want everything to be managed inhouse. We do our own ESG sustainability analysis on every investment. We know everything really well. That’s the reason why we stick to listed, daily dealt investments.

AM: You’re a comanager on this fund. “Who else manages the fund with you?”

SH: We have a representative from every asset class involved in the management of the strategy, but there are four of us that are on the portfolio construction group. It’s myself. It’s Lesley Dunn who is head of our credit teams. We have Nicoletta Demetriou, who looks after our infrastructure portfolio and we have Jon Stewart who looks after our property portfolio. So, it’s the four of us that make the decisions in the fund.

AM: You also run another fund, the managed fund. “How does the asset allocation compare between the two?”

SH: The managed fund is, as we were talking at the very beginning of our chat, is one of the accumulation strategies at Baillie Gifford. In some ways it dovetails into monthly income as you age. The managed fund is not only equities, it’s 75 per cent equities, 25 per cent bonds and cash and it can asset allocate between those. It’s managed in the sense of managing that overall exposure. The 75 per cent in equities is the biggest driver of that fund and there’s no income requirement on any of those equities. It’s much more about capital growth and wealth creation. Regional equity portfolios make up that 75 per cent. Then I look after the fixed income part and help to do the asset allocation with my comanager, Iain McCombie and we listen to all our regional equity managers and underlying fixed income managers when we do that asset allocation.

AM: There’s a few questions come in along the same theme, it is around inflation expectations over the medium-term, the next two to three years. You’ve got a history in fixed income. You worked at the Bank of England, so it feels like you’ve got a good handle on this. It’s going to be increasingly important, as you’ve mentioned throughout the webinar, that your strategy needs to outpace inflation. What’s your take on where it’s headed in the next two to three years?

SH: I’m actually fairly relaxed about inflation looking ahead. I think the immediate future, the next six to 12 months is always quite difficult to predict with a lot of accuracy. I think we’re seeing the underlying drivers of inflation be pretty contained and continuing to fall. There’s obviously a bit of a bump in the road with the tariff impact. Probably in the US, we’ll see a bit of a blip up in inflation s the tariffs come in, depending what level they’re at. That’ll just be a one-off impact that will come away again. I’m not worried about that, the central bank wouldn’t be worried about that because you’ll see it come back out the numbers in a year’s time.

The underlying trend for me and for inflation is I’m quite relaxed about it. It’s principally because of the use of AI. I think AI is going to transform the picture for inflation. A bit like what we saw in the 1990s with the advent of China coming into the global trading system. We effectively had a massive increase in global labour supply, which meant that labour markets weren’t as tight and you didn’t get as much wage inflation and you saw decades of disinflation. I think AI is a similar theme. What’s difficult to know is how quickly it plays out. My guess is that over the next two to three years we will see downward pressure on inflation from AI.

That doesn’t mean we’re necessarily going negative or anything, it just means downward pressure because if you think about it, in many jobs now, if they’re needing an extra person or somebody leaves, they will try and replace that person with AI and I think we’re already seeing that and the pace of development for AI models, I think we’ll see more of that to come. I’m actually pretty relaxed about inflation going forward. I do worry about it’s not all glory for bonds though because that would normally make you quite bullish on bonds, but I think there is a risk still on the fiscal side. I think long- dated bond yields may stay quite elevated because of the risks to do with high debt levels. It’s a double-edged sword.
 
AM: Staying at that shorter-end of the curve and staying diversified.

SH: Absolutely, staying diverse and staying away from those US treasuries and gilts and those things. Holding other types of bonds. As you say, maybe shorter-dated bonds will benefit more from the inflation angle if I’m right.

AM: That is all we’ve got time for. Thank you so much for your time. Thank you, Steven, for your time and insights and thank you for watching and for putting forward so many questions. We’ve more sessions like this coming up, so do keep an eye for those if you found today useful. Thank you everybody and goodbye.

Baillie Gifford Monthly Income Fund 

Annual past performance to 31 March each year (net%)

Source: FE, Revolution. Net of fees, total return in sterling.

*IA Mixed Investment 40-85% Shares Sector. 

Income distribution per unit to 31 March each year (pence)

Source: Baillie Gifford & Co.

Past performance is not a guide to future returns.

The Fund has no target. However you may wish to assess the performance of both income and capital against inflation (UK CPI) over a five-year period. In addition, the manager believes an appropriate performance comparison for this Fund is the Investment Association Mixed Investment 40-85% Shares Sector.

Important information and risk factors

The index data referenced herein is the property of one or more third party index provider(s) and is used under license. Such index providers accept no liability in connection with this document. For full details, see www.bailliegifford.com/legal.

This communication was produced and approved in May 2025 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

Investment markets can go down as well as up and market conditions can change rapidly. The value of an investment in the Fund, and any income from it, can fall as well as rise and investors may not get back the amount invested.

This communication does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority and is an Authorised Corporate Director of OEICs.

The specific risks associated with the Fund include:

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

• Market values for illiquid securities which are difficult to trade, or value less frequently than the Fund, such as holdings in weekly or monthly dealt funds, may not be readily available. There can be no assurance that any value assigned to them will reflect the price the Fund might receive upon their sale. In certain circumstances it can be difficult to buy or sell the Fund’s holdings and even small purchases or sales can cause their prices to move significantly, affecting the value of the Fund and the price of shares in the Fund.

• 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 has exposure to foreign currencies and changes in the rates of exchange will cause the value of any investment, and income from it, to fall as well as rise and you may not get back the amount invested.

• Bonds issued by companies and governments may be adversely affected by changes in interest rates, expectations of inflation and a decline in the creditworthiness of the bond issuer. The issuers of bonds in which the Fund invests, particularly in emerging markets, may not be able to pay the bond income as promised or could fail to repay the capital amount.

• Derivatives may be used to obtain, increase or reduce exposure to assets and may result in the Fund being leveraged. This may result in greater movements (down or up) in the price of shares in the Fund. It is not our intention that the use of derivatives will significantly alter the overall risk profile of the Fund.

• 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.

Further details of the risks associated with investing in the Fund can be found in the Key Investor Information Document, copies of which are available at www.bailliegifford.com, or the Prospectus which is available by calling Baillie Gifford on 0800 917 2112.