1. Why Do We Do What We Do?

    Emerging Market Investing

    Claire Gillies and Andrew Keiller. Third Quarter 2017.
  2. Investors should carefully consider the objectives, risks, charges and expenses of the fund before investing. This information and other information about the Fund can be found in the prospectus and summary prospectus. For a prospectus or summary prospectus please visit our website at https://usmutualfund.bailliegifford.com. Please carefully read the Fund’s prospectus and related documents before investing. Securities are offered through Baillie Gifford Funds Services LLC, an affiliate of Baillie Gifford Overseas Limited and a member of FINRA.

  3. Since we started running dedicated emerging markets (EM) portfolios in 1994, the philosophy underpinning what we do hasn’t changed. We’ve always been active, always focused on growth and never allowed ourselves to get bogged down in short-term earnings estimates or price targets. This has resulted in portfolios which are considerably different from much of the market, and has afforded us the support of a number of long-standing clients. Here, we revisit the evidence backing our investment philosophy: why do we invest in EM equities in the way that we do?
  4. Summary

     

     

     

     

  5. Being Selective

    Active investment may have had a less than favourable press of late, but it will come as no surprise to those who know us that we remain confident in our active philosophy. We would strongly suggest that EM equity is an asset class where active management works best and where having a dedicated EM manager makes sense. InterSec research has shown that within the active manager universe, dedicated EM managers have added more value through active management than the EM portion of international equity portfolios has over the last ten years1. 

    We warn against holding the index not just because passive investing forces investors to hold big companies which probably won’t exist in 20 years’ time, or because the EM index contains several state-controlled companies that do not have the dynamism that EM stocks are supposed to provide. In its simplest terms it’s because most ‘emerging markets’ don’t emerge. Being selective is critical, particularly now we are long past the China fuelled pan-EM boom.

    By definition, investing in EM means you are gaining exposure to the world’s fastest growth economies. But in truth, GDP growth doesn’t always lead to high stock market returns. Several studies over the years have examined this in detail2. Perhaps it is because GDP is an outdated and increasingly useless measure, but this is also the strongest argument for active investment in EM; you can’t hope that simply investing in a bunch of high growth economies will make you above average returns, in hard currency terms. Take Malaysia, for example, which has grown its GDP at an impressive 5.3% p.a. in US dollar terms over the last 20 years, and yet its stock market has contracted by 1.5% p.a. 

     

    GDP Growth versus Market Return Over 20 Years

    Source: IMF, Bloomberg and relevant underlying index provider(s). Data from 1996–2016.
    Past performance is not a guide to future returns.

     

    Further to this, you only have to look at the evolution of the largest EM companies over time to see the importance of being active. An investment in the four largest index positions in 1994 may have been fruitful in the short term. However, today, one has been delisted, another has lost the majority of its value, and the others have gone nowhere in share price terms. Disruption of the telecommunications industry, and the inability of State-Owned Enterprises (SOEs) to adapt successfully, would have left investors disappointed in the long run.

     

    Largest EM Companies by Market Cap

     

    SOEs are still around 27% of the EM universe by index weight and today, we still see large swathes of the market under threat. It’s true that emerging markets have a higher proportion of entrepreneur controlled companies versus developed markets, but SOEs have served to drag down the absolute returns investors have achieved through investing in EM as a whole. All the more reason to be selective. For those still unconvinced that active management is vital in EM, look at the make up of the index and its incumbents today. A number of long-term threats are apparent. Will internet finance eventually displace traditional banks? Can online networks (in both social and professional walks of life) leapfrog telcos? Will electric vehicle specialists and battery producers outdo traditional car companies?


    MSCI Emerging Markets as at 31 March 2017

     

    Source: MSCI.

    1 InterSec 2016 Year-End Investment Industry Report of the US Tax-Exempt Cross-Border Marketplace
    One of the most prominent examples comes from Jeremy Siegel, 1998 Stocks for the Long Run: http://www.riosmauricio.com/wp-content/uploads/2013/05/Siegel_Stocks-For-The-Long-Run.pdf

  6. Raison d’être

    The whole raison d’être of EM investment is to capture the growth premium relative to developed markets. Is this true?, we hear our value peers exclaim; in a universe where hard currency growth is actually relatively uncommon, is value not the safer approach?

    Underpinning our commitment to growth investing is the belief that, ultimately, those companies which can sustainably grow their earnings will be rewarded by the market. To evidence this we looked at different quintiles of earnings growth, in US dollars, over five-year periods in the EM universe. We found that in the last 20 years, the best quintile of earnings growers were rewarded, on a median basis, with a near doubling in share price.

    The relationship is striking and demands our full attention. It underlines the importance of having a process with an unwavering focus on finding these companies that can grow their earnings over the long term at double digit rates. If we can find these companies, our clients will be handsomely rewarded.

    But that’s not to say that it’s going to be a smooth ride. For the long-term EM investor focused primarily on individual companies, an active approach and resultant skewed portfolio, especially in a volatile market, certainly leads to periods of pain. We all know, over short time periods (by which we mean three years or less) share prices can readily detach themselves from operating fundamentals. A great example of this was in 2016. For instance, 86% of Brazilian companies outperformed the broader EM index, as did 77% of Russian companies. It didn’t matter which company you were invested in: if you were in the market at all, the chances are you did well. These markets weren’t driven by earnings; in this instance they were driven by economic and political factors.

     

    Median Absolute 5 Year Return by 5 Year Earnings Per Share Growth Quintile

    Source: Baillie Gifford & Co, Factset, Worldscope and relevant underlying index provider(s).
    MSCI Emerging Market and FTSE Emerging Market Indices constituents as of the end of December of each year between 1997 and 2016 and with a market capitalisation larger than time-adjusted USD1bn. Earnings growth rates are based on previous fiscal year data, all in USD.

     

  7. Staying the course

    At the individual company level, we took a look at strong performers in EM, defining those as companies which have delivered 20% p.a. total return in US dollar terms over a ten-year horizon; i.e. more than a six-fold return. We find that these highly successful companies were subject to rocky price trajectories, suffering an average maximum drawdown of 69% during the ten-year window. Clearly this is significant and gives some indication of the tolerance required of investors in order to access these substantial returns over the long term. Short-term discomfort comes with the territory. This figure, for EM strong performers, is also the most significant globally, on a regional basis.

     

    Average Maximum Drawdown During 10-Year Strong Performing Period

    Source: Baillie Gifford & Co, Factset, Worldscope, Datastream and relevant underlying index provider(s). Data from 31 December 1990 – 31 December 2016. Based on universe of global equities with market cap greater than $500m (historically adjusted) at start of period.

     

    Perhaps this begs the question, why EM? Can we access the same big returns elsewhere without having to tolerate such unease along the way? First of all, we observe that in the context of the average cumulative returns of strong performers over ten-year periods, i.e. more than 1,000% on average, compared to 69%, drawdown figures appear less significant. The second important observation is that the average cumulative return of an EM strong performer is, by some way, the largest on a regional basis.

     

    Asymmetry of Returns for Strong Performers (10 Years)

    Source: Baillie Gifford & Co, Factset, Worldscope, Datastream and relevant underlying index provider(s). Data from 31 December 1990 – 31 December 2016. Based on universe of global equities with market cap greater than $500m (historically adjusted) at start of period.

    Upside = total return, Downside = share price return

  8. The opportunity set

    Staying on the topic of strong performers for a moment longer, of course it’s not just the magnitude of returns available that’s important, but also the number of winners. Analysing strong performers globally, we see that an increasing proportion can be attributed to EM. For periods beginning in the early to mid ‘90s, strong performers were dominated by North America, and less than 10% could be attributed to markets outside North America and Europe. Now EM contributes more than half of the best returning companies globally. The evidence is compelling, that in seeking the best investment returns globally, EM cannot be overlooked.

     

    10 Year Strong Performers by Region

    Source: Baillie Gifford & Co, Factset, Worldscope and relevant underlying index provider(s). Based on universe of global equities with market cap greater than $500m (historically adjusted) at start of period.

  9. In today’s return environment, the need is as high as ever for equities to do the heavy portfolio lifting for our clients. EM equities specifically look very attractive, as long as the correct focus is maintained when investing in them. Our clients can be confident that in years to come we will still be working to the same principles that we do today. We will continue to invest in EM, we will be active, and we will be seeking to identify substantial growth opportunities with confidence that we, and our clients, will be rewarded over the long term.

    We believe that the chance of strong absolute returns from EM is significant on a long-term view, thanks to a number of strong businesses and improving macroeconomics for many countries. This is about a lot more than just high GDP growth, favourable demographics and rising middle class incomes as many might suggest. Many companies are displacing established peers and monopolising relatively new industries, whilst still growing at a rate well in excess of the broader market. EM investors are being given the opportunity to invest in companies that we believe will dominate in years to come, not just in their home markets but globally.
  10. 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.

    Any stock examples, or images, used in this document are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.

    As with all mutual funds, the value of an investment in the Fund could decline, so you could lose money. International investing involves special risks, which include changes in currency rates, foreign taxation and differences in auditing standards and securities regulations, political uncertainty and greater volatility. These risks are even greater when investing in emerging markets. Security prices in emerging markets can be significantly more volatile than in the more developed nations of the world, reflecting the greater uncertainties of investing in less established markets and economies.

    Currency risk includes the risk that the foreign currencies in which a Fund’s investments are traded, in which a Fund receives income, or in which a Fund has taken a position, will decline in value relative to the U.S. dollar. Hedging against a decline in the value of currency does not eliminate fluctuations in the prices of portfolio securities or prevent losses if the prices of such securities decline. In addition, hedging a foreign currency can have a negative effect on performance if the U.S. dollar declines in value relative to that currency, or if the currency hedging is otherwise ineffective.

    The most significant risks of an investment in The Emerging Markets Fund are Investment Style Risk, Growth Stock Risk, Long-Term Investment Strategy Risk, Geographic Focus Risk, Emerging Markets Risk, Asia Risk, Conflicts of Interest Risk, China Risk, Currency and Currency Hedging Risk, Equity Securities Risk, Focused Investment Risk, Frontier Markets Risk, Information Technology Risk, IPO Risk, Large Capitalization Securities Risk, Liquidity Risk, Market Disruption and Geopolitical Risk, Market Risk, Non-U.S. Investment Risk, Service Provider Risk, Settlement Risk, Small- and Medium-Capitalization Securities Risk. For more information about these and other risks of an investment in the Fund, see “Principal Investment Risks” and “Additional Investment Strategies” in the prospectus.

    The Emerging Markets Fund seeks capital appreciation. There can be no assurance, however, that the Fund will achieve its investment objective.

    The Fund is distributed by Baillie Gifford Funds Services LLC. Baillie Gifford Funds Services LLC is registered as a broker-dealer with the SEC, a member of FINRA and is an affiliate of Baillie Gifford Overseas Limited.

    Baillie Gifford has been managing dedicated Emerging Market portfolios since 1994 and launched the Baillie Gifford Emerging Markets Fund in 2003. This Fund follows the same philosophy and process as our other dedicated Emerging Market portfolios.

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    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.

    The Baillie Gifford Emerging Markets Fund (Share Class K)
    as at 31 March 2019

    Gross Expense Ratio 0.85%
    Net Expense Ratio 0.85%


    Source: Baillie Gifford & Co.

     

    Standardised Past Performance to 31 March 2019 (%)

      1 Year 3 Years 5 Years 10 Years
    The Baillie Gifford Emerging Markets Fund (Share Class K) -3.64 16.18 7.31 12.31
    MSCI Emerging markets Index -7.06 11.11 4.06 9.31


    Source: Bank of New York Mellon, MSCI. Net of fees, US dollars. Returns are based on the K share class from April 28, 2017. Prior to that date returns are calculated based on the oldest share class of the Fund adjusted to reflect the K share class fees where these fees are higher. The Fund is more concentrated than the MSCI Emerging Markets Index.

    The performance data quoted represents past performance and is no guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. For the most recent month-end performance please visit our website at www.bailliegifford.com/usmutualfund/emergingmarketsfund 

    The Baillie Gifford fund's performance shown assumes the reinvestment of dividend and capital gain distributions and is net of management fees and expenses. Returns for periods less than one year are not annualised. From time to time, certain fees and/or expenses have been voluntarily or contractually waived or reimbursed, which has resulted in higher returns. Without these waivers or reimbursements, the returns would have been lower. Voluntary waivers or reimbursements may be applied or discontinued at any time without notice. Only the Board of Trustees may modify or terminate contractual fee waivers or expense reimbursements. Fees and expenses apply to a continued investment in the funds. All fees are described in each fund's current prospectus.

    Expense Ratios: All mutual funds have expense ratios which represent what shareholders pay for operating expenses and management fees. Expense ratios are expressed as an annualized percentage of a fundís average net assets paid out in expenses. Expense ratio information is as of the Fundís current prospectus, as revised and supplemented from time to time.

    The MSCI Emerging Markets Index is a free float-adjusted market capitalization weighted index that is designed to measure equity market performance in the global emerging markets. This unmanaged index does not reflect fees and expenses and is not available for direct investment.

     

    Ref: 40562 USM WE 0030

  11. Claire Gillies

    Client Service Manager
    Claire graduated from the University of St Andrews with a BSc honours degree in Mathematics and Statistics in 2009. She joined Baillie Gifford the following year and spent six years as an analyst in the Investment Risk team before joining the Clients Department. Claire now works as a Client Service Manager and is a CFA Charterholder.
  12. Andrew Keiller

    Client Service Manager
    Andrew graduated from the University of Edinburgh with a first class honours degree in Mathematics and Business Studies (BSc) in 2011. Upon graduation, he joined Baillie Gifford as a Graduate Trainee and completed a two year programme of secondments across the firm. He now works as a Client Service Manager in the Emerging Markets client team. Andrew is a CFA Charterholder.